The recent mega fraud of Punjab and Maharastra Bank has shaken the confidence in Urban Cooperative Banks (UCBs). For revival of these banks, constant monitoring of financial health of these banks by the RBI is a must for which Supervisory Action Framework (SAF) is an effective tool. Under SAF, monitoring of the financial health of UCBs is done through three trigger points namely, CRAR, Asset Quality and Profitability. This SAF is in existence since 2012. The present article studies of financial performance of UCBs since the introduction of SAF which reveals several concerns. While SAF seems to be an effective supervisory tool of the RBI, its benefits are yet to be derived. For this purpose, it calls for more seriousness on the part UCBs to improve their overall financial performance by ensuring the participation bank staff at all level.
Reserve Bank of India (RBI) introduced Prompt Corrective Action (PCA) for the first time in December 2002 when public sector banks were witnessing a high and increasing level of non-performing assets (NPAs) and weakness in their overall financial performance. RBI imposes the PCA if a commercial bank’s financial condition worsens for which it specifies a ‘trigger point’ or ’risk threshold’ of each of specified areas of financial health of banks. When any trigger point/risk threshold is brought to the notice of RBI, it intervenes with corrective actions//restrictions. A bank would be placed under the PCA framework depending upon the audited annual financial results and RBI’s supervisory assessment. Once the bank comes under the PCA, the periodical submission of reports by the bank to the RBI and its meetings with the supervisory authority are compulsory. RBI revised PCA guidelines from time to time. It is happy to state that there has been encouraging response to PCA by public sector banks which is evident that few banks are slowly coming out of PCA due to their overall improvement if financial health (1). Encouraged from the success of PCA, RBI made this supervisory tool called as Supervisory Action Framework (SAF), to Urban Cooperative Banks (UCBs). Since SAF is in the larger interest of UCBs, it becomes necessary to create awareness of the recent revised SAF introduced in January 2020. Towards this end, the present article shares the relevant information. To begin with, let us examine features of SAF.
Features of SAF:
RBI conducts inspection of UCBs under the provisions of the Banking Regulation Act, 1949 to assess the financial position of a bank and its adherence to the various provisions of the Act and directions/instructions issued thereunder. It also monitors the financial position of UCBs based on periodical returns/statements submitted by them. Further, the Reserve Bank initiates supervisory actions based on its assessment of the financial position of a bank. The SAF envisages, in the initial stage of deterioration in the financial position, self corrective action by the management of UCBs themselves and, thereafter, supervisory action by the Reserve Bank in case the financial position of the bank does not improve. For supervisory action by RBI, there are certain trigger points which indicate the deterioration in the financial position of a bank. Such deterioration in financial shall refer to fall in the asset quality, decline in profits, capital inadequacy etc. As stated earlier, the management of the UCB should first identify the cause of deterioration and take necessary corrective actions, on their own, with a view to improve the financial position of the bank. But, such corrective action should be prompt as any delay could be detrimental to the interest of the depositors and other stake holders of the bank. The corrective action should include measures for augmenting capital, close monitoring of NPAs and their recovery, improving profitability by curtailing expenses, mobilizing low cost deposits etc. The UCBs should also prepare a time bound specific action plan for bringing about necessary improvement in its overall functioning and, the Board of Directors should monitor the progress in implementation of the action plan in its every meeting. In case necessary steps are not taken to improve their financials or steps taken do not result in the required improvement in the financial position of the bank, the Reserve Bank steps in and initiate supervisory actions as it deems necessary RBI revises guidelines on SAF from time to time to address issues arising in its implementation.
Revised SAF Guidelines:
SAF is more effective in bringing about the desired improvement in the financial health of UCBs as also expeditious resolution of UCBs experiencing financial stress (2). The latest RBI Circular of January 06, 2020 discusses the revised the SAF (3). There are three triggers which include: (i) Asset Quality when Net NPAs exceed 6% of Net Advances. (ii) Profitability when there are losses for two consecutive financial years and there are accumulated losses on its balance sheet. And, (iii) Capital to Risk Weighted Assets Ratio (CRAR) when it falls below 9%. For each trigger, there are certain Common actions which should be taken by the UCB which shall n include; a) Advising the UCB to submit a Board-approved Action Plan for each trigger b) Advising the Board of Directors of the UCB to review the progress under the Action Plan on quarterly/monthly basis, and c) Advising the UCB to submit the post-review progress report to Reserve Bank.
