'Tough to prevent PNB-like fraud': Patel slams govt for diluting RBI powers

Governor says frauds like PNB are painful; regulatory powers must be ownership-neutral

In a broadside against the government, which has been critical of the role of the banking regulator in failing to spot the massive fraud at the Punjab National Bank, Reserve Bank of India (RBI) Governor Urjit Patel on Wednesday said the central bank had “very limited authority” over public sector banks as its power to govern had been curtailed. 

Speaking at a function in Gandhinagar, the central bank governor indicated that RBI was actually helpless, as neither did it have power to replace the board of public sector banks, or force a merger, nor could it revoke the licence of a bank for any activity undertaken, as a series of amendments of the Banking Regulation (BR) Act by the government had taken away all the powers of the central bank in favour of New Delhi.

Banking regulatory powers were not ownership-neutral in India, Patel said, adding, “This legislative reality has, in effect, led to a deep fissure in the banking regulatory terrain: A system of dual regulation, by the finance ministry in addition to the RBI.”  Such fissures or fault lines were “bound to lead to tremors such as the most recent fraud”, he added, responding to criticism that the regulator had not been alert in detecting such cases.

“The BR Act exemptions for PSBs mean that the one agency — the regulator — that can respond relatively quickly against banking frauds or irregularities cannot take effective action.”

Patel said the RBI had more power over private sector banks than over PSBs and added that a level field should be created in regulating PSBs and their private peers. He also said PSB chiefs were actually aware of the powerlessness of the RBI. 

“MDs at PSBs find it comfortable to tell the media that business will be as usual for them under the RBI’s Prompt Corrective Action (PCA) framework, as even if they do not meet the stipulated restrictions, the ultimate authority over their tenure is with the government, and not with the RBI,” Patel said.  

Private sector banks have the market to fear if things go wrong, as fund-raising becomes difficult. For PSBs, there is no such compulsion. 

“It is an open issue whether centralised government control alone can be effective enough at designing and implementing governance of a banking franchise comprising over two-thirds of the sector’s deposits and assets. It would be better instead to restore regulatory and market discipline,” the RBI governor said.

Patel also criticised the government for having a separate chairman and managing director for a bank, stating that “they are the same” and that it implied that the “MD is primarily answerable only to himself or herself”. 

The central bank would take action against the bank in concern (PNB), he said. But, how much penalty could be imposed was already defined by the BR Act. In the past, whenever the central bank had imposed a penalty on banks, it was usually not more than ~50 million, which is effectively nothing.

Defending the central bank in relation to the PNB fraud, Patel said no banking regulator could catch or prevent all instances of fraud, and that it was the job of the banks to check their systems. The governor said the RBI had cautioned banks to fix their SWIFT network at least thrice. “It turns out, the bank had simply not done so. Clearly, the internal processes at the bank failed, allowing the operational hazard to remain in place in spite of clear instructions to close it,” he added

Bad assets and fraud were largely the making of banks and bankers had actively colluded to keep the accounts standard and allow “soft-landing” of the promoters, Patel said. 

Tearing into banks, the RBI governor said the lenders had often fudged accounts, or refused to recognise the true asset quality of the loans while disbursing even more loans, “so as to keep the accounts artificially in full repayment on past dues, protracted control for promoters over failed assets, and effectively granting them the ability to divert cash and assets, often outside of our jurisdictional reach”.

Therefore, the RBI was forced to pressurise banks to reveal the true extent of bad debt on their books and had to introduce a steep regulatory framework for resolution of loans in a time-bound manner. The RBI had to scrap various restructuring rules, including forbearance, for a simplified process as the schemes had themselves became “an end in itself with little resolution achieved”.

“The IBC (Insolvency and Bankruptcy Code) along with the RBI’s revised framework will help break the promoter-bank nexus, which has led to crony capitalism and an attendant NPA/credit misallocation problem as ever-greening suited some borrowers and some lenders under the earlier framework,” Patel said. “I have chosen to speak today to convey that we at the Reserve Bank of India also feel the anger, hurt and pain at the banking sector frauds and irregularities... these practices amount to a looting of our country’s future by some in the business community, in cahoots with some lenders,” he added. 

Patel likened the RBI’s actions as “the mandara, mount or the churning rod in the amrit manthan or the samudra manthan, of the modern day Indian economy”.

“Until the churn is complete and the nectar of stability safely secured for the country’s future, someone must consume the poison that emanates along the way. If we need to face the brickbats and be the neelakantha consuming this poison, we will do so as our duty; we will persist with our endeavours and get better with each trial and tribulation along the way,” Patel said. He added, “I do wish more promoters and banks, individually or collectively, through their industry bodies, would reconsider being on the side of devas rather than asuras in this amrit manthan.”