RBI’s ‘Neelakantha’ admits regulator is toothless when dealing with sarkari banks, but Urjit Patel can’t wash hands off PNB fraud

Urjit Patel articulates things in a much better way now compared with his initial days, a shy person and man of few words, as Reserve Bank of India (RBI) governor. His speeches now carry an interesting touch, a mix of tough talk and mythical metaphors, though still no match to some of his predecessors in office. On Wednesday, speaking at the National Law University in Gandhinagar, Patel raised some important issues that normally technocrats tend to skip for fear of their bosses in government.

During the speech, delivered against the backdrop of Rs 13,600 crore fraud at the state-run Punjab National Bank (PNB), Patel said the RBI is severely constrained with not having enough regulatory control over public sector banks (PSBs) compared with private banks. This needs to change, Patel suggested, implying that it is high time for a change in the status-quo in state-run banks’ ownership structure.

“Success has many fathers; failures none. Hence, there has been the usual blame game, passing the buck, and a tonne of honking, mostly short-term and knee-jerk reactions.,” Patel said, in an obvious reference to the criticism central bank received in the aftermath of PNB fraud, where billionaire diamond merchant Nirav Modi got away defrauding the bank for six years in connivance with certain bank officials.

RBI governor Urjit Patel. Pic courtesy: AFP

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“These appear to have prevented the participants in this cacophony from deep reflection and soul searching that can help solve fundamental issues that are the root cause of such frauds and related irregularities in the banking sector,” Patel added. What Patel explains primarily after this is central bank’s weaker regulatory powers over PSBs. He cited seven areas or instances where RBI cannot initiate actions on state-run banks, which control 70 percent of the assets of the banking industry.

There are 21 state-run banks in India, in at least half of which the government has over 70 percent shareholding. The seven areas which Patel explained include provisions like the RBI cannot remove directors and management at PSBs even if it wants to, cannot force a merger like it does in private banks, cannot revoke a banking license or trigger liquidation of PSBs among others. “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,” Patel said, adding “the market discipline mechanism for public sector banks is appreciably weaker compared to that at private banks. There is implicitly a stronger perceived sovereign guarantee for all creditors of PSBs, and the principal shareholder – the government – has not so far been interested in fundamentally modifying the ownership structure.”

The problem with PSBs can’t be explained in better words. And, this is for the first time in the recent past an RBI governor is flagging the issue of dual regulation of PSBs as major hurdle for the central bank to discharge its duty.  As Patel pointed out, it doesn’t augur well for the economy where the banking regulator has two sets of banks here it can exercise varying degrees of regulatory power. By admitting RBI is largely a mute, helpless spectator in the regulation of state-run banks, Patel has flagged the issue at the right time and in the right manner. That’s a clear message to the government to start working on overhauling the ownership structure of PSBs and get out of banking business at the earliest, else prepare for deeper troubles ahead.

In his speech, Patel brought in some interesting metaphors to illustrate RBI’s intent to clean up the perils of banking system, saying, “If we need to face the brickbats and be the Neelakantha consuming this poison, we will do so as our duty.” But that doesn’t clear the RBI of charges of laxity in banking regulation, particularly in the context of PNB fraud and a series of other bank frauds that have come to the fore of late.

In his speech, Patel passed the blame to the PNB for not playing by rules that ultimately led to one of India’s biggest banking frauds and said “it is simply infeasible for a banking regulator to be in every nook and corner of banking activity to rule out frauds”. But, this is a weak excuse to defend the RBI’s inability to identify and prevent a systemic issue that has been on for a long time.

The fact is that the staff at PNB who aided Modi to defraud the bank used a systemic flaw (disconnect between SWIFT entries and core banking network) for too long a period and the regulator, with all its might, couldn’t even come near to identifying it. The risk management tools designed by the central bank didn’t function at all. Patel said the RBI had issued precise instructions via three circulars in 2016 “to enable banks to eliminate the hazard” to avert PNB like frauds and the bank didn’t follow.

But he should remember that the RBI’s duty doesn’t end in framing guidelines but also in ensuring that rules are followed to the letter and spirit. It is quite possible that similar frauds happened in other banks as well, and like in the PNB case, the central bank simply didn’t know about it. Patel can’t wash his hands off the PNB episode.