Performance budget settlement process in public sector banks

Mohinder N. Kaura

The paper reviews the performance budgeting system adopted by nationalized banks in the seventies. Based on a questionnaire and interview survey of over 100 branch managers of four public sector banks, the study identifies some of the strengths and weaknesses of the branch level performance budget settlement process as it is practised, and provides a number of suggestions for improvement.

Dr. Kaura is a senior/acuity member, finance area, at The Administrative Staff College of India, Hyderabad.

Nationalized banks in India constitute a strategic sector. They account for the vast bulk of advances and deposits of the Indian banking system. They are endeavouring to penetrate into the remotest areas of the country in order to mobilize savings and investments and to weaken the stranglehold of the moneylender. As a rule they have more missions to perform than the private sector commercial banks, including opening branches with initially little business potentialoften in remote or underdeveloped areas, giving priority to the weaker sections of society, funding entrepreneurs that may be poor risks, etc. As large organizations with multiple, complex, and sometimes conflicting missions (e.g., earn a good profit versus service weaker sections), professionalization of their management is imperative, especially, the control of their variegated performance. The performance budgeting system is a significant tool of professional management that nationalized banks have adopted. If it works effectively it may have a far-reaching impact on the working of nationalized banks, and perhaps even on their organizational clients, since the latter could be induced by the banks to adopt an effective tool of management. In the context of banking, performance budeting system is essentially a multi-level and an on-going annual process of management -planning and control which enables a bank to accomplish its corporate goals by involving people from top to bottom for formulating and implementing a time bound and realistic action plan. A performance budget is a comprehensive operational document which translates the aspirations of a bank into meaningful and feasible action progrmmmes and activities for realizing that objectives. It does so by integrating financial as well as physical targets of performance on major items of business or service. In this sense, the system of performance budgeting represents a proper blending of corporate planning, management by objectives, and physical and financial evaluation system for management control purposes. The Banking Commission in its report in 1972 recommended various management tools including the introduction of planning and budgetary control systems in order that the
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banks are better able to increase their operational efficiency (4). Also in 1972, the Ministry of Finance, Banking Department of the Government of India, directed public sector banks to prepare annual business plans and take measures to introduce performance budgeting. Further, in the top management seminars sponsored by the National Institute of Bank Management in May 1972 and April 1973, it was decided to introduce performance budgeting in commercial banks. The report of the Productivity, Efficiency, and Profitability Committee on Banking (PEP committee) set up by the Reserve Bank of India in 1977 stressed the need for adopting planning and performance budgeting in banks and stated : "The performance budget helps the management to proceed along the projected goals and the performance evaluation at monthly or quarterly intervals indicates the deviations and corrective actions that should be initiated"(5). The performance budgeting system was initially introduced in 1972 by one of the major commercial banks in the country (State Bank of India) for accelerating the tempo of efforts to channelize credit to priority sectors. Subsequently, it was launched in other banks. Since 1974 most of the nationalized banks and some of the private sector banks have adopted this system. However, some of these banks introduced performance budgeting system in a phased manner rather than simultaneously extending its scope to all regions and all branches. Performance budget in a bank has to be formulated after taking into account several factors : (a) The policy framework provided by the Reserve Bank of India; (b) business potential available in the context of the economic, political, and social environment; (c) internal strengths and constraints in terms of the capacity of the staff and physical facilities available; (d) past trend of business in the bank, as well as in the industry; and (e) anticipated changes in both environmental factors as well as policies of the Reserve Bank of India. The overall process of performance budgeting as practised in commercial banks consists of two phases : Formulation and settlement of the budget and reviewing or monitoring of performance. (Figure 1 presents the details of the process schematically.) Vikalpa

Figure 1 Flowchart showing the process of performance budgeting in commercial banks

Input Long term plan and objectives Output Annual plan blueprint and head office guidelines