Besides Common actions, there are certain trigger-wise Specific Supervisory actions taken by the RBI. To elaborate, for (i) Asset Quality trigger, such specific supervisory actions include: a) UCB would be required to furnish an action plan for recovery of NPAs and to undertake special drive to reduce the stock of NPAs and contain generation of fresh NPAs. b) The Board of the UCB would review its loan policy, take steps to upgrade credit appraisal skills and strengthen follow-up of advances including loan recovery; c) Curtailment of sanction/renewal of credit facilities to sectors/segments having high proportion of NPAs; d) Reduction in exposure limits for fresh loans and advances; and, e) Restriction on fresh loans and advances carrying risk-weights of more than 100%. Similarly for (ii) Profitability trigger, additional specific supervisory actions include: a) The UCB is advised not to access/renew high cost deposits, launch special drive to reduce the stock of NPAs & contain generation of fresh NPAs, rationalize its branches and close down loss making branches; b) Prohibition on declaration/payment of dividend/donation; c) Restriction on incurring capital expenditure beyond a specified limit, without prior approval of the Reserve Bank and, d) Measures for reduction in interest and operating / administrative expenses.
Lastly, for (iii) CRAR trigger, supervisory actions include: a) For augmenting capital, specifically indicating the manner in which the capital would be increased either by fresh infusion, conversion of deposits into equity for improving CRAR to 9% within three months; b) UCB would be advised to reduce its exposure to the sensitive sectors like capital market, real estate, non-SLR investments and not to mobilize high cost deposits and raise resources at market related rates and review its credit /investment policy; c) In case CRAR of the UCB is less than 3%, it will have to explore options by seeking a Board-approved proposal for merging the UCB with another bank or converting itself into a credit society; d) Prohibition on declaration/payment of dividend/donation; e) Restriction on incurring capital expenditure beyond a specified limit without prior approval of the Reserve Bank; f) Reduction in exposure limits for fresh loans and advances; g) Restriction on fresh loans and advances carrying risk-weights beyond the specified limit; h) Restriction on expansion of size of the balance sheet; i) Restriction on fresh borrowings except for meeting temporary liquidity mismatches; j) Prohibition on sanction/disbursal of fresh loans and advances other than loans against collateral security of term deposits / NSCs / KVPs / insurance policies; and, k) Prohibition on expansion of size of the deposits.
Besides, Common and Specific supervisory actions by RBI as discussed above, Reserve Bank, as under section 35A of the Banking Regulation Act, 1949 (as applicable to co-operative societies), shall also consider to issue a show cause notice for cancellation of banking license when continued normal functioning of the UCB is no longer considered to be in the interest of its depositors/public. It is important to note that the RBI shall initiate supervisory action on the basis of the financial position of UCBs as assessed during the statutory inspection. However, action may be taken also on the basis of the reported/audited financial position. Besides these actions, the RBI shall initiate any other action based on merits of each case. These supervisory actions would be in two stages. In the first Stage, the Reserve Bank would commence the active monitoring of the performance of the bank. The monitoring would be done by directing the UCBs to submit to the Regional Office of the Reserve Bank, the action plan for improving their performance in the specific areas where there is a deterioration or cause of concern and returns, pertaining to the specified weak area, at quarterly/half-yearly intervals. In the second stage, the supervisory action would be in the form of prompt action aimed at arresting further deterioration in the financial position of the bank. With the introduction SAF, it is expected to facilitate the UCBs to improve their overall financial health. In this regard, it would be interesting to study performance of UCBs after the introduction of SAF in 2012.
