The Indian banking purgatory – 1/3

In the very early hours of 6th March morning (12 past 12, to be precise), I had shared with my mailing lists a long article by Tamal Bandyopadhyay on how the Indian banking system is being actually changed even as the ‘stone-throwing’ and hand-wringing continue. It was a well written article and one that gives a sense of perspective on the state of affairs in Indian banking and the government’s (and the regulator’s) response to it. Much is being done. As I wrote in MINT on the 6th March, Indian banking system is making progress one fraud at a time.

There is a lynch-mob mentality out there. People are casting their net in partisan waters to catch the fish from the other side and swallow it. I am unconvinced that RBI should be blamed or, for that matter, even the Board of Directors. Yes, one can attach moral responsibility to both bodies. But, honestly, being on the Boards of few companies, I can say with confidence that unless flagged either by the Internal Auditors or by the Statutory Auditors, the Board cannot, on its own, find out operational errors and frauds.

Let us say that the Board, after reading an RBI circular on how banks must reconcile SWIFT with ‘Core Banking’, creates a RBI-Compliance checklist. The Board can and will take up the checklist and ask the management to present status reports on the checklist. If the management said that it has been done and presents audit reports to show that nothing has been flagged, it would be very difficult for the Board to dig deeper into one specific area. If it happens, it must be mostly an extraordinary coincidence and a matter of luck too.

For the most part, it is a Management responsibility. Clearly, multiple layers of management must be involved or, alternatively, multiple layers were asleep at the wheel.

Check out parts of the speech by the former Deputy Governor Mr. K.C. Chakraborty in 2013:

Even in instances where investigations are concluded, there is a tendency to hold only the junior level officials involved in post disbursement supervision accountable and ignore the lapses on the part of higher officials who were involved in sanctioning of the advances, unless of course, the case becomes a high profile one or if some personal vengeance is involved. Our experience is that the accountability examinations do not comment on lapses of sanctioning officials even while the fraudulent intentions of the borrower might have been overlooked by the sanctioning officials ab initio.

Of course, in the same paragraph, he goes on to hold the Board/Top management too responsible for ensuring that systems are in place,….. But, even then, that is a 10,000 feet altitude recommendation. Quite specifically and actually on the ground, the Board can recommend and insist on a framework, can ask for reports on how the framework is monitored or complied with, etc. But, if layers of management were a party to the fraud, these reports and monitoring would come across as ineffective, ex-post.

In his speech on February 1 – that speech deserves to be blogged separately – Dr. Y.V. Reddy stressed the role/culpability of auditors in the emergence of Non-Performing Assets/fraudulent transactions:

An unexplored area is the role of auditors / Company Secretaries in blurring the distinction between genuine transactions and fraudulent transactions, perhaps, contributing to NPAs. [Link]

Rhetorical questions about what Raghuram Rajan was doing as RBI Governor, etc., are really roads to nowhere. Similarly, someone had flagged this article that shows that the UPA government had allowed private jewellers to import Gold in May 2014, five days before the new government took office. There may be many things wrong with this including, most obviously, cronyism, etc., but quite how the move could be made responsible for the bank fraud escapes me. The NDA government had scrapped it in November of that year, as the article says and all restrictions on gold imports were lifted for all.

Again, Mr. K.C. Chakraborty has this to say on what RBI does on a regular basis:

On its part, Reserve Bank promptly shares information with all banks detailing the modus operandi of fraud cases reported by any bank together with details of the entities involved in the perpetration of such frauds in the form of confidential caution advices. This also serves to encourage periodic review of existing guidelines, identify loopholes on the basis of caution advice, if any, and initiate corrective steps. Reserve Bank has also issued instructions requiring banks to report negligence or involvement of entities like Chartered Accountants, valuers and advocates resulting in perpetration of frauds, to their professional oversight bodies for appropriate deterrent action.

A final point: just as it is impossible for the regulator – RBI in this case – to do transactions based supervision, there are considerable limitations to the Board doing transactions based supervision too.

To sum up, it is really about the Management and the owner who appoints them! – the Government of India. To the extent that management performance and accountability are a function of the culture that government ownership brings about, the owner is equally culpable. Frankly, the government’s letter to RBI sent two to three weeks ago is a case of ‘passing the buck’.

That brings us to the central theme of Tamal’s piece. Much is being done. But, is enough being done?

Is what is happening in Indian banking a paradigm shift? It is and it is not. IBC (Insolvency and Bankruptcy code) and the NCLT (National Company Law Tribunal) auctioning off assets are paradigm shifts. But, management arrangements, selection, Board Composition, Board accountability, De-linking political nexus, etc., not even a minute particle has shifted yet.

This is a ‘wonderful’ occasion – a crisis is a gift to reformists-change agent-policymakers for the Government to sweep out the old and bring in the new retain parts of the old while blending something new. Or, at least, contemplate something like that. But, the door has been repeatedly shut on such possibilities, let alone do them.

The conclusion?

Much has been done under difficult circumstances by this government. No doubt. The Economic Survey has written somewhat cryptically about the ‘stigmatised capitalism’ being the reason for the difficulty in the Government coming around to grappling with the bank NPA issue. Of course, it is also true that Mr. Jaitley was on record in the initial days of the government that the NPA problem was not a big deal or something to that effect. But, those notwithstanding, the government has taken several decisions. It deserves credit.

It is also true that both NDA-1 and NDA-2 have done the cleaning up of the mess that they had inherited on multiple fronts. NDA-1 did inherit a banking NPA problem. It did the nuclear test in 1998 and faced the fallout. It faced 9/11 and the global recession. It endured two droughts (or, more?). But, the twin balance sheets – banks and corporations – were in fine fettle by 2003 and that is what facilitated the massive re-leveraging that happened between 2003 and 2008, facilitating a period of high growth. Also, it was Jaswant Singh who brought in SARFAESI. Yashwant Sinha liberalised the administered interest rate regime and partially succeeded. That was a very difficult reform, then. How difficult it is can be gauged from the fact that it still remains incomplete. Not much progress since then.

But, perhaps, much political capital is expended in these efforts that the reforms are never taken to their logical conclusion (as discussed above, with public sector banking).

It is not a criticism but an observation. So, what happens is that the door is still left open for fresh thieves to enter and burgle the house. That is what happened in 2004 and that might yet happen.

Alternatively, even if it is the same government that returns to office, the longer one stays in office, the greater the likelihood that they would cultivate bad habits that the Congress governments had practised.

That is why, perhaps, India should have one six-year term stipulation for all Prime Ministers so that they get the right things done in a hurry. May be?

Much remains to be done while it is also very true that much has been done.

I will end on that note. But, I have two more parts coming on this – one on a question raised by a friend if the expansion of the RBI Balance sheet was responsible for the rise in bad assets and the third one on Dr. Y.V. Reddy’s speech on 1st February. That piece should include comments made by former Mr. Qureishi, the former Chief Election Commissioner on election funding.

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