Are profits of PSU banks becoming hostages to Chairmen?

Earlier this week, a Deputy Governer of the Reserve Bank of India no less raised the issue that profits and losses of banks are becoming hostage to retiring or incoming chairmen, or something to that efect. This observation that profits of PSU banks tend to dip when the chaimen change has now become a bit of a derisive fact for stock market investors.

Among the banking fraternity, there are loud whispers that chairmen refuse to recognise NPAs towards the end of their career to avoid looking bad. As also, a tendency among incumbents to be more than cautious early in their tenure so that the profits start improving later in their career. In an interview with CNBC-TV18's Latha Venkatesh, Former Finance Secretary, S Narayan, Former Oriental Bank Chairman & MD, BD Naranag and UR Bhat, Head, Dalton Capital, talk about the effect a new chairman has on the profits of a PSU bank.

Below is the transcript of the interview.

Q: Is this just an optical illusion or do you in your experience actually notice that incumbent Chairmen want to start with a slightly poorer performance so that they look good in their tenure. What is your comment on the kind of data that was presented to you?

Naranag: There are two common things that make a serious impact on the bottom-line of the bank; that is pension provisions and NPA provisions, they are common denominators.

Second is how we handle it. It is true that the incumbent would like to see that slate is cleared and he doesn’t have to bear the brunt. But without realizing that banks are an institution on home, the whole country looks at their results and any major volatility will give a very, very wrong impression of the situation which otherwise doesn’t warrant. For a simple reason that when we talk of an economy for a layman, 60% of what it means is banking. So projecting so much of volatility into the bank results would mean you are just sending wrong signals to the entire investment community.

Q: How do savvy investors, big investors, institutional investors look at his whole trend. Are you, over the past several years, almost beginning to believe that every time a Chairman is retiring. let me get out of that stock?

Bhat: I think that is something the market has factored in in terms of valuations. If you see there is a huge valuation divergence, for the same amount of profit within public sector bank and a new generation private sector bank. Typically the price to book could be almost double, or for e.g. PE ratio would also be something like double, so which basically shows that the confidence level in the balance sheet of a public sector banks from the investor community is somewhat less. I think it really happens because of two reasons; one is everyone wants to look good so therefore do the big bath, take the big bath, clean the slate - that is what happens. Why is it that is possible? Because when we started the reform process in the early 90s, we came to this conclusion that on the 91st day if an asset is not serviced becomes non-performing. So the element of discretion that was available earlier has come down dramatically, that is what it looks like. But what really happens is there is a performing asset, there is a non-performing asset. There is class in between which is a barely performing asset or a technically performing asset, which is a sort of an animal where you scramble on the 90th day and see that it becomes performing by ensuring that the critical amount is remitted, and this is what incumbent Chairman continue to do and the new Chairman doesn’t have to do that because he knows that this is eminent NPA anyway so why should it become an NPA when I am fully in charge so let me do it in the first stage itself.

Q: Now what has happened is that the finance ministry and the Reserve Bank of India are insisting on system recognition of NPAs. Is that at least plugging some loopholes, you just have to go with the computer and when it shows a non-payment or even there can discretion be used and you are able to make some borderline cases as Mr. Bhat said?

Narang: At least if the banks accept and implement that system-driven NPA recognition system, 90% of it will be accurate. So the element of inaccuracy will be only 5-10%. Even that makes a great job.

Moneycontrol