Editor's note: The Rs 11,400-crore bank fraud in Punjab National Bank, that was perpetrated by billionaire Nirav Modi in collusion with a few bank employees, has once again brought governance practices in Public Sector Banks (PSBs) back to public debate. There are questions raised on the way these entries function. A political blame game is on. But the problems in this sector are far beyond one instance of fraud. After five decades of bank nationalisation, India's public sector banks face deeper structural problems ranging from poor management practices, ineffective risk-management systems, vulnerability to a political-corporate nexus, large chunk of bad loans and lack of sufficient autonomy. Firstpost will publish a multi-part series that examines the serious structural problems that have engulfed India's state-run banks and the likely course of this industry, which constitutes 70 percent of India's banking sector assets. You can read the first part and second part of the series here.
Various process failures of public sector banks in India are not new. What is new in the PNB fraud is that, for the first time, questions are being raised about the supervisory capacity and systems in Reserve Bank of India (RBI). The government has written to the RBI asking for why the scam was not detected in its systems. Concerned citizens have asked for similar information in the past and disclosures by RBI have not been adequate.
In 2011, the RBI refused to release information in response to a Right to Information query about some inspections carried out on cooperative banks. Its decision was overruled by the Central Information Commission (CIC). The CIC’s decision throws light on the functioning of RBI. One request (in the same query) to which the RBI did reply, indicates lack of documentation about the supervision process. The appellant had asked RBI to provide him with procedure, rules and regulations of inspection being carried out on co-operative banks.
The RBI replied: RBI is conducting inspections under section 35 of the B. R. Act, 1949 (AACS) at prescribed intervals.
The RTI applicant had asked for information about the procedure, rules, and regulations governing bank inspections. The RBI responded with pointing to the provision in the parliamentary law governing bank inspections. Section 35 of the Banking Regulation Act empowers the RBI to carry out inspections. How the inspection will be carried, what will be checked, how will sampling be done, and other details of the inspection process is not provided by legislation. It is expected that, based on this provision, the RBI would have developed rules, regulations and other documents setting out the detailed system of inspections. However, RBI did not share these. Either they do not exist, or they are too sensitive to be released.
In contrast, the Federal Deposit Insurance Corporate of the U.S. (which plays a similar role in bank inspection) releases detailed manuals on the process of inspections. The compliance manual is 1,275 pages long and it has its own website. Any person can read the manual and comment on the robustness of the procedures. All the 1,28,755 words of the compliance manual is open to scrutiny. The Japanese financial regulator’s 446 page inspection manual for deposit taking institutions is available here. It provides detailed information about how inspections will be carried out, including a checklist for inspections.
There are, no doubt, legitimate concerns about releasing inspection reports of banks and the RBI has, in the past, refused to release such information. Inspection reports contain commercially sensitive information not only of banks but of borrowers as well. Releasing that would harm businesses. Imagine you are trying to sell your house and negotiating to with a potential buyer. Through inspection reports, the potential buyer finds out that you have a large loan due for repayment in three months.
The potential buyer will draw out the negotiation process to turn on the heat on you. You do not want that.
However, this does not apply to the process of inspections. How much do we really know about RBI’s audit process? Why is there no transparency about the process followed? We do not know how much time is spent per day, how many auditors per branch of a bank, what template is followed, what aspects of banking are audited, etc. etc. Without public information on how RBI conducts banks’ audit, there is no accountability of the process. Since the CAG (Comptroller and Auditor General of India) does not audit RBI, even the normal accountability of other wings of government is missing for RBI.
We do not know if RBI updates its supervision systems when it comes across these types of frauds. In September 2016, a Deputy Governor of RBI highlighted the risks associated with SWIFT systems. Union Banks SWIFT system had been hacked in July 2016. The strategy on Union Bank was similar to the one used on the Bangladesh central bank. He prophetically noted:
…the incident has reinforced the fact that the various stakeholders have not learnt the lessons yet.
While this may be true of PNB, it may also be true of RBI. Did RBI change its supervision process after the 2016? Was SWIFT messaging audit a part of the RBI inspections? We do not know.
Banking inspection has issues with commercially important information, and there should be legitimate exemptions to disclosure of inspection reports. However, this does not extend to the system of inspections and supervision. The public has a legitimate right to know of systems and processes maintained by RBI to discharge its statutory duties.
Transparency and information systems of the RBI need to be overhauled. This has to start at the top: the RBI board. As this article pointed out in January 2017, the functioning of the RBI board is opaque compared to other central banks. Minutes published by the RBI usually just a two line summary; most functions of the board have been delegated to a sub-committee where only two directors are needed to meet quorum; specific functions have not been delegated to sub-committees; annual budgets are approved without much deliberation.
Laws which govern the functioning of RBI need to be changed to bring about transparency and accountability. This has to then be supported by scrutiny into the functioning of the institution. A tragedy is a terrible thing to waste. The legislature should take a relook at the legislative framework of transparency, accountability and governance of RBI. The Draft Indian Financial Code addresses many of these concerns and there is need to incorporate its principles in primary legislation.
(The writer is legal consultant, National Institute of Public Finance and Policy (NIPFP) and would like to thank Rajeswari Sengupta of IGIDR and Seetha Parthasarathy for inputs.)
Updated Date: Feb 22, 2018 11:18 AM