The lady on the street implicitly trusts public sector banks (PSBs) for their sarkari parentage and presumes her deposits are safe, since a bank owned by the government will not be allowed to go under and cause any loss to the public in any eventuality. That may be true in respect of the fixed deposits and savings accounts but may not extend to money raised through different type of bonds, which banks are increasingly issuing and which many a middleclass housewife is investing in as the deposit rates have declined.
The way the YES Bank's Additional Tier-1 (AT-1) bonds were dealt with in the recapitalisation exercise and the case of LVB (Lakshmi Vilas Bank), which involved a merger by a government fiat, are examples of how all forms of investment in banks are not treated alike. There could be legal distinctions in a case like AT-1 bonds; but that is not the purpose of raising it here.
The short point is that even in the case of PSBs there is no definite position that, in a crisis, the government would rescue bond-holders, even if they are part of the general public. To that extent, the implicit sovereign guarantee is not a given, and public awareness about the true financial and solvency position of the entity is not only relevant but critical as well.
Therefore, even PSBs have an obligation to be scrupulously diligent in the way the business performance and financial information are presented. The public needs to know whether as direct investors or as investors through mutual funds, the real worth of the PSBs. Are the PSBs' annual reports and information available in public domain trust worthy and representative of its true state of affairs?
If one were to consider the case of Union Bank of India, it would appear that the annual report drapes a char-woman and presents her as Cinderella!!
So, what is this discovery? How valid is a statement that the annual report, which is a legal document prepared as required under relevant laws cannot be trusted, when the same bears the signature of a host of directors and officers of the bank, and the seal of sanctity of true and fair affixed by not one, but a group of six statutory auditors, who swear allegiance to the discipline of none less than the ICAI (Institute of Chartered Accountants of India)?
This is a journey worth the time and effort for any professional or public-spirited person and the burden has been lightened by the tireless efforts of Girish Mittal, who has steadfastly pursued the task of getting the bank inspection reports in the possession of Reserve Bank of India (RBI) through the Right to Information (RTI) Act. One such report shared by RBI is that of Union Bank of India for the period 2015-16. Although dated, it is worth an analysis.
Thanks to the availability of the bank inspection report and the annual report for the same period, it becomes relatively straightforward to look at disclosures in the latter and the observations and findings in the former, and be amazed at the extent of differences and discrepancies.
It cannot lie in the mouth of any professional worth her salt to pretend that the respective reports have different spheres to occupy or roles to perform. The annual report, in its summation of the directors’ report, financial statements, the auditors report and the notes that are provided as explanation to the financials, cannot leave out anything of salience that touches on any part of the business or operations.
The inspection report of RBI doesn’t concern itself on the hygiene levels in the toilets or the quality of food served in the canteen if any, but on the core operations of the bank!
Like Schrodinger’s cat, that appears both dead and alive at the same time, depending on who sees it and from what perspective. Union Bank is presented as a veritable piece of delicious cheese in the annual report and as a fistful of nauseating chalk powder by RBI inspectors!
In order not to disappoint anyone keen and diligent to test the truth of the assertion made here, the reports are attached and made accessible along with this article. The annual report sings paeans to the exemplary functioning of management and lists out an awesome clutch of awards secured in almost every conceivable area of the Bank’s functioning!
It is those very areas of risk management, information technology (IT) security, human resources (HR), digital banking where Golden Peacocks and what not were showered on the Bank, the RBI inspectors have found not just gaps but yawning moats of lapses, inefficiencies, non-compliance, and total callousness to recognise the problems and demonstrate an intent to improve!
Thankfully, the chief executive officer (CEO) of the Bank was not decorated with the entrepreneur of the year award that many a media house or professional firms’ shower!
The list is long and leaves out no area of the Bank as outside the perimeter of mismanagement and maladministration. The worst is the total lack of diligence and commitment at the level of the board of directors to acknowledge that the Bank is a tinderbox and very many children were roaming in the vicinity with lighted matchsticks!
The annual report gives the total number of meetings held by the board and its various committees and it is a recommended exercise for someone diligent to compare with other banks and check if some of those, or all of them are typographical errors. The chairman could not have done anything other than attend meetings, going by the number presented!
The key question is, What was done and discussed in those and how did the minutes not capture the issues, resolutions, actions and follow-up? The inspection report has slammed the management of not having any semblance of risk management, succession plan for key positions, IT security, review of frauds and ballooning bad loans, just to annotate a few as the list is like lord Hanuman’s tail!
Internal audit was found to be grossly inadequate and even what little was done and reported by them was not dealt with by the concerned departments and over 300 internal audit reports are said to have piled up for disposal!
One of the key risk areas being cyber and IT security was found to be seriously impaired in terms of control and checks and even the basic-level password controls were not found.
Know your customer (KYC) process was standing out by its absence!!
Overseas operations, being out of sight, had very little focus at the board level and the Bank had little in terms of policy to address recruitment needs at the senior level and manage staff rotation, which is very critical in banking industry.
Lack of separation of front and mid office in treasury management, ad hoc way of dealing with large bad accounts and spiraling increase of 257% in frauds, embellished what comes out as a quality of management that even a pawn-broker in Pydhonie will be ashamed of!
The board and the risk management committee failed to lay down proper polices for asset liability management, an area that is the fulcrum of financial services business and the Bank was juggling liquidity with chunks of 14-day deposits, almost like a ponzi scheme. Anything more on the subject will test the patience and sanity of the readers!!
The annual report which found mention earlier for the glowing board comments, also brings out the aspect of the statutory audit. That six firms from different parts of the country could, in their professional judgement, give a clean report speaks volumes about the need for and the efficacy of external audits in banks!
As RBI often looks to auditors to solve all problems in the financial sector, this should be a benchmark for them to frame their future policies!
One cannot fathom the role played by the directors, especially, the shareholder directors and the two representatives, one each of RBI and the Central government!
They have, indeed, attended the meetings as shown in the annual report. If they knew of the problems and yet stayed on, they are guilty of abetment; if they didn’t know what was happening in the Bank then they, like the statutory auditors, are guilty of surviving like stowaways!!
In summary, RBI cannot escape the direct responsibility of failing to address such issues in a bank that handled almost Rs2.5 lakh crore of public deposits at the relevant point in time. The need of the hour is to divest RBI of the supervisory role it plays and limit it to framing the regulations only.
A new statutory body should be formed, partially with existing resources from RBI, to become the agency to appoint, supervise, direct the audit process, and jointly work with accredited chartered accountant (CA) firms to report on all PSBs. This body, over time, shall cover the entire financial services (FS) spectrum as the watch dog. The focus of audit shall change to fraud detection than mere clerical verification transactions and observance of accounting guidelines. The body shall function under the aegis of the Comptroller and Auditor General (CAG) of the country.
The adoption and reliance on technology to completely eliminate discretion in provisioning and categorisation of non-performing loans is critical so that the capital adequacy checks are uniform across all banks and complete uniformity and comparability exists across the industry. The role of the board shall be to apply risk mitigation processes and focus on talent augmentation and create the right succession plans for all key roles in the organisation.
It is vital that the alarm bells go off in the corridors of RBI and the finance ministry to course correct on a war footing and not disappoint crores of savers in the country who depend on these banks.
Note: I thank my friend and senior professional R Raman (FCA) for his insightful inputs about bank audits.
Here is the RBI's inspection report for FY2015-16...
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(The author is a CA and CS and retired as a partner at EY, Chennai heading tax and regulatory advice.