5 steps to cure India's banking system

Bankers pay a small price for their misdeeds, no matter how large the cost to their banks or to the economy at large, says TT Ram Mohan.

Illustration: Uttam Ghosh/Rediff.com

Punjab National Bank, Axis Bank, ICICI Bank - India’s troubled banking sector has had more than its fair share of high-profile mishaps in recent months.

Let nobody think that it is unique in being plagued by mismanagement or poor governance.

In banking, scams have become the name of the game worldwide - and the villains are overwhelmingly private banks.

In distant Australia, the chairman and CEO of AMP, a finance company, have resigned following damaging revelations about practices at the bank.

Half the board is getting emptied. AMP has been accused of charging customers to whom it provided no services, misleading the corporate regulator and trying to interfere with an independent report prepared by a law firm.

Australia’s banking regulator has accused three leading banks of rigging the country’s  primary interest rate benchmark.

The country’s largest bank, CBA, is being sued for allowing criminals and drug dealers to launder millions of dollars.

et another firm, Macquarie, has been accused of misusing client money over nearly a decade.

Australia’s banking system was considered better run than most: It had weathered the financial crisis of 2007 very well.

The news from Australia has reinforced the perception that, without exception, the culture in the financial services sector is seriously flawed - some have called it “toxic”.

In the US, Wells Fargo, once an iconic name in banking, has been hit a fine with $1 billion for abuses in its mortgages and auto loan businesses.

It has also been fined $500 million for inadequate risk management practices.

These actions come two years after Wells Fargo was rocked by allegations about opening unauthorised deposit and credit card accounts on behalf of its customers.

For these lapses, it was fined $185 million and there was a series of departures at the top.

The reputation of the bank, once seen as a role model and inspiration by our own private banks, is in tatters.

In the UK, the CEO of Barclays has been fined £640,000 for trying to uncover the identity of a whistle-blower employee in 2016.

The board has issued a reprimand and cut the CEO’s bonus for 2016 by £500,000.

The whistle-blower had written anonymously to the board raising questions about a top level recruit.

His lordship, the CEO, was displeased and asked his security team to find out who the whistle-blower was.

The CEO shouldn’t be keeping job. Instead, he gets away with a rap on the knuckles.

Last March, Barclays had agreed to pay $2 billion to settle allegations by the US Department of Justice that it had mis-sold residential mortgages in the run-up to the financial crisis.

Since the crisis, it has seen more than one CEO come and go in a frantic effort to change its culture. Clearly, little has changed.

Such episodes in banking have ceased to shock. The financial crisis of 2007 showed up recklessness on the part of bankers and comatose boards of directors.

Did the revelations put an end to bad behaviour? Not by a long chalk.

There has been a string of scandals thereafter: Libor-rigging, exchange rate rigging, mis-selling of financial products, violation of sanctions, money laundering and the like.

Bankers pay a small price for their misdeeds, no matter how large the cost to their banks or to the economy at large.

At most, they lose their jobs after having made enough to take care of the next generation or two. They seldom go to jail. Fines are overwhelmingly borne by shareholders.

Violation of laws and regulations and cheating of customers is so rampant that it’s worth asking how many private banks have a culture that is not toxic.

How do we address the problem?

First, reduce the incentives for taking risk by sharply increasing the requirement of capital. Do away with risk-weighted capital requirements. Have a simple leverage requirement (the ratio of equity capital to total assets) of, say, 10, which could go up to 20 over time. The lower the level of debt, the lesser the incentives boost return on equity through malfeasance.

Secondly, specify the responsibilities of top management explicitly and at length so that they are legally culpable for violations or lapses.

Thirdly, check whether incentives are leading to wrong behaviour. It may make sense to replace sales incentives for frontline staff with incentives for customer service as a whole, as some banks have done.

Fourthly, overhaul the composition of the board by getting independent directors nominated by diverse stakeholders - institutional investors, minority shareholders, employees.

Lastly - and this is bound to raise hackles - make sure there is a significant public sector presence in banking. We know the shortcomings in the public sector: Absence of performance incentives, political and bureaucratic interference, lack of management accountability.

But we must also recognise the positives.

Weak performance incentives for management also mean weak incentives to rip off customers, take excessive risk, fudge accounts.

It’s a different culture with its own pluses and minuses. When customers have a choice between competing cultures, it may serve to put a lid on toxicity in banking.

TT Ram Mohan is a professor at IIM Ahmedabad