Business of trust: IndusInd Bank events raise concerns over governance

While the bank has tasked an external agency to review the issues, reports suggest that discrepancy arose on account of derivatives positions taken by the bank to hedge its foreign-exchange exposure

Over the past fortnight, developments at IndusInd Bank have raised several questions regarding internal management and regulatory oversight. First, the bank informed the stock exchanges that the Reserve Bank of India (RBI) had approved the reappointment of its managing director (MD) and chief executive officer (CEO) Sumant Kathpalia only for a year. This was against the bank board’s approval of a three-year term. Interestingly, this was not the first time that the regulator approved a tenure that was shorter than what the board of the bank asked for. The RBI had earlier given a two-year reappointment against the board’s approval of three years. However, this was just the beginning. The bank later informed the stock exchanges about discrepancies in the accounting of derivatives, which, according to an internal review, amounted to 2.35 per cent of its net worth. The bank will need to provide about ₹1,600 crore.

 

Such material information is unlikely to be received well by the markets. Unsurprisingly, the bank lost over a quarter of its value in a single day on the stock exchanges. Since the banking business is based on trust, such developments, indicating poor internal control and management, can always affect the confidence of various stakeholders. Shareholders expressed their discomfort by dumping the stock. It is not yet clear if there was a similar reaction by depositors, which could have considerably complicated matters. Perhaps fearing such a consequence, the RBI issued a statement over the Holi weekend that the bank was stable and there was no need for depositors to worry. Indeed, the bank is well capitalised and there is no reason for panic. In fact, the promoters of the bank have expressed willingness to put in capital if needed. Since there is no immediate concern regarding the safety of deposits, public debate can focus on two broad issues.

 

While the bank has tasked an external agency to review the issues, reports suggest that the discrepancy arose on account of derivatives positions taken by the bank to hedge its foreign-exchange exposure. The problem arose because of different treatment of exposure by the asset-liability management (ALM) side and the treasury desk. While the treasury’s positions were marked to market, the internal contract between the two was not, which led to the discrepancy. Mr Kathpalia has said it was after the RBI’s September 2023 circular that the bank started reviewing its books and this was when the discrepancies began to surface. According to the circular, such internal trade had to be discontinued on April 1, 2024. Thus, the developments raise questions like why this was not disclosed earlier and whether the auditors of the bank and the regulator were aware of the issue. These are important aspects which must be clarified.

 

The second big issue is the appointment of MDs and CEOs in banks. If the regulator has a difference of opinion with the bank board on appointment, it must be shared with the markets. If a person is not fit for reappointment for three years, how is she or he fit for two years or one year? Such decisions can undermine trust in the management of a bank, which can have wider consequences. While regulated entities are expected to operate in a certain manner for good reasons, and the level of disclosures has increased over time, it is now time for regulators to disclose the rationale behind their decisions. This will enhance the level of both disclosures and decision-making.

 

 

(Disclosure: Entities controlled by the Kotak family have a significant holding in Business Standard Pvt Ltd)