By Gautam Chikermane
Instead of launching a series of investigations into how unaccounted-for money flows into the banking system from one side, gets cleaned up, turns legitimate and exits from the other side, it is disappointing to see the Reserve Bank of India (RBI) turn a benign eye on violations that could explode into issues beyond banking. A few days ago the central bank imposed penalties of Rs 49.5 crore on 22 banks that violated know-your-customer (KYC) norms and anti-money laundering processes exposed by Cobrapost in March and May.
In English that means the banking regulator penalised these banks for violations on two issues that India is currently debating. One, the conversion of black money into white, using insurance sales as the medium. The method is simple: buy a series of insurance policies of less than Rs 50,000, beyond which the KYC norms kick in. So, if you want to launder Rs 10 lakh worth of unaccounted-for money, go no further than the RBI-regulated banks. Commissions-chasing executives, led on by bonus-seeking top executives, will advise you to buy 20 life insurance policies worth Rs 49,000 each and one policy of Rs 20,000. Give the money three years and it’s laundered, snow white.
Two, there is the chance - small but not insignificant - that the money so laundered may have come from or could go towards financing activities that may not be in the best interests of India. Terror outfits, for instance. Or drug money. Or extortion. Or a plethora of activities that are illegal but find their way into the legitimate pipelines of India’s financial system through such schemes. Regulators, the world over, know that those who seek to break the law will always be one if not three steps ahead of enforcers.
While no banker would want to be seen to be complicit with either of the two issues, the incentive system doesn’t walk that talk. When top executives get their sales teams, who curiously function in no-regulator’s land, to squeeze consumers by selling products that deliver the highest returns to them - at the cost of investors and savers - they inadvertently create an infrastructure that encourages behaviour that one day would blow up in the faces of bankers.
By penalising banks at rates that are statistically insignificant, short-sighted bankers would be rejoicing – the RBI is doing more for banks than any association ever could. To put the penalties in perspective, the Rs 3 crore penalty on India’s largest bank, State Bank of India ( SBI), is less than one hour’s operating profit last year. Earlier, the penalty RBI imposed on India’s largest private bank, ICICI Bank, was Rs 1 crore, or about the operating profit it made in 16 hours. We are yet to see the logic of these fines: are they based on balance sheet size, profits, branches…or is it just another whim?
The argument behind not imposing fines that hurt banks is that these will in the end scratch depositors. This is a false argument. When a fine is imposed on the bank, it is not the depositor’s money that it is paid from. The money is appropriated from the profits of banks. Depositors’ money is untouchable, sacrosanct and must remain so. As a result, it is not depositors that lose money when a fine is imposed, but two other players in the system - the managements, whose bonuses should get shaved off; and investors, who, when they see share prices fall because of such high regulatory risks the management is taking, must seek a change at the top.
If RBI wants to fine banks, it needs to make that count. So, a statistically-insignificant rap on the knuckles is another way of saying, go right ahead with your regulatory breaches, nobody will touch you. Like the banks that create wrong incentives to cheat consumers, their regulator is building incentives that encourage, or to put it politely, doesn’t discourage, malpractices that border on financial crimes.
Here, the role of large investors and independent directors comes into play. On their part, independent directors must push bank managements to create systems that ensure such practices do not recur. Large investors need to warn the managements against walking on the edge of law - by taking Rs 49,500 instead of Rs 50,000 to escape KYC norms - is wilful breach of the spirit of regulation. Unfortunately, the RBI’s actions give comfort to the market. Instead of falling, the SBI share price rose by 1 percent on the day the fine was announced; Yes Bank jumped 3 percent, Punjab National Bank shot up 5 percent. If share prices rise despite a fine on a matter so serious, it is something we need to think about and correct.
Today, when India Post opens a small Rs 500 per month Public Provident Fund account for drivers, masons or electricians, it asks for a PAN. What makes RBI-regulated banks get away with impunity? The banking regulator must not shy away from imposing profits-debilitating penalties. Already, between the regulatory gaps of RBI and the Insurance Regulatory and Development Authority that regulates the insurance sector, banks have ensured that consumers lose Rs 1.5 trillion (that’s Rs 150,000 crore), according to a recent paper by the Indira Gandhi Institute of Development Research. This money has been pocketed largely by distributors in banks. But instead of learning from this colossal loss to many of them in rural areas, and tightening systems, the RBI is cheering the banks on. Unless, RBI changes its philosophy of fines and behaves like the regulator we expect, scams will continue to lurk in dark corners of finance’s first stop.