Co-op banks, audit firms and HFCs: All victims of ineffective supervision

Gaps in the regulatory system exist because the body tasked with overseeing them is toothless, or there is confusion about who oversees certain firms, or regulators simply don't exist in some cases

The liquidity crisis in housing finance companies, the spate of resignations by audit firms who fear being banned, and a diktat by the Uttar Pradesh government looking to merge all co-operative banks that it controls.

These seemingly unconnected events taking place in India’s financial sector ecosystem have something in common. They are all the result of gaps in the regulatory system, either because the body supposed to be overseeing them is toothless, or there is confusion about who oversees certain firms, or because in some cases, regulators simply don’t exist.

Crumbling co-op banks

Take the case of Uttar Pradesh, where Chief Minister Yogi Adityanath has raised concerns over rising non-performing assets (NPAs) and poor loan recovery rates in the state's co-operative banks.

Till September 2018, their NPAs stood at Rs 2,512 crore or 18.59 per cent, which is more than twice the state banking sector average of 8.75 per cent in the state. In fact, his government has already proposed merging all government-controlled co-operative banks into a single entity for better management, efficiency and credit growth. The merger proposal covers UP Co-operative Bank (UPCB), UP Sahkari Gram Vikas Bank (UPSGVB) and 50 district co-operative banks (DCBs).

Co-operative banks spread across multiple states come under the purview of the Reserve Bank of India. However, the central bank does not have much say over single-state co-operative lenders, and that is where a regulatory black hole is created. Sector experts say that co-operative banks have become a cesspool of local and state-level political corruption.

“Every co-operative bank belongs to some politician or the other. The question to be asked is do we need co-operative banks,” said R Balakrishnan, financial advisor and a founding member of Crisil. “Today when you have state-owned banks reaching everywhere, there are micro-finance companies, there is no need for co-operative banks. These are nothing but political tools and hence state governments will never let go of them.” 

However, former RBI deputy governor H R Khan disagrees with the contention that co-operative banks don’t serve a purpose. “Yes, they are more vulnerable to corruption, and a majority of them are not doing well. But the whole idea should be to do some consolidation and ranking of such banks, upgrade them and insulate them from political interference. There are models of efficient co-operative banks. We should not totally give up on co-operatives,” Khan said.

Audit firms: better safe than sorry

Then there is the issue of audit firms. As per an article in Forbes India, since January this year, seven auditors have resigned from listed firms. But last year touched a peak, when 69 auditing firms resigned, without stating any reason for the same.

Such resignations are now commonplace as auditors fear being barred. In January last year, the Securities and Exchange Board of India barred PwC from auditing listed firms for two years over the Satyam scam. Earlier this month, the RBI barred SR Batliboi & Co, an EY firm, from statutory audits of all commercial banks until April 2020. The firm was an auditor for Yes Bank.

“Audit firms are subject to multiple regulations. There is a case for better coordination among different regulators which oversee audit firms. The audit firms are also into advisory roles, which creates a conflict of interest. We need to build a strong Chinese wall,” said Khan.

Last year, the government created the National Financial Reporting Authority, which oversees chartered accountant firms and, therefore, audit firms as well. The audit firms are also regulated by the Ministry of Corporate Affairs, SEBI and in case of audit of banks, the RBI.

“Regulations can only do so much. The problem is the deep nexus between auditors and the companies they audit. It is a very tough environment to clean up. Other stakeholders should be involved in regulation of audit firms, not just CAs,” said Balakrishnan.

Conflict of interest 

The third issue here is that of the National Housing Bank. Given the liquidity crisis in non-banking financial companies (NBFCs) and housing finance companies (HFCs), there is need for greater regulation in this space, experts say. However, NHB, which oversees HFCs, is considered toothless by many.

“I have not seen any tough action by NHB. The NHB needs to be given more powers. However, that won’t be enough. It is about what a regulator does with the power it is given,” Balakrishnan says.

“The NHB is a refinancing agency, so its doing regulatory work will create conflict of interest. Their focus is more on refinancing and developing the market rather than regulatory supervision. It would be better if RBI also takes over supervision of HFCs,” Khan said.

Earlier this year, the government completed the takeover of NHB from the RBI for Rs 1,450 crore. RBI earlier held a 100 per cent stake in NHB. The National Housing Bank (NHB) has asked deposit-taking housing finance companies (HFCs) to slightly increase their liquid assets, stepping in as some sector players face a liquidity crisis.

Recently, NHB had asked HFCs to keep 6.5 per cent of the public deposits in debt-free securities, instead of the 6-per cent limit earlier. HFCs have to in keep 13 per cent as liquid assets--instead of 12.5 per cent earlier--with the remaining share of public deposits to be kept in the form of term deposits or certificate of deposits or in bonds issued by the NHB.

There are 18 HFCs accepting public deposits including ICICI Home Finance Company Ltd, PNB Housing Finance Ltd, L&T Housing Finance Limited, among others. The NHB notification came four days after cash-strapped Dewan Housing Finance Ltd (DHFL) announced it has stopped accepting fresh public deposits and renewal of existing deposits. DHFL’s credit rating was downgraded last week after the company missed an interest payment deadline on a set of non-convertible debentures.

The NHB is also looking at replicating the Reserve Bank of India’s recent circular asking large non-banking financial companies (NBFCs) to maintain a liquidity coverage ratio (LCR) in line with banks and carry enough collateral that can be used for liquidity needs, starting from April 1 next year.