Is RBI’s closer scrutiny of banks’ business models making CEOs uncomfortable?

Is Kotak Bank’s outgoing CEO Uday Kotak’s comment on the bureaucratisation of financial services a response to Governor Shaktikanta Das’ comment on the Reserve Bank of India’s (RBI) closer scrutiny of banks’ business models? It appears so.

Das recently said financial resilience is closely linked to a bank’s business model and strategy. The RBI has, therefore, started looking at banks’ business models more closely. “Aspects or deficiencies in the business model itself can spark a crisis in due course,” said Das, while speaking on ‘Future-Proofing the Indian Financial System’ at a conference organised by the College of Supervisors in Mumbai.

The RBI, as a lender of last resort, actually landed in a very uncomfortable situation when the two promising private sector banks—YES Bank and RBL Bank—were wobbling. In fact, YES Bank had to be rescued by a consortium led by the country’s largest bank, State Bank of India. In the case of RBL Bank, the RBI put its representative on the board, which also led to the hasty exit of MD and CEO Vishwavir Ahuja. The RBI was also blamed for not acting in time when the infrastructure financing institution IL&FS imploded, threatening the financial stability of the system.

In an address to bank shareholders, Uday Kotak said: “I feel the financial sector players risk becoming more robotic, curbing the entrepreneurial flair since the fear of making a mistake overrides the joy of creation and development. While we need ‘Arjuna’s eye’ on risk management, we must prevent bureaucratisation of financial services,” he said, while writing about the Indian economy being in a sweet spot and a good time for bold thinking.

Without going into specifics, Kotak said the policy and regulatory framework need to be aligned. “We must let entrepreneurship thrive, as I was fortunate to see in most of my career. There is a need to build regulatory trust, which requires action on both sides of the aisle,” he said.

The banking regulator, however, believes that a resilient, future-ready bank needs to be financially, operationally, and organisationally resilient. “To be financially resilient, a bank should have adequate capital buffers and be able to generate earnings even in times of severe macroeconomic shocks. It should also have adequate liquidity to meet its obligations in various situations,” said Das. In fact, the banks are leveraged institutions. The RBI is right, as the first priority of banks should be to protect the interests of depositors rather than take unwanted risks, says a private banker.

Concerns about financial stability cropped again up when a few US banks folded up because of asset-liability mismatches. There was no risk from the asset side (higher NPAs etc), but the mismatch in the assets and liabilities created a mess. “The recent events in the banking landscape of the US and Europe suggest that risks for an individual bank could crop up from segments of its balance sheet that might have been considered relatively safer,” said Das, while adding that the management and Board of Directors of each bank should continually assess the financial risks and focus on building up adequate capital and liquidity buffers even beyond the regulatory minimum for continued resilience and sustainable growth.

Business Today asked the RBI in a monetary policy conference about the likely risk emanating from the small finance banks (SFBs) as they offer higher deposit rates and deploy them in microloans, which are partly unsecured and also risky. 

M K Jain, the deputy governor, who recently retired, said then that these SFBs were converted from NBFC MFI. “Earlier, there was a lot of concentration geographically as well as in the business. Now there is a road map for diversifying, and it cannot happen overnight. They require more time to diversify. They are on the right path. As far as raising the funds at a higher cost and offering a better NIM, we do track the business model of the SFBs. We also conduct stress testing, and whenever we find that risk has built up, we do advise the banks to take care of the risk build-up,” he said.

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