Why does Indian central bank need things like Prompt Corrective Action despite having inspection powers under Banking Regulation Act?

Despite many years of rising NPA and bank problems, we just keep moving from one regulation to other. The latest regulation is Prompt Corrective Action which  apparently is not really new. It was started in 2002 and has been modified recently in 2017. As expected, media is buzz with whether this PCA 2.0 will correct banking problems.

What is not understood or questioned how these things have gone so wrong?

RBI is perhaps one of those few central banks which has extensive powers to regulate and monitor our banks. The central bank got these powers under Banking Regulation Act (1949). Section 35 of the Act gives wide inspection powers to the central bank. RBI in its first history volume celebrates passage of this Act which gave central bank powers to put our banks in order. Apart from capital and reserves requirements, the History notes:

(x) INSPECTION
The clause was redrafted somewhat on the lines of the Banking Companies (Inspection) Ordinance, 1946. The Reserve Bank was given full discretion to inspect a bank at any time so that the public might have no ground for drawing any unfavourable inference from the fact that a bank was inspected. Other important features of the new clause were that the Reserve Bank should employ only its own officers to conduct the inspections and that a copy of the Bank’s report on the inspection should in all cases be sent to the inspected bank.

(xi) FURTHER POWERS AND FUNCTIONS OF THE RESERVE BANK
In view of the much publicised criticism regarding the aloofness of the Bank, a new clause was added enlarging the Bank’s powers and functions in relation to banks. The clause empowered the Bank to caution and advise banks, to assist them as intermediary or otherwise in proposals for amalgamation and to grant loans to them [under amendment proposed by the Select Committee to Section 18(3) of the Reserve Bank Act referred to later] against any security the Bank might consider sufficient. The Bank could also call upon an inspected bank to hold a meeting for considering matters relating to the inspection and to make such changes in its management as might be necessary thereupon. The Bank was also placed under a statutory obligation to submit an annual report to the ‘Central Government on the trend and progress of banking in the country.

The act gave RBI a responsibility to issue a statutory report on banking which became Report on Trend and Progress of Banking in India. Read the BR Act (1949) for more details. One would imagine there is enough ammunition in the act to act on basic banking principles. We have thought and worked on the source of banking problems nearly 60 years ago. One wonders which other central bank has such powers over its banking system.

Despite such powers, we continue to get routine banking problems like NPA, misgovernance etc.  It is highly unlikely that these inspection reports are unable to spot bad loans kind of problem right at the time when these loans are given. One can understand the NPAs rising due to some unforeseen shock like say global recession hitting every other economy. But what we have been seeing is NPAs resulting due to routine banking stuff like lending excessively during booms, bad monitoring of loans, lending more to cyclical sectors and so on. How is it that inspection teams are not really addressing these issues right at the beginning or couple of years after the loan? Why do problems become so big at the first place?

Thus, the real question is not whether PCA 1 or 2 can solve the problems. Infact they only complicate matters with all kinds of things like thresholds, actions, interactions.

The real question is why is Banking inspection and supervision is not really addressing these issues right at the beginning? Why is the inspection not prompt enough when that is its entire purpose? How and why do basic banking problems become so big?

This is quote similar to the recent issue of Wholesale banks. Instead of questioning the rationale and closure of earlier wholesale banks – development financial institutions- we are again thinking of starting the same entity under a different name.

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