The Price of Transparency

“

"In banking, the temptation to hide bad news is the first step toward institutional decay. Laying your cards on the table, no matter how alarming the numbers, is not just a moral choice—it is a strategic decision that clears the path for recapitalization and resurgence."

During the late 1980s and early 1990s, the Indian banking sector stood at an exciting crossroad. The Reserve Bank of India (RBI) and the Ministry of Finance were actively encouraging nationalized banks to support Indian entrepreneurs establishing joint venture (JV) projects abroad. The rationale was clear: Indian banks needed to gain exposure to international project finance, establish foreign currency credit lines, and understand the mechanics of offshore trade documentation. However, entering these international waters without the requisite deposit bases or localized country risk ratings created structural vulnerabilities that soon came back to haunt the industry.

1. Sourced in the Corner Office: The Push for Global Joint Ventures

The operational appetite for this expansion often started at the very top. At one nationalized bank, the newly appointed Chief Executive arrived fresh from heading the Kuala Lumpur branch. Having spent years abroad, the CEO was fed up with the routine administrative hassles of domestic credit—handling traditional cash credit accounts, term loans, bills purchase, and local overdrafts. He wanted a modern, sophisticated portfolio.

Right at this junction, regulatory directives aligned with the CEO's ambition. The government urged banks to finance joint ventures set up in Southeast Asia by highly experienced Indian industrial houses—including prominent names like the Mittals, Bombay Dyeing, Texmaco, and others. Our bank lost no time in bringing these industrial groups into our fold, offering generous financial support both on our own and in consortium with other banks. The JVs were set up in Indonesia—a country where our bank did not have a physical branch, though we did maintain operational branches in Hong Kong, Singapore, Colombo, Seoul, and a Foreign Currency Banking Unit (FCBU) in Colombo. In short order, a major steel unit and several textile units were established under this scheme.

2. The Asset-Liability Mismatch (ALM) Trap

While the Indonesian government lent strong administrative support and the export prospects for these units looked highly favorable, the financing structure had a critical flaw: Asset-Liability Mismatch (ALM). Because Indian banks were not permitted to take local deposits from the public in Indonesia, they lacked a stable, low-cost domestic funding base. To fund these long-term foreign currency loans (which were denominated in US Dollars), the banks had to rely on short-term local interbank call money markets, and short-term swap markets and roll-overs. This meant funding long-term assets with "hot," short-term money. To make matters worse, Indian banks at the time did not enjoy strong sovereign or country credit ratings in the global interbank market. Consequently, the rates we had to pay to borrow and roll over these funds in international markets were extremely stiff, squeezing our interest spreads.

3. The Double Devaluation and the Japanese Yen Trap

For a while, the going was good. But the vulnerability of the cash flows soon exposed the project to massive currency risk. The joint ventures generated revenues primarily in Indonesian Rupiah. Suddenly, the Indonesian currency underwent a massive devaluation. Before the borrowers or the banks could adjust their cash flow models, a second devaluation followed. The Rupiah cost of servicing the US Dollar-denominated interest and principal skyrocketed.

In an attempt to rescue the borrowers from expensive Dollar loans, the financing banks exercised an option to convert the USD-denominated loans into Japanese Yen (JPY) loans, which carried lower nominal interest rates. This proved to be a disastrous miscalculation. The Japanese Yen appreciated dramatically. The principal value of the loans in terms of the local Rupiah ballooned to two and a half times the original borrowing. With a sluggish domestic Indonesian market, stagnant exports, and a principal liability that had more than doubled in local currency terms, the units reached a point of no return. Overdues mounted rapidly. The bank could not even recover the swap and roll-over costs of the foreign currency lines.

4. The Promoted Candidate's Burden

As the files deteriorated, they were classified as Non-Performing Assets (NPAs), requiring massive loan loss provisioning. It was at this critical juncture that the author was put in charge of the Indonesian files at the Head Office. The assignment was widely seen as a corporate landmine. The interviews for my promotion to Executive Director (ED) were approaching. In the previous round of promotion interviews, candidates from other banks had been grilled extensively about their offshore NPAs, with several qualified executives being rejected simply because their banks had "drowned" in foreign currency defaults.

When I expressed my deep apprehensions to my superiors about taking over these troubled files right before my interview, I was sarcastically told that if I refused, they would ensure my Confidential Report (CR) explicitly noted that I was avoiding the bank's most critical files. With no choice but to accept, I took charge of the Indonesian portfolio on a war footing.

5. Skeletons in the Cupboard: The Rs. 1,000 Crore Decision

As the balance sheet publication date approached, the statutory auditors delivered a shocking blow to the Chairman: the bank’s accumulated losses and provisioning requirements on these Indonesian files meant we would have to declare a loss of over Rs. 1,000 crores. At that time, a loss of this scale was entirely unprecedented in Indian banking. The CMD called a closed-door meeting of senior executives. The mood was somber. The CMD laid out the facts and asked a fundamental question: should we allow the balance sheet to reflect the full extent of the loss, or should we find accounting workarounds to keep these skeletons hidden in the cupboard?

The CMD appreciated the courage of the team but warned us of the far-reaching consequences: Loss of VIP Customers (high-net-worth clients would panic and shift deposits), sagging morale (junior and middle-level staff facing public scrutiny), and the slog (senior executives working double-time to rebuild morale and run recovery drives on a war footing).

6. Transparency Pays Off: Sovereign Recapitalization and Resurgence

The publication of the balance sheet made our bank the talk of the town. Competitors made fun of us, and anxiety was high. But our transparency triggered a decisive response from the regulators and the state. Having laid all our bad debts bare, the Ministry of Finance and the Reserve Bank of India realized that the bank's operational core was sound and that the capital wipe-out was due to structural offshore JV policies. Consequently, the government stepped in and funded our bank with Rs. 600 to 700 crores in sub-debt and equity recapitalization.

This massive capital injection lifted the balance sheet and boosted staff morale. Armed with clean books, the bank launched aggressive recovery drives. Over the next few years, we achieved outstanding recoveries on the bad debts, allowing us to write back substantial provisions directly into our profit and loss account. Within a short period, the bank went from declaring historic losses to posting substantial profits. We successfully launched a public issue (IPO) that was heavily oversubscribed and reclaimed our position among the top-performing nationalized banks in the country.

Many competing banks that had initially mocked IOB's transparent disclosures eventually repented. By hiding their own bad loans, they missed out on the government's recapitalization funds, leaving them to struggle with hidden NPAs for years to come.

Key Takeaways for Modern Bankers

• Avoid Funding ALM Mismatches: Long-term project finance must not be funded by short-term call money or volatile swaps, especially in countries where the bank lacks a stable deposit base.
• Currency Risk is Multi-Dimensional: Converting a loan from one foreign currency (USD) to another (JPY) to capture lower interest rates can backfire catastrophically if the conversion currency appreciates.
• Embrace Balance Sheet Transparency: Hiding NPAs only delays recovery. Clean, transparent disclosures are the only way to restore long-term investor trust and unlock regulatory support.