Analysis of external and internal environment

Regional policy guidelines

Branch's past performance and environmental data

Compilation of draft branch budget

Settlement of branch budget

Divisional administrative expenditure data

Divisional budget formulation

Settlement of divisional budgets

Head office administrative expenditure data

Bank budget formulation and its approval by Board

Performance review at different levels, branch, division, and head office

Decision on corrective steps

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The settlement process The settlement of budget is a vital step in the process of development of realistic and mutually acceptable budgets. It bridges the planning gap that may exist between draft branch budgets compiled by the branch manager on the basis of his judgment of the likely business potential, and aspirations of the bank as embodied in the head office policy guidelines. During the settlement meetings with the divisional manager, the branch budgets are adjusted to the needs of the corporate plan and the available business potential. "An ideal settlement process recognises the planning gap that usually exists between the branch manager and regional manager. It calls for a free and frank dialogue between the regional manager and the individual branch manager with a clear awareness on the part of both of the constraints under which they have to work and of the goals to be reached(3)." Similarly, to close the planning gap that might exist between the draft divisional and regional budgets, a settlement meeting is necessary in which the divisional and regional managers hold a face to face discussion with the chairman and managing director and the chief of functional departments at the head office.* This process of settlement of divisional budgets involves the matching of apex-level aspirations with the regional potentials, strengths, weaknesses, opportunities, and threats. Thus the budget settlement process involves the crucial matching of the macro and micro level planning expectations through an interface of the controlling authority and the executive in charge of the budget centre. The purpose of this paper is to examine critically the performance budget settlement process followed in commercial banks and to offer suggestions for overcoming its imperfections with a view to enhancing the effectiveness of the system. Methodology For the purpose of the study, 20 public sector banks were statistically selected. Based on the size of operations, i.e., the level of deposits and
*In banks having four tier organizational structure (head office, zone, division, and branches) there will be an additional budget settlement level. 38

advances, these banks were divided into four groupslarge, medium, small, and newly nationalized banks. From each of the groups, the bank closest to the mean of deposits/ advances was chosen. Since the branch is the operational unit through which almost the entire business of the bank is achieved, the settlement of the branch budget has been given the pivotal place in the analysis presented in this paper. A questionnaire was administered to 5 per cent of the branches of the sample banks and was evenly distributed to the branch managers of rural, semi-urban, urban, and metropolitan branches. The response rate was 58.1 per cent. The questionnaire data were supplemented by semi-structured interviews with executives working at different levels of the sample banks. Relative importance of various inputs in the settlement of the branch budget Branch managers were asked to rank the importance given to various inputs by their bosses, that is, the divisional managers, in finalizing the budget for their branches (Table 1). They assigned the highest rank to policy guidelines issued by the head office which is closely followed by past performance of the branch. Both these factors were very close to each other in claiming the first rank. Environmental data and regional/divisional policy guidelines are ranked low. Only in the case of metropolitan and semi-urban branches with a balance of deposits and advances, have branch environmental data been given a high rank. However, regional policy guidelines have been given the least importance irrespective of the population centre and overall nature of the business of the branch. The high importance currently given to head office policy guidelines in setting the branch budgets seems justified. But the low importance given to the branch environmental data, compared with the branch's past performance, is far from desirable. The past performance is merely an indicator of the past attainments and is not a good gauge for decision about future potentialities. Judgments about future capabilities should be based on branch environmental data. Since the past data relating to branch are available with both the divisional manager and the branch, there is not much scope for a two-way communication about it. Policy guidelines also assume the Vikalpa

form of a one-way communication.Failure to give high importance to the branch's strengths, weaknesses, opportunities, and threats, as reflected by the information relating to its environment, hampers the process of two-way communication, which is so essential for developing realistic and mutually acceptable budgets at the grassroots level. Since the regional policy guidelines have negligible impact on budget formulation and settlement, either this activity can be dispensed with or made more useful to serve as a link between the branch budget and the corporate budget. The manner in which the budget settlement meetings takes place is equally important for the effectiveness of the performance budgeting exercise in achieving its objectives. Although 100 per cent perfection of the settlement process can seldom exist, the presence of largescale imperfections would prevent the achievement of objectives. What is needed is an efficient matching of branch potentialities and the aspirations of the bank as embodied in the head office guidelines and draft plan document, through active participation and discussion between the divisional manager and his branch managers. In other words, the settlement of the branch budget must take place through "a well meaning exchange of views on the most viable budget that would have organisational commitment. Jointly testing various alternatives in

the light of their respective implications is certainly involved but that is something different from bargaining (6)." Regarding the manner in which decisions concerning targets for deposits, advances, and manpower requirements are arrived at in the course of budget settlement meetings in actual practice, the branch managers were divided in their responses to a specific question. The summary of their responses is shown in Table 2. Nearly 60 per cent of the branch managers supported the view that the targets/assessments concerning deposits, advances, and also manpower requirements are made jointly by branch managers/divisional managers by participation and discussion. A sizeable number of respondents held the view that targets/assessments are first made by the higher authorities and then discussed with the branch managers for finalization and modifications. A few of the branch managers indicated that in their case, targets/assessments are made by the higher authorities and announced without giving them any opportunity to raise questions. In contrast to this, the apex level unanimously supported the view that targets/assessments are made jointly by the divisional/regional and branch managers. The study on performance budgeting in public sector banks made by NIBM in 1977 found that only in the case of 37 per cent of the

Table 1 Ranking of importance of various factors in finalizing branch performance budget

