PNB fraud underlines need for more privatisation: Arvind Subramanian

Public ownership creates a complicated three-way line of control - ownership and regulation between the government, the regulator and the banks themselves, says CEA

After state-owned Punjab National Bank (PNB) was jolted by a Rs 114 billion fraud, the government’s chief economic advisor Arvind Subramanian, had raised several questions on the external controls used by the Reserve Bank of India (RBI). He tells Dilasha Seth internal controls are weak in public sector banks (PSBs) and this calls for the privatisation. Edited excerpts:

Another big crisis in the public sector banking space has surfaced. What should be the response at the policy level? 
 

In the PNB episode, it is clear the internal controls broke down. But, what about the external controls by the regulator? That is more important. The case reinforces the need for privatisation, as internal controls tend to be weaker due to government ownership.

The government is bound  by the Bank Nationalisation Acts of 1969 and 1980, the State Bank of India Act and SBI (Subsidiary Banks) Act. Would you bat for their repealing?
 

That is for the government to decide. The Act is possibly the biggest constraint but that is not for me to decide. However, we need private sector participation in the sector. 

You are pitching for private participation but Axis Bank was also involved in the letter of Undertaking issued by PNB, although it later sold it.
 

Right, but internal controls break down more in PSBs, as history shows. Axis Bank is also involved, which shows internal controls broke down there, too. That is why we need a second line of control, by the external regulator. Private ownership is no panacea and no guarantee against future crisis. But, public ownership creates a complicated three-way line of control — ownership and regulation between the government, the regulator and the banks themselves. Whereas, with private sector participation, some of this gets attenuated. As we can see from the global financial crisis, problems have occurred under private ownership, too. Therefore, we need effective regulation.

What external regulations do you recommend to check such frauds?
 

In 2016, former deputy RBI governor SS Mundra made a speech, where he said SWIFT (the globally used financial messaging system) should be integrated with the core banking operation. Why was that not followed up? Again, there is no foolproof method against fraud. We need to examine the need for better regulation. While private participation is one, it is also about how we get better regulation.

Is the case for privatisation also to do with disparity in the compensation levels of private and public banks employees?

Yes, that could be one reason. You need good talent to set up a risk management and evaluation system. PSBs, like the private sector, must have the freedom to recruit and retain personnel. Currently, they face restrictions in decision making and are stymied by the 4Cs (Courts, Comptroller and Auditor General, Central Vigilance Commission and Central Bureau of Investigation).

What type of re-look do you prescribe for haircuts (write-offs) on stressed assets?
 

It is done case by case. The National Company Law Tribunal process will determine the haircuts.