One of the many WhatsApp messages which went viral after the Rs 12,000-plus crore Punjab National Bank read, “I died laughing when I saw a Rs 3 pen still tied with a rope at a PNB branch.” Embedded in the dark humour is a metaphor for poor governance structures. The crux of the issue afflicting the safety of public monies is the state of supervision. Regulation verily is a Phantom Thread – viably visible when everything is hunky-dory and invariably found missing when all hell breaks loose. On the ground the real fugitive is accountability.
Last month Finance Minister Arun Jaitley spared no punches when he observed that “unfortunately in the Indian system, we politicians are accountable, the regulators are not”. It was a calibrated and calculated comment about the failure of regulation. And it seems to have hit home.
On Wednesday, Reserve Bank of India Governor Urjit Patel presented a spirited defence of the institution. Caught in the fusillade of public anger Patel responded with uncharacteristic passion to dub the post-scam discourse as “the usual blame game, passing the buck, and a tonne of honking”. The Governor then, in unusual candour, went on to speak truth to the government.
He set the tone with a sucker-punch of an assertion – Banking Regulatory Powers in India are NOT Ownership Neutral. He then went on to read out chapter and verse, the list of clauses and sub-clauses from the legal landscape to underline the helplessness of RBI when it came to regulating public sector banks, which account for nearly 70 percent of Indian banking.
Making this worse is the persistence of delays, of criminal investigation and judicial process. The Governor points out that “RBI data on banking frauds suggests that only a handful of cases over the past five years have had closure, and cases of substantive economic significance remain open. As a result, the overall enforcement mechanism – at least until now – is not perceived to be a major deterrent to frauds relative to economic gains from fraud.”
Did The RBI Do What It Could?
There is no disputing the landscape of legislative framework. The quagmire of public ownership and political management is at the heart of the fissures in the landscape of regulation and supervision.
There is also no denying the state of sloth on decisions. SS Mudra retired as deputy governor on July 30, 2017.
Equally true is the fact that this is only half the story – rather, the RBI Governor is only half right in his diagnosis. Arguably, as the Governor says, not all scams can be prevented. It is also arguable that a doctrine of deterrence is essential. The authority of public institutions stems from the exercise of power. The question that begs to be asked is, whether the RBI has done what it could.
For sure, the RBI is faced with constraints. It cannot act to remove directors or the management of public sector banks. But does it need the ultimate power to prevent malfeasance? The RBI is empowered (under Section 35 A of the Banking Regulation Act) to give directions where it is in the public interest. How often has that been deployed? Has the power of inspection been utilised?
A call for more power is not a credible demand when existing provisions have not been leveraged.
On February 20, 2018, following the PNB fraud, the RBI issued a release. It said: “The risks arising from the potential malicious use of the SWIFT infrastructure” has been a risk factor. The RBI said it had “confidentially cautioned and alerted banks” on three occasions since August 2016 and added, “Banks have, however, been at varying levels in implementation of such measures.”
So what did the RBI do since August 2016 about the “varying levels of implementation”? Did it order a special audit? Did it inform the owner about the delinquency? Were the auditors – external and RBI – informed? Did it at least inform the public at large that the repositories of their savings were playing truant in following instructions? Surely the law does not preclude putting the issue out in sunlight, cautioning the savers!
For sure, the RBI has expressed its helplessness in acting on the boards of public sector banks. Since 2015, over 2,000 cases of frauds and cheating involving over Rs 4,000 crore have been reported in private banks. What action has the RBI taken? Take the issue of letters of undertaking issued by PNB. The fraud evaded three levels of systemic checks, concurrent auditors, external auditors, and the audit teams of RBI. What is the course of action that RBI has proposed to the Government on internal and external auditors and, indeed, on its own audit team?
In December 2017, the IMF in the India Financial System Stability Assessment Program Report observed “The laws and/or regulations should explicitly authorize the external auditor to inform the RBI of any concerns at any time; also, before the annual statements have been finalized and published. The RBI should be given the explicit authority to obtain information at any time from the external auditor.” How has the RBI proceeded on this advice?
By the end of January, public sector banks had declared their results for the October-December 2017 quarter (Q3FY18).
Many underlined increased provisioning for the quarter against bad loans. Among the five that reported a profit was Punjab National Bank. Net profit was up 11.1 percent and gross non-performing assets were lower. The unstated question is, can the results of the other 20 banks be taken at face value?
How credible is the reporting given the RBI’s own lament on the state of oversight?
The elephant in the room is the political management of public assets. It is true that a succession of committees have mooted that government brings down its equity in banks.
Urjit Patel’s speech has been interpreted in some quarters as a call for privatisation of banks. The text says “From the RBI’s standpoint, legislative changes to the BR Act that make our banking regulatory powers fully ownership neutral – not piecemeal, but fully – is a minimum requirement.” He opines it as the “most readily feasible” of options – forsaking the call for change in ownership, at least for now. The question is whether the state will forsake special dispensation without divesting from ownership.
Must RBI Do Everything?
Public sector banks are subject to the oversight of the RBI, the Finance Ministry, the Comptroller and Auditor General of India, the Central Vigilance Commission and of course the Central Bureau of Investigation. That hasn’t deterred scam artists. Central to the issue of safeguarding of public monies – from outright scams or the deleterious effects of bad loans – is accountability.
Accountability is daunted by poor capacity. There is institutional capacity and then the capacity of the institution. It is indisputable that, given the complexities of banking and emerging challenges, capacity for regulation and supervision needs a total overhaul. This calls for the creation of a cadre of young professionals and induction of technology.
There is also a need to examine whether the Reserve Bank of India is the institution that should host this function.
The RBI is the issuer of currency, manager of foreign reserves, the monetary policy authority, banker to the government, regulator of banks and more.
The Financial Sector Legislative Reforms Commission had proposed hiving off functions leaving RBI to focus on monetary policy, banking and payment systems first and then eventually, after the creation of a unified financial authority, purely on monetary policy. The world of central banking has moved on in the past few years – and frequently after a crisis.
The question is whether the RBI must do all that it is doing. The function of banking regulation has been separated from the central banks in many domains. In over 30 countries the central bank is not the authority for banking supervision.
- In Australia, after the Wallis Inquiry, the Reserve Bank of Australia looks after monetary policy and payment systems while banking supervision is with the Prudential Regulatory Authority.
- In Canada, banking supervision is with the OSFI, an independent federal agency.
- In the United Kingdom, the Prudential Regulation Authority succeeded the Financial Services Authority to supervise banks and credit institutions.
There are many templates. Essential to the exercise is efficacy and accountability.
In his impassioned speech, Patel brought into play the imagery of Neelakantha consuming poison. Urjit means energised or powerful and Urjita is one of the names of Lord Vishnu. Patel must focus on Shristi, in creating a new modern architecture.
Shankkar Aiyar, political-economy analyst and Visiting Fellow at IDFC Institute, is the author of Aadhaar: A Biometric History of India’s 12-Digit Revolution; and Accidental India.
The views expressed here are those of the author’s and do not necessarily represent the views of BloombergQuint or its editorial team.