Metropolitan Importance Urban Semi-urban Rural Depo- Adva- Bala- Averasits nces nee ge heavy heavy Rank I II I II I II II I

Depo- Adva- Bala- Depo- Adva- Bala- Depo- Adva- Balasits nces nee sits nces nee sits nces nee heavy heavy heavy heavy heavy heavy II I III I II I II I I II I II II I II IV

a) Past perfor mance of the II branch b) Policy guide lines of the I head office c) Policy guide lines from III the regional office d) Environ mental data IV for the branch

III

IV

IV

HI

IV

III

IV

III

IV

III

III

IV

IV

II

III

IV

III

IV

III

III

IV

IV

III

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branch managers were targets for deposits and advances fully discussed by both parties(l). Hence there may have been a marked improvement in the mode of budget settlement meetings during the last three years, as the present study revealed that targets are fully discussed with nearly 60 per cent of the branch managers. Table 2 Procedure for settlement of branch budget targets as perceived by 107 branch managers Deposits Advances Manpower % of res- % of res- % of respondents pondents pondents Settlement procedure 1. Targets/ assessments are made jointly by branch manager and divisional/ area manager by participa tion and discussion 2. Targets/ assessments are first made by the higher auth orities and then discus sed with the branch manager for finalization and modifi cation, if any 3. Targets/ assessments are made by higher authrities and announced with hardly any opportu nity to raise questions or offer comments 4. No response Total

In response to a question related to the mode of budget settlement, over two thirds of the branch managers indicated that for arriving at an agreement on targets for the budget, both the divisional managers and branch managers have to make a compromise. Over a fifth indicated that they had to compromise, while only 7 per cent stated that their divisional managers compromised. Decision on changes in targets Any changes decided in the level of deposits, advances, and manpower needs for the branch in the course of budget settlement meetings, could be justified by the potential suggested by the branch environment, the level of past performance, divisional managers' comments, and promise for additional facilities. Table 3 presents the branch managers' views on the basis for making such changes. Over a third of the branch managers reported that the decisions for changes in budgeted targets were justified by the potential suggested by the branch environment and about anolher one third indicated that changes were justified by past performance. About 28 per cent held the view that the changes were justified by the divisional managers' comments to higher authorities, and promise for additional facilities. A surprising feature of the budget settlement meetings is that a majority of divisional managers have rough targets for deposits and advances for different branches with them, when they come to the meetings. Table 4 shows that three fourths of the branch managers believe this to be so. In the NIBM study too, about 84 per cent reported divisional managers having rough targets. Reasons for imperfections of the budget settlement process

57

62

55

22

19

13

16 4 100

14 5 100

26 6

The findings suggest two imperfections in the, process of budget settlement currently operating in commercial banks in India; participative budget settlement is absent in a significant minority of cases, and in the absence of a realistic environmental scanning, target setting tends to be a mechanical process. Several reasons could be advanced for this unsatisfactory position. Firstly, divisional/regional managers have to attend to a large number of branches which are geographically widespread. The time available for finalizing the branch budget is inadequate and so the budget settlement assumes the form of a large conference attended simultaneously

100 Vikalpa

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Table 3 Justification for revision of branch targets during settlement meetings (%)

Area

Divisional/ regional managers' comments to higher authorities

8
6 1 4 19

Potential suggested by the branch environment 8 11

8 6 33

Past performance by the branch

Promise for additional facilities

Metropolitan

10 11
6 2 29

1
2 4 2 9

Urban Semi-urban Rural Total

Table 4

Divisional/regional managers having targets in mind at the budget settlement process according to branch managers (%] Areas Metropolitan Urban Semi-urban Rural Total
Agree 21
24 20 10 75

Disagree 6
7 3 5 21

No response
2 1 1
4

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by 20 to 30 branch managers in which barely a few minutes can be devoted to the budget for each branch. In fact, one of the respondents reported that in his bank all the branch managers of the state were called together for a meeting and in such a big group, it was not possible to discuss all the points relating to a branch with the controlling authority. Hence budget settlement meetings often do not offer much scope for an open discussion between the divisional manager and the branch manager, so essential for ensuring involvement of the units. Secondly, the atmosphere for discussing in a free and frank manner gets vitiated due to display of authority by the divisional manager or the fear of superior authority in the minds of the branch managers. Added to this is the problem created by the tendency of divisional managers to attend the budget settlement meetings with preformed rough targets for each of the branches under their charge. This breeds the habit of branch managers resorting to underbudgeting and the divisional manager arbitrarily raising the targets without convincing the former about the bases for them. Consequently, budget settlements iare often not carried out on the basis of facts and logic and are reduced to mere bargaining or targeting sessions. Lack of mutual trust between the controlling units and the budgeting units adversely affects the credibility of the annual budget settlement process. Another reason for unsound settlement procedures is the lack of suitable methods for drawing meaningful interpretations from the environmental data by both the parties for judging business potential. "The matching, therefore, has necessarily to rely largely on impressions with some back up from historical data regarding past performance (6, p. 364)." The problem gets aggravated when the discussion in a settlement meeting is restricted to levels of deposits and advances and excludes additional manpower and other resources needed for achieving increased business targets. "Owing to the essential inter-linkage between business and manpower, such an approach obviously causes problems in that one critical aspect of matching is left hanging (6, p. 373)." The by-passing of the input budget demotivates the branch managers from putting their best effort for accomplishing the goals of the bank. The quality of customer
42

