It is rare to hear speeches by the current RBI Governor and even rarer to see him hit back at critics of RBI’s role in the recent bank fraud.
In a hard hitting speech, he takes on several issues surrounding the bank fraud. The key part of the speech is that RBI does not have powers to regulate the Public Sector Banks as much as it has for private sector banks. In other words, the banking regulatory powers should be ownership neutral:
All commercial banks in India are regulated by the RBI under the Banking Regulation (BR) Act of 1949. Additionally, all public sector banks are regulated by the Government of India (GoI) under the Banking Companies (Acquisition and Transfer of Undertakings) Act, 1970; the Bank Nationalisation Act, 1980; and the State Bank of India Act, 1955. Section 51 of the amended BR Act explicitly states which portions of the BR Act apply to the PSBs, most common thread across the omissions being complete removal or emaciation of RBI powers on corporate governance at PSBs:
- RBI cannot remove directors and management at PSBs as Section 36AA(1) of the BR Act is not applicable to the PSBs.
- Section 36ACA(1) of the BR Act that provides for supersession of a Bank Board is also not applicable in the case of PSBs (and regional rural banks or RRBs) as they are not banking companies registered under the Companies Act.
- Section 10B(6) of the BR Act that provides for removal of the Chairman and Managing Director (MD) of a banking company is also not applicable in the case of PSBs.2
- RBI cannot force a merger in the case of PSBs as per Section 45 of the BR Act.
- PSB’s banking activity does not require license from RBI under Section 21 of the BR Act; hence, RBI cannot revoke a license under Section 22(4) of the BR Act as it can in the case of private sector banks.
- RBI cannot trigger liquidation of PSBs as per Section 39 of the BR Act.
- Furthermore, in a remarkable exception of sorts, in some cases there is duality of Managing Director and the Chairman – they are the same – implying the MD is primarily answerable only to himself or herself.
This legislative reality has in effect led to a deep fissure in the landscape of banking regulatory terrain: a system of dual regulation, by the Finance Ministry in addition to RBI.3 I will now take a few minutes to explain why this fissure or the fault line is bound to lead to tremors such as the most recent fraud.
Temptation to engage in fraud at the level of employee or employees is always present, in banks (or in corporations), be it in public sector or private sector. The question then is whether there is adequate deterrence faced by employees from undertaking frauds and enough incentives for management to put in place preventive measures to preempt frauds.
….. 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. It might also be the most readily feasible of these options.
But this is not clear. If this arrangement has been so problematic, how come RBI continues to have one independent director sitting on the PSB Board? What has been their role? One would imagine that RBI nominee would bring the required discipline and expertise. But this has not been the case. Is all this then mere corporate board dressing?
No Banking Regulator Can Catch or Prevent All Frauds
Another point is in order before I move to the broader issue of bank stressed assets and their resolution. There has been a tendency in the pronouncements post revelation of the fraud that RBI supervision team should have caught it. While that can always be said ex post with any fraud, it is simply infeasible for a banking regulator to be in every nook and corner of banking activity to rule out frauds by “being there”. If a regulator could achieve such perfect outcomes, it would effectively imply that the regulator can do anything that banks can do, and by implication, can simply perform the entire banking intermediation activity itself. What is needed is that various mechanisms to deter frauds and other irregularities are in place and have bite so that fraud incidence is low and magnitudes contained. Indeed, frauds have happened at banks in regimes with varied levels of banking regulatory quality and in both public and private banks.
In the specific case at hand, the Reserve Bank had identified, based on cyber risk considerations, the exact source of operational hazard –through which we understand now the fraud had been perpetrated. In particular, the RBI had issued precise instructions via three circulars in 2016 to enable banks to eliminate the hazard. It turns out ex post the bank had simply not done so. Clearly, the internal processes at the bank failed in allowing the operational hazard to remain in place in spite of clear instructions to close it. As we have stated in RBI’s only press statement on this case to date, this was essentially an operational failure at our second largest public sector bank. The RBI will undertake actions against the bank that it is empowered to but this set is limited under its BR Act powers over PSBs.
Indeed, in a recent interview to the Press Trust of India, March 11 2018, the IMF Deputy Managing Director Tao Zhang has reinforced this point along with others I alluded to above:
“[W]e think the PSB recapitalisation should be part of a broader package of financial reforms to speed up the resolution of NPAs, improve PSB governance, reduce the role of the public sector in the financial system, and enhance bank lending capacity and practices… The experts recommended legal changes to enable the RBI to extend all the powers currently exercised over private sector banks to public sector ones; in particular, regarding Board member dismissals, mergers, and license revocation… Having said that, banks’ operational risk management, risk culture, internal control frameworks and external audit function should typically play a central role in preventing fraud.”
It is a fair point that banking supervision cannot catch all frauds. But this fraud was happening over 7 years and is a fairly big amount. The branch was based in Fort Mumbai right under the nose of RBI and not a remote branch. If supervisors had asked the right questions over such a large loan, then one could have atleast sniffed something fishy in these deals.
Then he speaks about the recent measures taken by RBI to improve the credit culture of banks. It has become a fashion to quote something from the historic texts. Deputy Governor had invoked Sudarshan Chakra and the Governor speaks about Samudra Manthan:
I have chosen to speak today to convey that we at the Reserve Bank of India also feel the anger, hurt and pain at the banking sector frauds and irregularities. In plain simple English, these practices amount to a looting of our country’s future by some in the business community, in cahoots with some lenders. As safeguards of your deposits at banks, and starting with the Asset Quality Review of banks announced by the Reserve Bank in 2015 – since ably conducted by our supervisory teams and as acknowledged objectively by experts of reputed multilateral agencies, we are doing all we can to break this unholy nexus.
I see what we have undertaken for cleaning up the credit culture of the country – in particular, the comprehensive regulatory overhaul announced by the Reserve Bank on February 12th for prompt recognition and resolution of NPAs at banks – as the Mandara mount or the churning rod in the Amrit Manthan or the Samudra Manthan of the modern day Indian economy. Until the churn is complete and the nectar of stability safely secured for the country’s future, someone must consume the poison that emanates along the way. If we need to face the brickbats and be the Neelakantha consuming this poison, we will do so as our duty; we will persist with our endeavours and get better with each trial and tribulation along the way.
I do wish more promoters and banks, individually – or collectively through their industry bodies, would reconsider being on the side of Devas rather than Asuras in this Amrit Manthan.
The owner of our public sector banks – the government –which has provided the IBC, the related ordinances and the bank recapitalisation package to get the churn going, might consider making further, equally important contributions by:
- Making banking regulatory powers neutral to bank ownership and leveling the playing field between public sector and private sector banks; and,
- Informing itself about what do with the public sector banking system going forward as part of optimising over the best use of scarce national fiscal resources.
It is an open issue whether centralised government control alone can be effective enough at designing and implementing governance of banking franchise comprising over 2/3rds of the sector’s deposits and assets. It would be better instead to restore regulatory and market discipline.
These, and other structural reforms to the banking sector, would enable India to grow sustainably at respectable rates. Thank you.
This is making the central bank look very righteous (devas) and make the banks appear as villains (asuras). The reality is not as simple.
RBI is equally to blame in all this banking mess. Their is very little accountability for all its actions. This speech is surprising and has perhaps come die to sever pressure. PNB fraud is a case of several oversights and RBI oversight is one of them.
I give credit to the Governor for bringing to limelight these several issues which have hindered RBI in playing its regulatory role. However, it is a bit too much to say RBI is the Neelakantha (Lord Shiva!) in all this so called Manthan…