Falling between two stools

RBI's dual role leads to contradictions in its actions

Even as the role of regulators gains prominence across the world, due to the increasing activity and complexities in the financial sector, in India regulators are looked upon as an extension of the government, which can (obviously) do no wrong.

The Reserve Bank of India (RBI) is changing rapidly in both regulatory style and content. Governors like Bimal Jalan and Y V Reddy are men of repute and integrity, who possess the intellect to make significant changes in the regulatory style "" from dictatorial to consensual.

But while the recent changes are significant and substantial, contradictions mainly arise from the RBI's role as the implementer of monetary policy and its proxy ownership of public sector banks (PSBs).

It is precisely these functions that not only bring about contradictions in its actions from time to time but also hinder its role as a progressive regulator for the banking sector.

As the regulator of the banking industry, the RBI should be at the top of the heap as far as risk management in the financial sector is concerned.

The emerging complexities in the banking sector, the new products that are being brought in by the collective will of the marketplace and the push from private sector players, brokers and foreign banks, all require a superior understanding of the risks involved.

With options "" like using PSBs as the last line of defence to absorb the shakeout that normally takes place every couple of years "" narrowing, it is imperative for the regulator to be right every time and, more importantly, be seen to be right every time.

The cooperative bank crisis revealed that the RBI was not too aware of what was happening in the market. Whether it will be more aware and more informed the next time a crisis strikes remains to be seen.

Those at the top at the RBI understand the importance of risk management, but not the rank and file. Upgrading the skills of RBI staff and enforcing a professional approach towards regulation is, therefore, of prime importance.

What is also required is a separation of the RBI's roles as a regulator for the banking sector and the implementer of monetary policy. The earlier this is done, the better the chances of avoiding the inevitable conflicts.

Consider the push to drop interest rates. The driver for this is the government's growing interest burden as a result of its borrowings to finance the deficit.

But this move conflicts the RBI's role as a regulator of banks: with the spread of industry narrowing, if it were not for their income from treasury, most banks would show operating losses.

The banking system's objective to have a strong capital base, therefore, contradicts with its role of carrying out the dictates of the government to drop interest rates.

There is a need to take a hands-off approach towards the entire issue of interest rates. The RBI and the government have no business to dictate the rates in international transactions, in areas like external commercial borrowings (ECBs), syndication loans and buyers' credit.

As it is, companies are working hand-in-hand with bankers to circumvent the RBI ceilings in ingenious ways. A regulator should have no role to play in this situation. If it feels that banks are misguiding corporations or fleecing them, the answer lies in demanding greater disclosures.

Similarly, it is time the RBI discards its old habit of dictating deposit rates on savings deposits and non-resident Indian (NRI) deposits. It also needs to stop its periodic meddling with market forces.

Nowhere else in the world do you have the regulator's representative sitting on the boards of so many banks that are critical in the country's financial system.

If the government as the owner of nationalised banks wants to have its say in the functioning of the boards and nominates its representative on the board, it is understandable (although there are better ways of doing it).

But for the RBI to have its nominees on the boards makes a mockery of the hands-off approach that a regulator needs to maintain objectivity.

What is worse, several times, these nominees have proved to be naïve and ineffective and, often, a hindrance to business development.

Moreover, despite being part of almost every decision taken at the board and management committee levels, the RBI is free to feign ignorance of the internal developments and sit in judgement through a system of onsite and offsite inspections.

The inspection of banks by RBI nominees also needs to be reviewed. Often, the management at these banks is left with the impression that it has only been investigated, and not properly guided or inspected during the annual exercise.

It is natural that many managements go out of their way to please the visiting teams in various ways "" at times, crossing the limits, both moral and ethical. Compare this to the position in other countries, where inspectors even bring along their bottles of water and pay for the coffee provided.

The world over, regulators are making an extra effort to be transparent and friendly. Here, regulators take pride in being unhelpful or vague. Senior bank officers have to queue for hours outside the cabins of RBI officers to seek answers to even routine queries and there is never an effort to be creative in solving the problems.

Contrast this with the Federal Reserve Board (FRB) and the Financial Services Authority (FSA), which have relationship managers for every bank, available for support all times. They also have contact centres and call centres to look into routine matters.

After the September 11 attack, for almost a month afterwards the first call to managers of Indian banks in the US was invariably from FRB representatives asking whether they needed help or liquidity support, enquiring about difficulties in working during troubled times and reiterating the commitment of the state and the regulator that the bank can seek any assistance, at no cost and without committing any breach of regulation.

In India, in every crisis, the regulator first seek to disclaim all responsibility or look for scapegoats.

It's time to have a proper mandate for the regulator. The RBI Act is now ancient. The government needs to spell out, through appropriate legislation, the objectives of regulation of the banking and the financial sector.

Like the American FSA "" an autonomous body working like a corporate entity in the private sector "" the objectives and responsibilities should be clear.

As far as the FSA is concerned, maintaining confidence in the financial system, promoting public understanding, consumer protection and fighting financial crimes have been given as the objectives and the enforcement powers range from levying of fines and criminal prosecution of the offenders to cancellation of the banking licence.

There is an urgent need to improve technological competence within the RBI. True, the position is now better than a few years ago, but even now glitches abound. The RBI collects enormous amounts of data and most of it is probably used to make up its annual report.

Instances where the data is used for regulation are few. With the banking industry entering into a period of sophistication, data can be manipulated by banks; it is imperative that the analysis of the data at the RBI is incisive and used to support banks' regulation.

Finally, the RBI has to have and use punitive powers much beyond what is being done today. Foreign banks that have indulged in serious crimes of insider trading, mis-selling and flouting regulations have been let off with a warning or a rap on the knuckles, whenever the RBI has been smart enough to catch them.

The problem is much deeper than it appears. New private banks are also always on the lookout to stretch the rules beyond acceptable limits. A new breed, brokers in the foreign exchange and money market business, is now added to this list.

It's time our regulators stand firm. Regulators need to be smart and forward looking. For this to happen, the RBI has to open its doors for recruitment of professionals from industry and universities, not at the bottom waiting for a long crawl but at the decision-making levels.

Unless skill levels are improved, neither the regulated banks nor the regulator can thrive without being a risk to the system. The wealth of experience and competence that the RBI has at the top needs to percolate downwards.

The gap between banks in India and abroad is narrowing. It is not the GAAP alone that is important, we need to bridge the gap in competence. As banks mature, the regulation system needs to keep pace and mature as well. Only then will we find our rightful place in the global financial system.

(The writer's email is kvk61@hotmail.com)