'Health Of Our Banking System Can Govern Health Of Our Economy'

A country’s economic health is closely related to the health of its banking system. In turn, the health of the banking system is largely determined by the quality of loan book of individual banks. For maintaining the quality of a bank’s portfolio of advances, credit monitoring is one of the important tools.

The role of credit monitoring function starts right from the moment exposure is assumed, and ends only when the exposure is fully recovered. It includes organizational structure, policies, systems, data management and processes.

Here are a few key reasons why a well-oiled credit monitoring function in a bank is essential for maintaining health and growth of banks’ advances portfolio:

1.   Preventing pile up of bad assets

During the period 2010-2014, in pursuit of profits, banks had relaxed certain well accepted credit monitoring norms to accelerate lending. Such lending was particularly concentrated on certain sectors such as infrastructure, power and roads on the corporate; on the retail side maximum lending happened for the housing and personal loan (including credit cards) portfolios. 

In the aftermath of a decelerating economy, the banks were left holding a pile of non-performing assets from such lending. The overall GNPA of all scheduled commercial banks increased from around 4 per cent in March 2014 to 7.6 per cent in March 2016. 

Stung by the non-performing assets, banks got wary and stopped lending which further accentuated the economic deceleration. The important lesson to learn from this is that highest credit monitoring standards are to be maintained at all times and any relaxation can only happen in exceptional circumstances. 

In fact, credit monitoring processes should take into account the different stages of economic cycles and build safeguards accordingly.

2.   Preventing excessive leverage

As per RBI’s Financial Stability Report (June 2016), the debt equity ratio (DER) for public limited companies has deteriorated to 3.3 in 2014-15 from 2.5 last year, in its sample. Likewise the DER of private companies also worsened to 1.6 from 1.4 during the same period. Excessive corporate leverage will impact the debt servicing capacity and may exert pressure on asset quality during adverse times. 

Also, some of the high leverages were found to be assumed for reason of diversion of funds for non-productive purposes through veiled corporate structures. Credit Monitoring function has an important role in ensuring that companies do not assumed such excessive leverage beyond their means for debt and interest servicing. This involves through investigation of the veiled corporate structures and by having restrictive covenants.

3.   Funds diversion

Monitoring of end use of funds is critical to ensure that the depositor’s money is not siphoned off for unproductive purposes. Of late, Indian banks have witnessed several cases of promoters diverting the bank funds for personal purposes. 

Not only does it endanger the average public’s hard earned money, but such acts lead to other economic consequences such as creation of a parallel economy, tax avoidance and asset bubbles. Strict credit monitoring practices ensures that the funds are utilized only for the purpose for which they are lent.

4.   Industry Monitoring

Industries are cyclical in nature and have different points of inflexion. It is crucial to monitor the portfolio from an industry perspective. This is because, depending on the current position of the industry, banks have to take strategic calls in increasing, downsizing or protecting the exposures. Another reason is that, a growing bank has to take calls in taking exposures in the upcoming industries. 

As the economy matures, new industries may emerge which require funding for it to get established and grow. To take a right judgemental call on whether to take exposure in an industry, credit monitoring function needs to undertake detailed studies on such industries.

Regulatory initiatives

Regulatory initiatives have been brought in by RBI to strengthen the credit monitoring process. Towards this, it has introduced Special Mention Accounts (SMA) and Red Flag Accounts (RFA) for monitoring purposes. 

SMA-0 and RFA accounts above Rs 5 crore are to also be reported to the CRILIC database which RBI shares with the member banks. RBI also clamped down on the increasing unhedged foreign currency exposures by increasing the provisioning and capital requirements. 

Many of the corporates had started indulging in using foreign currency exposures for speculative activities. Detailed Guidelines on formation of Joint Lenders’ Forum (JLF), Corrective Action Plan (CAP), ‘Refinancing of Project Loans’ and other regulatory measures were also issued to banks for enabling prompt steps for early identification of problem cases.

Conclusion

Credit Monitoring has an important role to play not only in protecting bank’s exposures but also in ensuring that the funds are channelized for the right purposes. It acts as a guardrail in ensuring that the bank’s health and the country’s economic health stay in the right trajectory. 

Technology solutions are available in the market which will help automate the credit monitoring process to a large extent. This ensures that the credit monitoring function is kept objective and process oriented. Also, through automation credit problems can be identified at an early stage for appropriate redressal.