The underwhelming scenario of Indian banking – A discussion on the DFS

In a recent ( 21st September 2020) paper titled “Indian banks: a Time to Reform”, authors Viral V Acharya and Raghuram G Rajan mention that “the winding down Department of Financial Services in the Ministry of Finance is essential, both as an affirmative signal of the intent to grant bank boards and management independence and as a commitment not to engage in ‘mission creep’ when compulsions arise to use banks for serving costly social or political objectives”.  By using the word ‘mission creep’, the authors have highlighted the tendency of the DFS becoming unintentionally wider in scope than its initial objectives. Both of them are US economists having the right experience and exposure on Indian affairs particularly from close quarters while serving the RBI and the government.

More or less the same observation has been made by me in “Banking India – accepting deposits for the purpose of lending” published in 2017 in the chapter titled ‘the underwhelming scenario’ of Indian banking.  Compared to authors’ views based on their experience from the top, my views in the book are based on my own three decades of far and wide operational experience in commercial banks as well as in Reserve Bank of India.  The underwhelming scenario in which Indian banks operate, emerges from a style of functioning that is a mixture of the legacy of the British rule and our country’s functioning democracy. The underwhelming scenario includes not only the DFS, but also others such as RBI, Judiciary, Indian Banks Association, Foreign Exchange Dealers Association of India (FEDAI), State level Bankers Committee, and Central Vigilance Commission. Here the discussion is on the role of DFS available from the annual report of the Ministry of Finance 2019-20.

Department of Financial Services (DFS)

The DFS is one among the five departments that constitutes the Ministry of Finance of the Government of India and mainly engages in appointments, funding, strategic planning and even in operational management of banks. 

Appointments:

The DFS appoints Deputy Governors and Governor of Reserve Bank of India, Chairman and MDs of SBI, CMDs and EDs of Nationalised banks, Boards of Directors of RBI and PSBs. It also appoints CMDs and directors of NABARD and chairman of RRBs. It makes Board level appointments of IIFCL, EXIM, IFCI and handles personnel matters relating to whole time directors in SIDBI and NHB.  They fill up posts of Chairperson, Presiding Officers etc., of Debt Recovery Tribunals and its appellate DRATs. The DFS also appoints the Registrar/ MD & CEO of CERSAI, that maintains the database of securities mortgaged to banks.

What we need to understand from the above is their potential to remove the incumbents who might no longer see eye to eye with the DFS. From that position of influence, the DFS controls the functioning of public sector banks and their regulator. By making appointments for other institutions such as NABARD, SIDBI, EXIM Bank, IIFCL, DRTs, CERSAI etc, the DFS takes on itself the responsibility for the flow of credit to agriculture and allied sectors, industries, (MSME), international trade, Infrastructure projects, home loans etc. 

Human resources

Pay and perquisites approved by the DFS after Indian Banks Association negotiates the wage settlement with labour unions of banks, becomes the industry standard for bank jobs. The labour unions for both private and public sector banks are common. Thanks to this arrangement, CEOs of banks are relieved from a major HRM responsibility. 

Operations

The DFS has a say in ‘what to sell, where to sell and how to sell bank products. The recently popularised products such as ‘PM Jandhan Yojana’ and ‘Stand up India scheme Mudra loans’ etc, are examples of ‘what to sell’ products designed by the DFS. Similarly, the bank and branch licencing policy, as approved by the DFS though implemented by RBI, decides on the operational area which is illustrative of DFS guidelines on ‘where to sell’ bank products. The grievance mechanism of the DFS to monitor customer service in banks becomes the benchmark for the quality of customer service or how to sell bank products.

Funding: 

Thus, the DFS, having a major say in the leadership and operations of commercial banks, is also involved in providing capital to PSBs and other institutions having a pivotal role in banking.

Recapitalisation:

The annual report mentions that during the last 6 years, public sector banks were ‘recapitalised to the tune of 4.07 lakh crore since March 2014’. This is a significant amount, even though these banks return a major chunk of the sum by subscribing to government bonds, available as the statutory liquidity ratio (SLR) instruments. When we look at the deposit growth more or less during the same period, we find that (between March 2014 and December 2019), the deposits in PSBs grew by 16.05 lakh crore (trillion). The PSBs would have invested additionally a sum of 3.05 trillion rupees in government bonds, out of a sum of 4.07 trillion rupees received in the form of recapitalisation.