Performance of UCBs:
Referring to the RBI Report on Trend and Progress of Banking in India for the period 2011-12 to 2018-19, changes in the financial position of Scheduled Urban Cooperative Banks (SUBCs) with the help of three triggers of SAF namely, Capital Adequacy, asset Quality and profitability (4). Regarding the first trigger i.e. Capital Adequacy, SUCBs are required to maintain a minimum statutory capital under the Basel I norms to risk weighted assets ratio (CRAR) of 9 per cent. As of end-March 2019, more than 96 per cent of SUCBs maintained CRAR of 9 per cent and above. But, data also suggests deterioration in CRAR of SUCBs to 9.8 per cent in H1:2019-20 from 13.5 per cent in H1:2018-19. Further, over the years, CRAR declined from 11.8 per cent in 2011-12 to 9.8 in HI : 2019-20. This deterioration in CRAR is on account of high and increasing level of GNPA ratio. Coming to the second trigger i.e. Asset Quality, during 2019-20. SUCBs’ GNPA ratio witnessed a an increase from 7.1 per cent in HI: 2017-18 to 10.5 per cent in H1: 2019-20 and further to 10.5 per cent in H1: 2019-20> This reflects large delinquencies in Punjab and Mahahrastra Cooperative (PMC) Bank, the fraud hit bank. This bank, which is among the top-10 urban cooperative banks which had lent over Rs.6,500 crores to HDIL, forming 73 per cent of total advances of Rs.8,880 crore (5). Thus, over the years, the GNPA ratio went up from 7.0 per cent in 2011-12 to 10.5 per cent in HI: 2019-20. Lastly, the third trigger i. e, Profitability ratio too observed deterioration which is measured through different ratios. One of them is Return on Equity (RoE) which fell down sharply from 10.51 per cent in 2011-12 to 8.71 per cent in HI: 2018-19 mainly on account of below par performance. The situation is worst when SUCBs posted losses in H1:2019-20. Bank-specific factors like credit risk, interest and non-interest income and the overall macroeconomic environment weigh in as the key determinants of declining SUCBs’ profitability.
Thus, despite SAF as an effective tool for monitoring of RBI in monitoring of banks, their financial health continued to decline which is a matter of concern. The higher GNPA ratio adversely affects profit performance, capital adequacy, credit expansion, rating and their reputation. Hence, this is matter of concern to the bank management, Reserve Bank of India, Government and the society at large. Towards, efforts of SUCBs need to be strengthened to step up the quality of loan assets for which certain approaches are suggested.
Good Quality Lending – Suggested Approaches:
To start with, a branch manager should scrutinize a credit proposal carefully & professionally and respect the laid down due diligence in credit to decide whether to sanction or otherwise. For this purpose, he has to verify the authenticity of important credit information provided by a potential borrower in the credit proposal. The application form for availing of credit should be simple and the project proposal should contain vital information needed for assessing the feasibility of the project and acceptability of the borrower to the bank based on credit history and local enquiry made by the branch manager. The major items in the project proposal shall include: brief profile of the applicant, purpose and quantum of credit sought for, borrower’s experience in the line of activity, success rate of the borrower in the earlier business, existing borrowings, credit history of the applicant, particulars of the project/proposed activity, technical feasibility of the project, supply and demand gap for the proposed business activity, projected cash flows and financial viability, credit rating, margin and securities to be offered etc. The branch manager has also to study the relevant information from the secondary sources of information and local enquiry, besides holding an interview with the applicant to arrive at a conclusion on authenticity of information provided by the applicant. The quality of lending is decided on how the credit proposal is appraised by the branch manager. For this purpose, he should examine certain critical aspects of the credit proposal in detail. These include; strength of the proposal, suitability of the bank credit to the borrower, future prospects of the business activity, genuine credit requirements of the borrower, projected income generation, margin & securities offered, valuation of collaterals, credit history and credit rating of the business unit based on financials etc. While doing the credit appraisal of the proposal, the branch manager should avoid any kind of mediators and hold direct interaction with the applicant.
