How the RBI can get its act together

In the concluding part of the series, the author draws attention to the central bank's problems that need urgent fixing

The Securities and Exchange Board of India (SEBI) framed regulations for credit rating agencies (CRAs) way back in 1999. Indeed, India was the first jurisdiction in the world to do so. The idea behind such regulation was to protect investors. However, the more frequent users of credit ratings are banks and non-banking financial companies (NBFCs), which are regulated by the RBI. Has the RBI taken a single step to make CRAs more effective and efficient? Has any back-testing been done by the RBI? Or has it asked banks or the Indian Banks' Association to assess the efficacy of credit ratings? Banks and NBFCs followed the system blindly without ever questioning the ratings. When one asks questions, one gets the response that CRAs do not rate an entity but only the instrument. How can you rate an instrument issued by an entity in isolation unless cash flows are in escrow? The RBI has been a silent spectator to the mess.

Single-point banking: The present banking system — with multiple banking arrangements in multiple locations with cross-flows among various entities and banks — makes the job of a bank officer more complicated than that of an air traffic controller (ATC). An ATC can at least see everything on a radar. The complicated banking arrangement suits a delinquent borrower who conducts transactions in such a manner that detection becomes next to impossible. The RBI has aided such an unruly banking system by remaining a silent spectator.

Pressure and demands from banks have taken precedence over prudence. Has the RBI analysed why an entity needs dozens of bankers? IL&FS had banking arrangements with 22 banks. Does anyone need any more proof of the mess? The digital era is the era of single-point banking. Should the RBI bother about the stability of the financial system and protect people at large or consider the privacy of borrowers and competition amongst banks? The RBI must make a choice and communicate that to stakeholders.

Multiplicity of laws: The RBI has separate laws for the State Bank of India, three different laws for PSU banks, besides the Banking Regulation (BR) Act, 1949. Some banks are companies; hence Companies Act is applicable. Some are listed, so SEBI LODR (Listing Obligations and Disclosure. Requirements Amendment Regulations, 2018) regulations are applicable. As a result, it has to follow different yardsticks for different banks. How can a regulator maintain market integrity when it has different rules based on who the parent is and how and when the entity came into existence? Till date, the RBI has not reconciled the BR Act with the Companies Act 2013; it continues to refer to the Companies Act, 1956. The Companies Act, 2013, was a game- changer for governance; but the RBI seems oblivious of the development. It does not even have a universal governance code. 

Bank licensing is another area that establishes the fact that the central bank probably doesn’t know what makes a bank strong. For some banks, it recommends high promoter equity; for some it wants to reduce equity and for PSUs it is agnostic.  One doesn’t understand how for similar businesses in same environment, three different ownership levels will result in agnostic risk management. If high promoter equity is bad, why is it not bad for PSUs or new private banks? If low equity is bad, why is it not bad for older private banks? The rationale for such measures is known only to the RBI just like the secret formula of Coca-Cola is known only to the company that owns it.

Big Brother syndrome: Other regulators that are younger than the RBI are expected to take cues from the latter and its experience. Unfortunately, this learning is one-sided. The RBI doesn’t believe that it has anything to learn from regulators who might have better systems. How else can one explain its failure on LOUs (Letters of Undertaking), causing huge losses to Punjab National Bank? LOUs were an unknown banking product, untested and didn't have international acceptance. The RBI, in its master circular, had clubbed LOUs and LOCs (Letters of Undertaking/Comfort) with Letter of Credits (LCs) and Bank Guarantees (BGs), giving the  impression that all these instruments are on a par with each other. This was a cardinal mistake, as LCs and BGs are more than a century old, with globally accepted standards and uniform laws. On the other hand, LOUs and LOCs were home-grown products, untested on their behaviour and attendant risks. Clubbing them with LCs and BGs gave them respectability that they did not deserve. This could have been avoided if the RBI adopted the practice of its fellow regulator SEBI. 

The RBI has been part of the SEBI committee for products in the forex derivative market. It participated in the product design, assessing risks and in their introduction. And even after the introduction of some products, it was involved in their monitoring to ensure there was no risk to the system. Could the RBI have done the same with LOUs?

PMC Bank stress: Do we still need co-operative banks? This question should have been part of the RBI’s internal debate long back as the structure of co-operative banks has nothing co-operative about it. Over a period of time these banks, with a few exceptions, have become fiefdoms of strong-armed people, allowing political patronage to prosper. These are a new system of princely states so to speak, with checks and balances only on paper. 

India Bulls and LVB merger: Once again, the issue of ownership of banks is in focus. Who is fit and proper to own a bank? Does skin in the game (equity ownership) carry more risk or is it the other way round? Barring PSUs that are in financial mess despite higher promoter equity, it appears that risk is associated more with low promoter equity. Most private banks with low promoter equity, excepting a few, are currently facing problems. Is curbing voting rights a better solution than curbing their economic interest? 

The RBI needs to go back to the drawing board and look for rationality in all its regulations.

The time has come for the RBI to overhaul its internal systems, open itself up to a consultative process, scout for feedback and accept criticism as a tool of improvement. It must realise that it can also make mistakes and be ready to make amends. It must change the archaic laws to suit the demands of the new millennium. This must be done on a war footing to ensure that its prestige is not lost. 

(Concluded)

The writer is founder and managing director of Stakeholders Empowerment Services