service provided, which is an important output of one period and an input for the next period, also does not figure in the discussion. It would be useful to quote here the views of a banker on the position of controlling authority presented in a paper in a national seminar. "The actual settlement however is a difficult job because the regional manager has not only to settle the business budget but also the resource budget. There again his hands are mostly tied. So, what he has to do is to plan his budget within the given resources and ask the branch to execute theplan(2)."
Suggestions for improvement

Several suggestions can be made to minimize the shortcomings and to make the system of performance budgeting fully serve the purpose for which it was originally introduced in the commercial banks. These suggestions flow from the findings of the research as well as suggestions made by respondents. Firstly, the practice of head office deciding in advance as to how much each region should contribute and the divisional manager in turn having rough targets for each branch in his mind at the settlement meetings should be discontinued. During the budget settlement meetings the branch manager should be asked to give reasons or justify the draft budget prepared by him and if his explanations are adequate and convincing, the targets proposed by him should be accepted without change. It would be better if the budget is finalized with the divisional/regional manager after a free and frank discussion of the branch potential and its problems, item-wise, across the table, rather than by display of authority. The performance budget session should be attended only by a few branch managers at a time. The budget should not be imposed from the top under any circumstances. Although both the parties are to be equally involved in finalizing the budget, the primary responsibility for creating a conducive and supportive atmosphere for settlement, through joint participation based on facts and logic rather than extraneous factors, is that of the divisional/ regional manager. Secondly, it would be preferable if the controlling authority visits all the branches for the Vikalpa

purpose of budget settlement, so that the discussion can be more open and fruitful. Thirdly, for the success of performance budgeting, the provision of infrastructure in general and manpower in particular is absolutely essential. The planned business results can only be achieved when needed resources are provided to the branches. In fact one of the respondents mentioned that manpower requirements should be finalized even before budgeting for business starts. Failure to budget the manpower and other resources results in a dilution of the branch managers' commitment to the branch targets. Hence, performance budget for business must be correlated with manpower and physical resources budget. Manpower requirements should not be based on the number of vouchers but on a broad understanding of the problems of the branches including the capacity and efficiency of the existing staff. Fourthly, in framing the draft budget and its settlement, greater emphasis should be placed on the quality rather than the quantity of growth. Improvement of customer services and reduction of sick accounts should also form part of the performance areas in the budget. Also the targets for deposits should be examined to see whether the growth is in savings or term deposits or current accounts. Fifthly, for ensuring that the branch and the regional budgets are based on business potential suggested by the branch environment, and for providing timely feedback to the branches on their performance, special staff should be provided in the regional offices for collecting and processing information relating to the region and branches. This will strengthen the information base at the regional office and be of immense help to regional managers in meaningful settlement and review of branch budgets

based on their strengths and weaknesses on the one hand and embodying an element of challenge in the budget proposals on the other hand. Lastly, training of branch managers and the regional managers is necessary for educating them on the methodology for translating the environmental data into meaningful budget targets. This will also ensure proper understanding of the basic purposes of the performance budget exercise. Further, this will promote the right kind of attitude in the branch managers as well as the regional managers for cultivating a rational approach towards performance budgeting and its successful implementation. Needless to say that the introduction of a managerial innovation like PBS should be accompained by an effective programme of human resources development.
References

1. NIBM report on performance budgeting in nationalised banks, National Institute of Bank Management, Bombay, 1977, p. 53. 2. Pathak.K.B., "The settlement process," paper presented at the National Seminar, M.S. University, Baroda, 1979. 3. Puri, A.S., "Performance budgeting," IBA bulletin, Indian banks association, November 1979, p. 10. 4. Report of banking commission, 1972, pp. 331-33. 5. Report of the committee on productivity, efficiency, and profitability in banking, Reserve Bank of India, 1977, II-2. 6. Roy, T.S., "The macro-micro matching prob lems under performance budgeting". State Bank of India Bulletin, October 1979.

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