RBI Governor: Time for banks to look deeply within & reorient banking

Keynote Address by Shri Shaktikanta Das, Governor, Reserve Bank of India – Delivered at the Unlock BFSI 2.0 with Business Standard on Thursday, August 27, 2020, has been reported in RBI web site which is reproduced below:

https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1099

His speech will be analyzed in the following manner:

• How COVID 19 forced RBI to take timely steps,
• Actual steps are taken to face the situation,
• The current state of commercial banking today with its imperfections and how to prepare for the future.

 He started his lecture by explaining how in the wake of the current pandemic, RBI has stepped forward and announced various liquidity, monetary, regulatory and supervisory measures in the form of interest rate cuts, higher structural and durable liquidity, the moratorium on debt servicing, asset classification standstill and recently creating a special resolution window within RBI Prudential Framework for Resolution of Stressed Assets.

We totally agree with his assessment that decision was taken in consultation with stakeholders and aimed at striking a balance between protecting the interest of depositors and maintaining financial stability on one hand and preserving the economic value of viable businesses by providing durable relief to businesses as well as individuals affected by the Covid19 pandemic, on the other. Abnormal situation blown out of bounds by the instant collapse of the economy without any notice or study of deceleration, forced both the government as well as RBI to act decisively to help all stakeholders. Whether the decisions were taken in the course of normal banking did not appear to have been discussed during deliberations.

He carefully drew the attention towards the following direction:

“I would like to dwell upon the following theme: It is Time for Banks to Look Deeply Within: Reorienting Banking Post-COVID. Just like boosting the immunity of the population is the key to tackle pandemics, the key to long term financial stability would be to foster tangible improvement in the inherent ability of the banks to withstand the exogenous shocks like the current pandemic.”

He drew the attention of the causes of weak banks to be traced to one or more of the following conditions:

• An inappropriate business model was given to face the business environment;
• The quality or the lack of governance and decision making;
• Misalignment of internal incentive structures with external shareholder/stakeholder interests and other factors.

 Accordingly, the core of resilient banks would be made up of good governance, effective risk management, and robust internal controls, in his projection of thoughts.

The above formed his arguments for a vibrant banking situation to grow out of the present failure to step out of the present situation.

His whole arguments thereafter spoke of a future for banking to meet the better business of banking.

He exhorted the banks to look at prospective business opportunities in the rural sector which remained unexplored despite efforts to support it.

 They needed to look at start-ups, renewables, logistics, value chains, and other such potential areas. The banking sector has earned a responsible role to play not only as a facilitator of growth of the economy but also to earn its own bread. Thus, a complete relook at the business strategy and orientation is the immediate need of the hour. Some of his views based on the current state of affairs or for the future may be narrated as under:

• He narrated how big banks were created out of the present structure to face the future with the massive ones out of India to meet scale and efficiency on equal footing.
• He expected these giant banks to acquire the latest technology, which would match their size and aspirations to grow, change from a transaction-based approach to business-oriented ones.
• A pocket full of technological tools like big data, artificial intelligence, machine learning to leverage upon, in order to be able to compete with the global players in reaping the benefits of ‘creativity’ is looming large all over.
• Banks while striving to meet the expectations of their investors, borrowers, and other stakeholders, will have to run the affairs of the bank in professional and sound management so that its Board of Directors would support the management at every step.
• He exhorted them to come out of risk-averse attitudes developed in the past due to bad decisions and the current pandemic to take risks with proper risk management tools. He wanted banks to smell frauds during the course of banking operations rather than waiting for the signals to emerge. Frauds did emerge out of diversion of funds by borrowers, cyber-based or some others in the banking accounts of investors.
• Banks needed to tighten their underwriting and credit monitoring standards to ensure that incidences of frauds would be reduced by early detection and followed up by initiating appropriate legal action against the fraudsters. Here too, the need solicited the leverage on technology, namely, artificial intelligence, to study the patterns of such incidences and the root cause behind their recurrence.
• An effective early warning system and forward-looking stress testing framework should be an integral part of the risk management framework of the banks. Banks should be able to pick-up incipient signals of stress faced by their borrowers and take proactive remedial action, which may include a viable resolution of the credit facilities aimed at preserving the value of the assets and not just aimed at reducing the short- term burden on the balance sheet of the banks.
• He emphasized that a good governance framework and effective risk and compliance culture should be complemented by a robust assurance mechanism by way of the internal audit function. This would form an integral part of sound corporate governance which should provide independent assurance to the Board of the bank as well as to external stakeholders that the operations of the entity would be performed in accordance with the set policies and procedures.
• He explained that RBI had already advised all banks, large non-deposit taking NBFCs and all deposit-taking NBFCs to assess the impact of COVID-19 on their balance sheet, asset quality, liquidity, profitability, and capital adequacy and that based on the outcome of such stress testing, banks and NBFCs should work out possible mitigation measures including capital planning, capital raising, and contingency liquidity planning, among others. Upfront capital infusion would also improve the sentiment of investors and other stakeholders alike for the sector to continue remaining attractive for investors, both domestic and foreign, over the medium to long-term.
• He concluded with the following quote from Leo Tolstoy from War and Peace: “A battle is won by those who firmly resolve to win”

Our observations

One needs to recollect the timely and historic efforts taken by RBI towards various liquidity, monetary, regulatory and supervisory measures in the form of interest rate cuts, higher structural and durable liquidity, moratorium on debt servicing, asset classification standstill and recently a special resolution window within RBI Prudential Framework for Resolution of Stressed Assets.