For credit appraisal, the branch manager should take into account bank guidelines by referring to the latest circulars issued by the controlling office. For proper assessment of demand and supply gap, market information and data in respect of various credit products offered by the bank should be made available to the branch managers by the controlling office. Further, minutes of credit committee meetings held at the district level should also be made available to the concerned branches for assessing demand and supply gap. More importantly, the controlling office should create a data base to guide the branch managers on the latest developments in the market. For this purpose. the data base should contain various items such as zone-wise studies done on bank credit products, industry-wise/ activity-wise data collected by the local industry associations/ chamber of commerce, government plans and developmental activities in the local area, branch-wise credit growth and loan recovery rate etc. Further, close review and monitoring of achievement of targets set for branches for credit should be done by the controlling office on periodical basis and extend necessary support to ensure that targets are achieved in true spirit.
To ensure the good quality credit, few more aspects need to be ensured. For instance, the branch manager should strictly implement the terms and conditions of loan sanction and disbursement schedule without any deviation. If disbursements are in stages, at each stage of disbursement, it should be ensured that the earlier amount disbursed is fully utilized. Frequent visits are to be made by the branch manager to verify the status of the primary securities. If any deviations are noticed, further disbursement should be stopped and the controlling office should be informed suitably. The branch manager should also verify the documents such as bills/ invoices submitted by the borrower after the purchase of assets with bank finance. Rates, quantity and type of product need to be verified from the independent source and it should be matched with the project report submitted by the borrower.
During the post disbursement of loan, the branch manager should ensure the end use of funds, regular submission of the stock statements by the borrower and subsequent stock verification at the site, actual business performance vis-a vis projected business performance, regular payment of loan installments/ deposits in cash credit account and arresting the slippage in asset quality by undertaking preventive action timely. In terms of RBI guidelines, monitoring of Special Mention Accounts (SMAs) is a must to prevent standard accounts becoming NPAs. Prevention is better than cure for which accounts need to be closely followed up. After obtaining any warning signal of loan default or sickness, preventive action is needed. The most crucial task is to step up recovery from NPA borrowers. There are two types of recovery measures namely, non- legal and legal. Legal measures need to be initiated after undertaking all non legal measures which include sending a reminder, paying visits to the borrower’s residence/ business premise, debt restructuring, loan compromise, recalling of advances and write off. Legal recovery measures are initiated when securities are available and the borrower is non-cooperative. These recovery measures include: initiating action under section 101 of State Cooperative Societies Act; loan recovery through Lokadalats, Civil Courts and Debt Recovery Tribunals; recovery under SARFAESI Act and Insolvency Bankruptcy Law. Though it is observed that NPAs are part of loan portfolio of every bank, it should be attempted to keep the level of NPAs low. Non-Legal measures are preferred to legal measures in terms of quick recovery and cost of recovery. Stern action is needed in respect of willful defaulters. For effective loan recovery, it calls for professional, collective and timely action and maximum use of technology.
The aftermath of PMC Bank fraud, a need is felt to strengthen the supervisory function of the RBI for urban cooperative banks. In this respect, one of the effective supervisory tools is SAF whose guidelines have been revised from time to time. In terms of revised guidelines of January 2020, the RBI monitors the financial health of UCBs through three important triggers namely, CRAR, Net NPA ratio and Profitability ratio. From the study of financial performance of SUCBs, it observed that their CRAR is above 9 per cent at present. But, CRAR is needs to be raised in view of the growing credit risk. Further, SUCBs have reported losses during Hi 2020. To make them profitable. it calls for aggressive marketing of bank products, cutting down cost of operation by depending on technology at the optimum level, professional approach in decision making and ensuring transparency at all levels. Similarly, efforts SUCBs need to be strengthened to take loan recovery on a war footing. Thus, if the existing trends in financial health of SUCBs continue, more lenders are expected to come under the SAF. Hence, it is necessary to monitor their performance with the help of SAF more closely which is an effective tool in the hands of RBI. But, what is important for weak SUCBs is to respond to the framework positively and undertake loan recovery from hard core NPA borrowers more aggressively, besides improve operational efficiency. Towards this end they have a long way to go.