Risk Management: No longer an Option for Financial Organizations
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The business world would be nothing without risk. Whether it’s investing in a radically new company that aims to send rockets to Mars, a mobile application that deletes pictures after 10 seconds, or a website that lets you connect with old friends, every business is subject to risk and the possibility of success is usually far lower than the likelihood in failure. While private equity investments in new ventures are fraught with higher risks, banks having access to more concrete and substantiated data are supposed to be in relatively safer waters. Unfortunately, for many finance companies and banks, the need to follow set protocols without applying any intelligence in the process has challenged this norm.
The issue of non-performing assets has been a persistent issue that plagues the Indian financial industry, particularly public sector banks. While some of these are attributable to corruption, the majority are a result of overconfidence, ignoring, overlooking or not validating the raw data, or forgoing protocol. Former RBI Governor Raghuram Rajan has warned that the next crisis in India’s banking sector would come from loans given to the unorganised micro and small business (MUDRA) as well as loans and credits extended through Kisan Credit Card. He went so far as to state,“Clearly, bankers were overconfident and probably did too little due diligence for some of these loans. Many did no independent analysis."It would be safe to say that India’s financial sector is in desperate need of reform; more with regard to the mind-set, as opposed to mere legislation. Some effective reforms that can be implemented swiftly include:
Mandatory On-Ground diligence
An additional layer of on-ground independent verification needs to be urgently introduced into the current credit system. The credit rating system in India, especially in corporate and SME lending, completely fails to discuss this problem as even the rating agencies themselves primarily rely on the financial ratios provided on paper; data which is largely unverified on the ground. This is important, because what appears to look good on a spreadsheet may not necessarily give the same impression when viewed first-hand. For example, a company might claim 20 branches in India, and these numbers will be clearly reflected in any comprehensive assessment. That being said, other relevant information which is not directly related to finance such as : whether they genuinely exist, their size, operations, level of activity, working conditions, neighbourhood impression and feedback about the company, any legal notices attached on the premises etc, all of which ultimately act as an indicator of credit worthiness of the business, will not be highlighted in any financial assessment. Given the industry’s absolute reliance on the in-house assessments and the credit-rating system, which is seen as sacrosanct, a bank or financial enterprise would likely never even visit all the sites of a business in which they’ve invested or provided a loan.
Exercising Caution And Avoiding Overconfidence
It can be tempting to lend to a company that may seem to fit into the paper framework without authenticating the data. This sort of risky, overconfident behaviour for many banks and financial institutions, strictly after the law of the word and not implementing it in spirit, is responsible for several non-performing assets. Eliminating this attitude, and taking decisions based on hard, validated facts and not mere spreadsheets, is necessary to resolve the current state of the Indian financial industry.
Risk management is a continuous exercise, which has unfortunately become too esoteric for its own good. Still, it is necessary to make systemic changes to the Indian finance sector that can only be brought about by changing the thought processes of each banker, as opposed to simply developing short term solutions that will have little impact on how the industry conducts its business.