Stable Policies deliver Stable banks

In my earlier articles,  I discussed the section 35 RBI inspection and about the risk from the imperfect system of delegation of financial powers within the organisation. On the same dimension, this article discusses the need of stable management policies so as to reduce the operational risk.

We notice that highlights of annual results of banks reflect unusual accounting practice of additional provisions, carry back etc. This practice exposes their imperfect systems, inconsistent practices and absence of long term policies. 

Those briefings to press according to me,  hide other significant achievements of the bank. If you look at IBA data on banks for three years (say 2017-19),  you can understand that the Assets and Operating results of banks have grown steadily while their net result appears like random numbers. Perhaps it signifies that there are some more tasks in the boardroom to be completed. One among them is the long term policies covering every aspect that lead to profit generation and risk management.

Thus, the random numbers as net result indicate that banks apply their discretion to decide their net result. The logic behind such decisions is not  applied evenly among all banks or every year for a particular bank. Therefore comparing these figures of net result may not lead analysts to sensible inferences. Roving young journalists using their professional liberty frame news that are not music to bankers ears.

While analysing performance of top ten banks of India, for my book ‘Banking India’,  I did not reckon Netprofit as an indicator of  performance. According to me, the operating result is the end result of the activities of all employees, while net profit is a number coming from the discretions  of a few. 

Two important observations before we move forward on the topic are 

1. The discretion to make more provision for assets, in effect are overbearing of all practices and policies. 

2. When some data cannot be used ‘as it is’ for analysis, the organisation loses the benefit of statistical predictions and strategy formulation. 

Net result is a valuable data,  no doubt

Net result or net profit is a very commonly understood term to indicate profitability of an enterprise. A continuous fall in the net result or inconsistent rise in net result indicate threat for the continuance of the enterprise or it indicates the challenge in front of the management for reorganisation, reengineering of the whole organisation or a change of the business model. If that data has to be relied upon for strategy formulation, the process of arriving at the figure must overcome the damage caused by discretions. This can be managed with the help of stable policies with following features:  

• Allow major changes very rarely

• Review regularly not occasionally

A typical bank 

Let me take forward this discussion as applicable to a typical bank with an organisation structure consisting of a Chief Executive Officer, (a member of the Board of Directors) who is supported by a Chief Financial Officer, a Chief Credit Officer and a Chief Development Officer. Of course, the Business heads are allowed to operate independently and report performance to the CEO. The CFO directs investment assets, the CCO directs the loan assets portfolio and the CDO controls all Fixed assets both tangible  and intangible and human resources (employees).

Alternatively, we assume that the incumbent CFO, CCO and CDO  manages investment risk, credit risk and operational risk respectively. They roll out policies relating to retail and wholesale business.

Chief Financial Officer

He apprises the CEO about ‘Profit,  Profitability and Risk associated with Investments and on the substantive value of assets. 

INVESTMENT

The policy on investments is based primarily on Govt and RBI guidelines and then on continuous profit generation at the lowest cost. It must be comprehensive and cover the following (illustratively)

• rules and regulations on opening and operating bank accounts with other banks and RBI, 

• method of   allocation of  investments in various portfolios of investments for sale or retain or write off. 

• the ceiling on overnight minimum maximum reserve level, method of revaluation. 

Investments hinge on market risk and decisions are very time sensitive. The more details the policy has, the lesser individual discretion it allows.

PROFIT 

Net result or net profit is arrived by deducting provisions and transfer to various reserve funds. A consistent system of regular provisioning, makes the data on net result comparable with other banks and within the bank with data of earlier years.

Practices such as partial provisioning, downsizing of balance sheets by setting off assets with provisions, moving assets as off balance sheet items, etc need a fresh re-look. A major revamp of book keeping by banks even though is overdue, currently, the consistency in the provision policies can be managed so as to provide sensible data for analysis and for future strategy planning. 

Bank policies on profit management have to follow RBI guidelines and govt notifications while drafting the following:

• Interest rate policy – RBI

• Risk management policy- RBI

• Audit policy- RBI

• Licencing policy – govt (specifically,  compulsory branch expansion,  restricted area specific expansion etc., and licensing policy for setting up substitutes of banking like non banking, treasury n post office banking, app based banking etc.) 

Chief Credit Officer

He organises the main function of banking – credit for economic growth. Correct deployment of funds gets rewarded in the form of 

• growth in the number of (self confident) entrepreneurs instead of a labour market flooded with children graduated from schools and universities. 

• Optimum cash circulation by  recovery of loans

• Higher Net Interest Margin. 

LOANS

Banks loan policy must help in identification of borrowers, right level of margin requirements, and best possible risk transmission and burden of interest on  borrowers. It must include the scheme of imparting training to field officers that helps them take smart decisions in 

• selection of borrowers, 

• approving right  amount  of funding

• customising easy terms and conditions 

• release of funds at right time, 

• covering risk externally by insurance 

• scheduling repayments flexibly

Among other common contents are risk rating, categorising various borrowers, deployment of funds for regional growth,  liaison with local govt, MIS reporting, vigilance, inspection audit,  insurance,  documentation management, etc.

Chief Development Officer

His job has the variety, ambiguity, people management and unique relevance. Therefore the more brainstorming is done while preparing the policies, the more comprehensive the policies will become.  There is ample scope for performance and innovation.

HUMAN RESOURCES

In the personnel area,  the HR policy cover the following:

• Recruitment,  training, placement,  promotion, career progression, retirement,  suspension from service,  vigilance, dismissal 

• Wage, incentive, penalties, grievance

• Labour union, labour laws

• Third party entities such as lawyers,  engineers,  chartered accountants etc (not in employment but empanelled as a resource )

(More detailed area for HR policy can be an interesting brainstorming task.) 

PREMISES AND FIXED ASSETS

Personnel matters occupy more time of the CDO than Fixed Assets. But if things are not in a perfect position, litigation can be a vast area of operational risk. 

The policy on Fixed Assets,  Premises and  Intangibles covers the following: 

• Items that  can be purchased centrally and locally including stationery, IT products,  AMC etc..

• The purchase procedure considering govt guidelines,  as applicable

• Insuring the assets under various risks

• Renewing licenses,  leases,  registration etc.,  in respect of those assets tangible or intangible. 

Often,bankers are jolted by  fraudulence, litigation and mismanagement of employees, customers and investors. All these can be managed by perfecting systems founded on ample stable policies. 

I have discussed briefly the importance of policy guidelines for improving indian banking system. They are like vitamins, absence of it calls for concern. I tried to make it short. I therefore welcome queries from readers for better comprehension.