Modi government Vs RBI: The three mistakes of Urjit Ravindra Patel as governor in the context of the PNB fraud

Urjit Patel took over the mantle at the Reserve Bank of India (RBI) in the first week of September, 2016, from his illustrious predecessor Raghuram Rajan. Compared to Rajan, who was a globally reputed economist (and yes, the man who predicted the 2008 global financial meltdown), Patel was a relatively low-key figure. But even when he was serving as Rajan’s deputy, Patel had earned his place in the history of Indian central banking by being the chief architect of a panel that recommended radical changes in the way India approached monetary policy and its inflation targeting mechanism.

It was the Patel-panel that set a new framework for the central bank’s monetary policy and proposed that the retail-price based Consumer Price Index (CPI) inflation be the primary price trend indicator for the RBI’s monetary policy, moving away from Wholesale Price Index (WPI) inflation. So when Patel assumed charge from Rajan there were expectations. Of course, more than Patel’s ascension, it was Rajan’s departure and BJP leader Subramanian Swamy’s campaign against Rajan that hogged the headlines back then. Unlike Rajan, who turned every central bank interaction with the public or the media a high drama event what with his way of articulation on topics outside his core job, Patel was a silent face that the media slowly got used to.

RBI governor Urjit Patel. AFP.

RBI governor Urjit Patel. AFP.

Patel has always been a man of a few words, with his interactions strictly limited to the subject of the day. Even during major events like demonetisation, the central bank’s communications to the public came late or were inadequate. The RBI was severely criticised for its conduct during the implementation of the noteban, during the remonetisation exercise and for the counting of demonetised notes that isn’t over even now.

However, everything changed at Patel’s recent speech at the Gujarat National Law University. He deviated from his usual self by a great degree when he attacked the government, in public, in the aftermath of Rs14,000 crore fraud at state-owned Punjab National Bank (PNB), and highlighted the RBI’s weaker regulatory powers over public sector banks (PSBs). In that speech that kicked-off a verbal battle between the finance ministry and the RBI, Patel listed out seven areas where the RBI couldn’t exercise ultimate control over PSBs.

These included provisions such as the inability of the apex bank to remove directors and management at PSBs even if it wants to, to force a merger like it does in private banks, to revoke a banking license or to trigger the liquidation of PSBs among others. Patel cited these arguments to defend the RBI in the wake of criticism that it couldn’t act to prevent PNB-like frauds or. In other words, Patel told the world that day that the RBI lacked enough independence to do its job. The government, logically, defended itself. The finance ministry cited clauses in the banking regulation act to show that the central bank indeed has enough powers to act if it wanted to.

On Monday, the government’s chief economic adviser (CEA) Arvind Subramanian too joined the clash, as reported by The Indian Express, saying the independence of a central bank is not only acquired through law but also by actions and good decision-making. In the backdrop of bank frauds beginning with the PNB-Nirav Modi scam, there are three key mistakes or questions that Urjit Patel has committed or owes an answer to:

Firstly, Patel indeed brought forth some important points when he cited the issue of dual regulation in the Indian banking sector. It is a fact that the RBI cannot issue licenses or liquidate public sector banks, no matter how serious the problem at a particular bank. But, the question remains as to why he took 18 months to highlight an extremely serious issue such as the RBI’s inability to regulate one set of banks in the country? Should Patel have waited for a series of bank frauds to surface before realising this fundamental problem with the RBI’s regulatory operations? This either means Patel was aware of the constraints all along but chose not to speak for some reason (the fear of losing his job or a disinterest in altering the status-quo), or was simply unaware about the serious flaws in the acts pertaining to banking regulation. The latter is an unlikely scenario. But surely, Patel’s rebellion against the imperfections or status-quo in the regulatory set up should have happened long back. That’s his first mistake.

Secondly, The RBI, under Patel, (and even prior to that) miserably failed to detect serious compliance issues in the banking system. As Patel rightly pointed out, the RBI can’t originate or terminate a government bank. But it has other powers that allow it to instill the fear of law in any bank as this writer pointed out in an earlier column. The RBI conducts regular checks of bank balance sheets and monitors banking operations through various methods. The fraud at PNB, where diamond merchant Nirav Modi and his uncle Mehul Choksi sought help from a corrupt banker to secure fake letters of undertaking (LoUs), went on for a good six to seven years. The basic problem that the PNB cited, the inability to detect SWIFT entries since it was not connected to the CBS, should not have happened in the first place. The RBI issued a strong diktat to the lender to do so only after the scam surfaced. After PNB, several bank frauds have been reported. It’s not that all of them happened only now. Presumably, these were going on for long. The RBI can’t escape from allegations of being inefficient and lax despite being the banking regulator for years. Patel’s explanation was that the RBI issued guidelines to banks, but that lenders didn’t follow. The RBI’s duty doesn’t end in just spelling out the rules. Harping on this point was Patel’s second mistake.

Thirdly, the RBI, yet again, tried to cover up its inefficiency to identify problems and deal with them with precision by announcing a blanket ban on LoUs. It decided to kill a legitimate trade instrument outright, something traders have been using for long. Both importers and exporters use LoUs extensively as this is one of the cheapest instruments available to them.

The RBI banned it without giving much thought about the larger impact on the country’s importers and exporters. This is a big mistake from the RBI as this writer pointed out in an earlier column. In effect, this measure is likely to be counterproductive as it will impact even genuine traders. This was like retiring a machine altogether to repair a faulty component. As this Businessline report shows,  banning of LoUs has already begun to impact small companies as the cost of funds have gone up substantially. This is an instrument widely used by SME entrepreneurs to secure buyer’s credit and they shouldn’t have been punished for one Nirav Modi’s fault and the RBI’s own inefficiency.

In the verbal battle between the central bank and the finance ministry post the PNB fraud, the central bank is clearly on a weak ground. It is extremely difficult for Patel to defend the RBI’s failure to detect systemic flaws that resulted in a series of bank frauds.

The three key mistakes Patel committed in the context of the recent bank frauds raises major questions about the way India’s central bank operates, raises questions about its effectiveness as a banking regulator and, more importantly, whether the concerned laws have all along treated the central bank in this country in a wrong manner. It’s perhaps time for a relook at the very structure that governs the Indian central bank and the way it functions.

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Updated Date: Mar 27, 2018 11:56:28 IST

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