Why RBI should use its powers to supersede inefficient bank boards

Regulator needs to send a strong signal to errant lenders

A long pending demand from the regulator to be given powers to supersede bank boards, was finally granted by the law makers in December 2012. The move was in the backdrop of giving fresh set of bank licences, and the regulator wanted more powers as large corporate houses were under consideration for granting licences. Eventually though no corporate houses got a licence, the power to supersede bank boards remained with the banking regulator. 

Take the recent case of Chennai-based state-run lender, Indian Overseas Bank. The regulator has now initiated ‘prompt corrective action’(PCA) on the bank which means there will be restriction on branch expansion and recruitment. However, there are no restrictions on loans. 

The early symptoms of trouble at the bank were visible about a year back, when the bank posted Rs 245 crore loss during the July-September quarter of 2014-15. Losses more than doubled to Rs 545 crore in the next quarter. The next two quarters saw some profit but bad loans rose and capital eroded. Return on asset continued to be much lower than the threshold that triggers PCA, which is 0.25 per cent. 

But despite having powers to supersede boards, RBI allowed the bank board to function. In December 2013, after imposing lending curbs to Kolkata-based United Bank of India (UBI), RBI, in February had written to the government for the need of superseding the board. But the UPA government during that time did not act, though the reasons are not known. 

The Banking Regulations Act, enables RBI to supersede the board of directors of a bank for upto 12 months if it feels that the board is not working in the interest of shareholders and depositors. If such a step is taken, RBI could run the bank by appointing an administrator till a new board is appointed. In such a scenario, while shareholders wealth decline, depositors money stay safe. More importantly, RBI watchers indicate the central bank can supersede the board if the top management fails to deliver. 

UBI board was not superseded. But has that helped UBI? The state-run lender’s gross NPA is as high as 9.57 per cent, while net NPA is 6.30 per cent. Return on asset was consistently below the 0.25 per cent PCA threshold, for the last five quarters, except for one. Capital Adequacy ratio was 10 per cent as on June end. 

Was the prompt corrective action by RBI on IOB, really prompt?