RBI is being naive; auditors alone aren’t responsible for the banking mess

The RBI strictures  on auditors of public sector banks (PSB) makes one wonder if it is being naive or is looking for scapegoats, or both. It hasn’t dawned on the banking regulator that the pecking order of checks and balances in banks to prevent frauds and NPAs is as follows: 1. Collaterals with sufficient margins especially if the collateral happens to be a volatile product in the market; 2. A system design that is at once fool-proof and easy to operate; and 3. Efficient and effective audit at the pain of auditors being hauled over the coals for professional negligence The RBI seems to be jumping the gun by putting the blame for the current sorry state of PSB affairs at the doors of the auditors instead of addressing the first two issues. To be sure, it should go for their jugular but only after ensuring that a bank doesn’t take an exposure unless it has covered itself sufficiently with collaterals and there are no systemic defects. [caption id=“attachment_4377953” align=“alignleft” width=“380”] Representational image. Reuters.[/caption] Gold loans are by far the safest bet for banks as the prudential norms for lending makes sure that there are no defaults and even if there are, the bank saves its skin. This is ensured by conservative valuations and sufficient margin at the time of the grant of the gold loan. Home loans too are safe for the same reasons even though there is a danger of asset-liability mismatch (ALM), with a bank venturing into the long-term when innately its time horizon is always short-term or medium-term. PSBs are in a soup because they did not insist on sufficient collaterals from the borrowers be it Kingfisher Airlines or Bhushan Steel or Essar Steel, due to political interference (behest lending) or otherwise. What happened at the Punjab National Bank (PNB) was systemic fraud, period. When transactions can be consummated with a click of a mouse, it is all the more reason why there must be heightened precautions, internal controls and its sub-set, internal checks. In this context, the role of block chain technology cannot be overemphasised. Now let us come to audit and auditors. There is no dearth of audit in banks including PSBs — statutory audit i.e. year-end audit, concurrent audit, revenue audit and what have you. The problem starts with the appointment of statutory auditors. Public sector companies’ auditors are appointed at random by the CAG from a panel of auditors maintained by it, but curiously this fundamental precaution has been cast to winds by permitting PSBs to pick their own auditors. This provides full scope for mutual back scratching tendencies and laxity in auditing. Concurrent and revenue auditors fare no better with their tick-box approach, and taking the events that have taken place as a fait accompli, without bothering to suggest changes in systems, internal checks and internal controls. Auditing laxity is witnessed both in the lending banks and in the borrowing companies. L’affaire Kanishk Gold shows how a Chennai-based company borrowed merrily from a clutch of banks by cooking up its accounts. Window dressing is the oldest trick in an accountant’s repertoire often winked at and sanctified by the auditors of the company. The Satyam Computers fraud that rocked the nation in 2008 was as much an accounting fraud as it was a banking and share market fraud. Time has come to stop handling auditors, both at the lenders’ end and at the borrowers’ end, with kid gloves. More often than not, the lending banks set store by the financials supplied by the borrower, as sanctified by its auditor. But sadly this implicit trust is broken in hindsight. Our banking laws must be amended to enable banks and the RBI to go for the jugular of lax and complicit auditors both of the lending banks as well as the borrowers. The RBI is right about the need for heightened vigilance from auditors, but where it has erred is in jumping the gun. Prevention is better than cure. If collaterals are taken and a sound system is put in place, audit laxity may not come to haunt banks. Behest lending puts lending norms at a discount. Banks must be insulated from this menace.