Credit culture needs to change

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K. Yatish Rajawat | 29 Oct, 2019
The fraud at Punjab and Maharashtra Co-operative (PMC) Bank shows that there is a rot in the system and not the bank. If unchecked, it can cause irreparable damage to the system. The complicity of bank officials with the Wadhawan family and its companies shows that there is a systemic flaw in the credit system. The extent of it may vary from one bank to another, but its existence is now undeniable.

Addressing a press conference after the Monetary Policy Committee review, Reserve Bank of Indai (RBI) governor Shaktikanta Das said that the PMC incident was an isolated one and there was no need to panic. Yes, there is no need to trigger panic but there is an immediate need to revamp the audit process carried out by RBI and internal auditors of banks. These audits failed to detect multiple accounts, over 20,000 accounts with the same address and ownership. This shows a systemic failure. Auditors need to use technology and simple programming languages like Python to sort through large databases to identify risks, especially concentric risks. It also shows that core banking solutions (CBS) a software platform mandated by RBI is prone to manipulations.

Finance Minister Nirmala Sitharaman seems to be cognizant of this challenge as she has asked public sector banks to appoint risk assessment officers at higher salaries. Cooperative banks also need risk assessment audit, as they are incapable of hiring such talent. RBI has to appoint these risk assessment auditors so that the extent of the problem in cooperative banks can be gauged and addressed.

There is a culture of hiding risks associated with a borrower at several points in the process of credit approval and disbursement. This has become part of the credit system. If a borrower cannot pay interest on loans, they do not disclose his situation and position as it shows the branch, the branch manager and credit team in a bad light. The managers see it as a personal failure. The bank also takes strict action against staff responsible for approving such loan.

The system treats default as a failure of the employee more than the borrower. The employee's failure in judging the capability of the borrower is an individuals failure not because of economic cycles. Therefore, to prevent a borrower from failing, bank employees go to extreme lengths. Renewing loans, giving it to associated companies, ensuring that the interest payments are funded, and even committing fraud with the system. They try to hide it as long as they can, praying and hoping that the borrower will recover and repay.

This is the behaviour of the credit department in all banks. This is corroding the banking system as it's endemic, barring a few private banks. The system does not know the exact risk it is carrying as nobody wants to acknowledge the borrower's position till it blows up in the media. There is a conspiracy of silence among bank managers as every disclosure has a ripple effect across branches and banks.

The system needs correction to revamp the credit system, both process reform and behaviour change is required. The behaviour nudge is important versus any aggressive action as the latter will freeze the credit flow in the system already suffering from a slowdown. The asymmetric relationship between the bank manager and the borrower needs correction.

There is too much power with branch managers. Some banks have shifted the process of sanction to a central committee for loans beyond a size. But routing every single loan through a central committee slows down the process of sanction and disbursement. Hence, technology, data and artificial intelligence needs to be used to create solutions for approval and disbursement.

Decisions need automation in core banking solutions and manual interventions need to be reduced. The process of loan approval begins at the branch level. Due diligence needs to be outsourced. The paperwork, physical verification of assets, valuation of assets, determination of the creditworthiness of the business and individual to pay -- these are data collection steps and here biases and corruption affect the outcome. There needs to be competition among branches to do it in the most exhaustive manner. We should see successful completion of this process as an accomplishment whether or not it grants the loan. This is the only way to bring rigour in this process.

The different processes in the system - evaluation, determination of interest rate to be charged and credit rating also need a revamp. There is graft, corruption and malfeasance. Branch managers lobby credit rating agencies for a better credit rating to justify their own evaluation report and offer a cheaper loan to the borrower. In a consortium, bankers blindly followed the evaluation of the largest lender which, if it's State Bank of India (SBI), the report is copied and pasted by all the other banks. In terms of evaluation, SBI, because of its size, has a better evaluation system than most private sector banks. And if it wants, it can pull data on the past performance of cash flows of the promoters.

If SBI is not involved, the credit evaluation report is poor and prepared after the decision to lend or not is already made. Borrowers can influence lending in both public and private sector banks. Sometimes, to meet targets, branch managers behave like entrepreneurs. All checks and balances in the system are up for subversion if the manager has decided to lend. In the last few years, bankers have become wary of taking decisions that involve risk and do not want to lend either. The pile-up of NPAs and recovery has become the only target for most PSBs. Bankers are in a hurry to send a borrower to the insolvency board. They do not want to restructure for fear of being questioned. The pendulum has swung in the other direction. In a nutshell, the system is in a jam. Therefore, a revamp needs to be done in stages. The objective should not be to punish the bank employees but to change the overall credit culture.