RBI's twin meetings with banks usher in new era of governance, compliance

Governance and business models of regulated entities came in for special attention of the central bank this year, reports Raghu Mohan

Mint Road’s twin meetings with the boards of state-run and private banks on May 22 and 29 this year must go down as an initiative like none other to improve governance till date. A bland communique issued to boards well over a month before said it was primarily to discuss “issues related to governance, ethics, the role of the boards, and supervisory expectations.” Many bankers and board members who thought it would be just another interaction with the top brass of the Reserve Bank of India (RBI) got it wrong.
 

It is for the first time that a Mint Road helmsman gave us a peek into the power structures within banks boards; and of personality cults.
 

Said RBI Governor Shaktikanta Das: “… we have noticed the dominance of CEOs in board discussions and decision making. It has been seen in such cases that boards are not asserting themselves. We would not like this type of situation to develop.” Das referred to instances of agenda papers not being circulated well in advance of board meetings and power-point presentations being circulated in lieu of the same. And here is a pithy gem: “These power-point presentations are like a guided tour, and directors should clearly look beyond a guided tour.”
 

The meetings were a follow-through on Finance Minister Nirmala Sitharaman’s announcement in the Union Budget for Financial Year 2023-24 (FY24) on the need for improving governance and investor protection in the banking sector. Sitharaman had proposed certain amendments to the RBI Act, 1934; the Banking Regulation Act, 1949; and the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970. And built on Mint Road’s ‘Discussion paper on governance in commercial banks in India’, released on June 11, 2020. The objective of the paper was “to align the current regulatory framework with global best practices while being mindful of the context of the domestic financial system”.
 

The grapevine has it that the current supervisory cycle will be tough on some.

And some more on compliance
 

An omnibus framework for self-regulatory organisations (SRO), sector-agnostic at that, is in the works. “SROs can play an important role in strengthening the compliance culture among their members and also provide a consultative platform for policy making,” said Das in the October 6 Monetary Policy Statement. It is significant – it breathes life into Sitharaman’s statement in the Annual Budget for FY24 that financial regulators would be requested “to carry out a comprehensive review of existing regulations so as to simplify, ease and reduce cost of compliance.”
 

Just how critical Mint Road views SROs can be gauged from Deputy Governor’s M Rajeshwar Rao’s speech in Cairo (March 5, 2023). Speaking at the 17th Annual Conference of the Foreign Exchange Dealers Association of India (Fedai) – the country’s first ever SRO – Rao held that the primary motivation is to enhance effectiveness in regulations by drawing upon the depth of technical expertise of practitioners. The involvement of market experts could also enhance effectiveness in regulations by highlighting various technical and practical aspects, nuances and tradeoffs involved in regulatory policy.
 

The spotlight will be on banks. Why? The Indian Banks’ Association (IBA) is not an SRO as widely believed – it’s a lobby group. The RBI had first asked IBA to weigh the idea of becoming an SRO way back in 1998, a development which Business Standard reported on September 21, 1998. A quarter century on, we are very much in the same place even as Mint Road has said that fintechs should set up an SRO.
 

Now, will IBA apply to become an SRO, or will banks opt to set up an altogether new entity?

Applying the brakes
 

The surprise regulatory move of the year was the upping of risk weights on unsecured credit by 25 percentage points to 125 per cent, and on credit cards to 150 per cent. Bank loans to non-banking financial companies (NBFCs) will also become costlier as this is applicable on such exposures as well. The RBI’s move caught regulated entities (REs) off guard even though the issue had been flagged by Das with their corner-room occupants in July and August 2023 – on consumer credit and the dependency on bank borrowings.
 

The red lights were flashing before this interaction.
 

In its 'Report on Trend and Progress of Banking in India (T&P: 2021-22)', Mint Road observed that in recent years, banks appear to have displayed ‘herding behaviour’ in diverting lending away from the industrial sector towards retail loans. That “empirical evidence suggests that a build-up of concentration in retail loans may become a source of systemic risk.”

As CareEdge noted in a report, overall credit combined for banks and NBFCs saw a compounded annual growth rate (CAGR) of 12 per cent during FY17-FY23 and stood at Rs 170.5 trillion in FY23. During this period, the personal loan book (including all retail for NBFCs) growth stood higher with a CAGR of 19 per cent. In absolute terms, personal loan credit had nearly tripled in the past six years to Rs 51.7 trillion forming 30.3 per cent of the overall loan book in FY23, as against Rs 18.6 trillion or 21.5 per cent of the overall loan book in FY17. The rate of growth of the personal loan book is almost double the rest of the banking sector’s lending.
 