Though the bankers showed their resilience during the severe start of COVID 19 even risking the lives of its human resource, everyone expects them to prepare for future, equip with the best technology to face risk management, frauds, meet the competition from online sources which do not come with huge infrastructural costs but with quick decision-making skills and ability to be mobile at moment’s notice and with the best technically savvy manpower resources.

RBI should also move out its armed chair approach of the past, travel around the country, meet stakeholders like depositors, borrowers of all types, bankers both at corporate and ground levels and equip themselves with the manpower ready to learn new technology, apply on jobs and produce the best results in corporate governance. Slack behavior on the behalf of RBI in new areas of mobilization of resources like bonds or funds from around the world has been pointed out by experts frequently during meetings.

With the best RBI Governor at the helm of affairs, I do wish the bankers at the top of the organizations are honest, committed to the common man but prepare for the worst competition and unbelievable and outstanding results.

Let me also drag you to the recent lecture by Mr. Jerome H Powell, Chairman, U.S. Federal Reserve at “Navigating the Decade Ahead: Implications for Monetary Policy,” an economic policy symposium sponsored by the Federal Reserve Bank of Kansas City, Jackson Hole, Wyoming, U.S.A. Some important issues stressed in his speech are as under: (Actual quotes which are crystal clear for understanding)

• “We began this public review in early 2019 to assess the monetary policy strategy, tools, and communications that would best foster achievement of our congressionally assigned goals of maximum employment and price stability over the years ahead in service to the American people. Because the economy is always evolving, the FOMC’s strategy for achieving its goals—our policy framework—must adapt to meet the new challenges that arise
• With interest rates generally running closer to their effective lower bound even in good times, the Fed has less scope to support the economy during an economic downturn by simply cutting the federal funds rate.¹² The result can be worse economic outcomes in terms of both employment and price stability, with the costs of such outcomes likely falling hardest on those least able to bear them.
• On a happier note, the record-long expansion that ended earlier this year led to the best labor market we had seen in some time. The unemployment rate hovered near 50-year lows for roughly 2 years, well below most estimates of its sustainable level. And the unemployment rate captures only part of the story.
• Having declined significantly in the five years following the crisis, the labor force participation rate flattened out and began rising even though the aging of the population suggested that it should keep falling. For individuals in their prime working years, the participation rate fully retraced its post-crisis decline, defying earlier assessments that the Global Financial Crisis might cause permanent structural damage to the labor market.
• The historically strong labor market did not trigger a significant rise in inflation. Over the years, forecasts from FOMC participants and private-sector analysts routinely showed a return to 2 percent inflation, but these forecasts were never realized on a sustained basis.
• Overall, our new Statement on Longer-Run Goals and Monetary Policy Strategy conveys our continued strong commitment to achieving our goals, given the difficult challenges presented by the proximity of interest rates to the effective lower bound. In conducting monetary policy, we will remain highly focused on fostering as strong a labor market as possible for the benefit of all Americans. And we will steadfastly seek to achieve a 2 percent inflation rate over time.
• Reference:
• U.S. Fed chairman speech:

https://www.federalreserve.gov/newsevents/speech/powell20200827a.htm

Conclusion

Both the speeches relate themselves to the common citizen or resident who needs a reasonable monetary policy turned towards ensuring good employment, offering a reasonable return to an average depositor, or offering funds to borrowers that are market-oriented but without hindering the growth of a business.

One can easily find that Indian banks have to grow, compete with the best in the world, have the risk appetite, and effective risk management with the best technology on an evolving scale and make required corrections to upgrade governance standards. Equal up-gradation on a wider scale befitting its status is equally expected from R.B.I. Frequent interactions of the current governor to meet the common man and defend or learn from the mistakes is a common trait of an outstanding order.

American central bank administrators working at multitudes of our economic size have multiple occasions to explain their position, listen to the intelligentsia, and make a corrective course on the way of governance.

Though the contrast is sharp, both teach us the same. We must opt for that date when India would equate the U.S.A. and learn from its growth.

To leapfrog from the current position of the economy to the American position is the real challenge and opportunity for us. The U.S.A. which continues to lead the world will be always available for us to learn and collaborate.

*****

Disclaimer: The views expressed in this article are mine and neither taxguru.in nor the central banks of India and the U.S.A. are responsible. One can easily refer to the actual speeches for guidance.