Risk weight

Another interesting DFS decision mentioned in the report is about alteration in risk weight on consumer loans. Any change in risk weight alters the total value of the Risk weighted Assets (RWA) upon which the capital adequacy ratio of banks is worked out.  Therefore, the reduction in the risk weight of consumer loans other than credit cards, results in lesser need for recapitalisation funds for the PSBs and that gives relief to the DFS.

Other govt institutions

Further, the DFS also decides on the annual allocation of funds to government owned National Bank for Agriculture and Rural Development (NABARD) meant for onward lending to cooperative banks and regional rural banks that are primarily engaged in financing agriculture and allied activities. Another institution, owned and funded by the government, called Exim bank provides financial assistance to exporters and importers and coordinates all institutions engaged in financing export and import. There are other institutions of similar kind such as India Infrastructure Finance Company ltd., engaged in infrastructure finance, National Housing bank engaged indirectly in-home loan sector by providing subsidies and SIDBI engaged in financing indirectly loans in micro enterprises, small enterprises and medium enterprises (MSME), receiving funds from the DFS. 

Strategic level Management

Supervision

Let us move to some of the accomplishments mentioned in the Annual report which can be described more as part of strategic planning in respect of banks. A PSB reforms agenda called EASE covering ‘governance, prudential lending risk management technology and data driven banking and outcome centric HR’ was introduced from January 2018. This appears as something which fits into the job of a supervisor. As regards Indian banks, the RBI carries out their off-site and on-site supervision and follows up with quarterly meetings with individual CEOs and monitorable action plans.

Merger and Acquisition

Another achievement mentioned in the report is related to the merger of ten PSBs into four to ‘enable investments in technology, better customer reach, wider array of products and services, enhanced lending capacity and operating efficiency’. Mergers and Acquisitions are common in business and they are considered as strategies for growth and enhancing profitability. It would not have been exceptional had these mergers been initiated by CEOs of individual banks rather than brokered by the DFS.

The report also mentions various measures to ‘facilitate and incentivise lending’. That includes reduction of interest rates, introduction of schemes for restructuring of loans, direction to enhance loans by 25 % on working capital limits to MSMEs and a few platforms for discounting, loan approvals, etc.  All these are strategic planning measures that should have been initiated by the CEOs of banks to sustain the crisis the pandemic has brought to all. 

Further, the report says that ‘the insurance coverage of depositors in insured banks has been increased from one lakh to 5 lakh per depositor’. This deposit guarantee limit is a lure for savers and a selling point for banks. Neither in private nor in public sector, a bank has been allowed to go for liquidation in the recent past. Therefore, the commercial sense of the decision will be on the collection of additional premia if any by the DICGC from individual banks partially resulting in cash flow from PSBs to the DICGC, both under DFS. Had the DICGC been in the private sector and the ceiling differed from bank to bank on the basis of premia, this initiative could have been magnificent.

Operational level Management 

While most of the above have been related to strategic planning to be initiated by CEOs of individual banks, here are some initiatives taken by the DFS that can be viewed as operational management. According to the report, ‘The result of the consistent and coordinated efforts of the government in respect of FI related interventions in the country is reflected in terms of 37.83 crore Jan Dhan accounts opened till 1-1-2020 under PMJDY, with a deposit balance of over Rs.110,161 crore’. Looking for a commercial sense, this deposit growth of 1.10 trillion rupees forms part of 40.76 trillion rupees recorded by commercial banks since 2014. 

Further the report speaks about a mobile application Jan Dhan Darshak, ‘launched in 2018 to provide a citizen centric platform for locating banking touch points such as bank branches, ATMs, Bank Mitras, Post Offices etc.in the country’. This is a job which private start-ups do since the data is available in the public domain. 

Conclusion

Both on the strategic level and operational level, the DFS is involved in the management of banks. In order to accomplish a task, either we engage ourselves directly or indirectly or delegate it to the right person. If that person is found wanting, we are forced to plunge. The point that I am trying to make here at the end of this discussion, is about the probable reason for stretching their role by the DFS. You would have guessed it. It may be the shortcomings on the part of the CEOs and the Board of directors in delivering the expected results.

The option to save the DFS and Indian banks from criticism lies in understanding the importance of good corporate governance and putting professional Boards of Directors distinguishable by their proper concern for tasks and respect for other directors and their views.

References:

1. Govt of India, Ministry of Finance – Annual report 2019-20
2. Indian Banks: A time to Reform by Viral Acharya and Raghuram G Rajan (21st Sep 2020)
3. Banking India: Harihara Krishnan (2017)