While the RBI’s measure is a pre-emptive strike, it will have a downside effect on financial inclusion.

Stricter penalties 
 

A new penalty framework for REs is in the works as reported by Business Standard on November 20. These may include linking them to the size of the RE, particularly in the case of systemically important ones. 
 

A case for holding back the payout to key management personnel rather than an RE taking the rap. 
 

A key agenda set by Mint Road as part of its enforcement initiatives for FY24 is to examine the feasibility of a scale-based approach to the issue. The larger setting to this is as follows: The T&P: 2021-22 has it that during this period, the major reasons for the imposition of penalties on REs were due to non-compliance with exposure and IRAC (income recognition and asset classification), fraud reporting, and violation of cybersecurity guidelines. In FY23, there were 211 instances of imposition of penalty with the sum at Rs 40.39 crore; in the preceding financial years, these figures were at 189 and Rs 65.32 crore and 61 and Rs 31.36 crore. Compared to penalties imposed globally, which run into hundreds of millions of dollars, the amounts imposed by RBI are small. The highest penalty by RBI till date is Rs 58.9 crore in March 2018 on ICICI Bank for its failure to adhere to directives regarding the sale of securities from its held-to-maturity portfolio.

Going green for planet blue
 

On April 11, 2023, the RBI announced a framework for acceptance of green deposits to foster and develop the green finance ecosystem in the country. Among global central banks, Mint Road is an early mover on green finance. In December 2007, it advised banks to put in place a board-approved plan of action towards helping the cause of sustainable development. It brought out a discussion paper on climate risk and sustainable finance in July 2022, which was preceded by a survey of banks in January 2022. In a first, RBI’s 'Report on Currency and Finance' is on the green theme: ‘Towards a Greener Cleaner India’.

As Das noted in his foreword: Climate change induced risks to macro-financial prospects of the country and the range of policy options available to mitigate climate risks require dedicated research. Such research becomes even more critical in the context of the complexity and non-linearity of the ways in which climate, economy, financial systems and related policies operate.

What has not come through is a green taxonomy. A hint of what’s in store was given by RBI deputy governor, M Rajeshwar Rao, speaking at Business Standard’s BFSI Insight Summit in Mumbai in December 2022. “A formal definition of green finance along with a taxonomy is the need of hour as it would enable more precise tracking of finance flows to green sectors in India, which in turn, would help design effective policy, regulations and institutional mechanisms directed towards increasing both public and private investments,” he said.

The NBFC plot

In September, the RBI updated its updated list of upper layer non-banking financial companies (NBFCs) ­­based on the scale-based regulations for non-bank lenders. It has 15 of them – Bajaj Finance, Shriram Finance, LIC Housing Finance, and L&T Finance among others. Over time, RBI has almost aligned the regulatory norms for NBFCs and banks. On April 29, 2022, it had issued guidelines on compensation of key managerial personnel (KMP) and senior management of NBFCs. 
 

They are required to constitute a nomination and remuneration committee (NRC), which will be responsible for framing, reviewing and implementing the compensation policy. The NRC is also required to ensure ‘fit and proper’ status of the proposed as well as existing directors and that there is no conflict of interest in appointment of directors on board, KMPs and senior management. Now read the governance norms and hike in risk weights on bank exposures to NBFCs – it is clear that business will have to be relooked by some of these entities. 

Step by step, adding strength to regulation
 

• The RBI has built on its ‘Discussion paper on governance in commercial banks in India’, dated June 11, 2020. Its objective was “to align the current regulatory framework with global best practices while being mindful of the context of the domestic financial system”.
   
• An omnibus framework for self-regulatory organisations is in the works. It breathes life into Finance Minister Nirmala Sitharaman’s statement in the Budget for FY24 that financial regulators would be requested “to carry out a comprehensive review of existing regulations so as to simplify, ease and reduce cost of compliance.”
   
• The surprise regulatory move was the upping of risk weights on unsecured credit by 25 percentage points to 125 per cent, and on credit cards to 150 per cent. It caught regulated entities off guard even though the issue had been flagged before.
   
• Compared to penalties imposed globally, which run into hundreds of millions of dollars, the amounts imposed by RBI are small.     
  
  The highest penalty by RBI till date is Rs 58.9 crore in March 2018 on ICICI Bank over the sale of securities from its held-to-maturity portfolio. There’s also no empirical evidence of REs being “shamed” by such censure as repeat offenders are many; some may even be factoring it in as the cost of doing business.