RBI and the PNB scam: regulation in ruins

The common citizen is today a victim of false hopes. On the one hand is the narrative of India as the bright spot in the global economy with glowing growth numbers. There is the story of how India has moved up on the index of ease of doing business. We are a technology powerhouse and sell solutions to the world. Drunk on this Kool-Aid, the ordinary citizen looks to a brighter future when suddenly comes a reality check.  A hole of over Rs.10,000 crores in the Punjab National Bank, the nation’s second largest bank. Suddenly, the nation worries if the money of ordinary citizens is safe in the banks.

At one level, the PNB plunder is a specific story of a heist of phantasmagorical proportions. A diamond duo walk away with cash (or the equivalent thereof) and disappear into the world in which India was supposed to be the emerging star. No one in that world does anything or attempts to stop the fraudsters. The CBI begins an investigation while the top brass work on unscathed. At the PNB, the top management reports to work. No one quits.

At these times, it is important to ask some simple questions. Who has plundered the deposit of the common man?  Is the deputy manager involved?  Is it the PNB top management?  Is the finance ministry and the government of the day not to blame? The answer is ‘yes’ to all of these.  And what do we say of the towering institution called the Reserve Bank of India, which is the banker to the government, the ‘supervisor superior’ as it were, a bank that is meant to check the wrongdoings of all other banks? There, too, it is business as usual, with secure jobs, plush offices and no questions being asked on duties and responsibilities.

The RBI, of course, agrees that it “has a critical role to play in ensuring the safety and soundness of the banking system-and in maintaining financial stability and public confidence in this system.” Its regulation aims at “protecting depositors’ interests, orderly development and conduct of banking operations and fostering of the overall health of the banking system and financial stability”. This is presented as its ”mandate/goal”.

Now consider in this light the two press statements issued by the RBI after the PNB revelation. The first on Feb. 16 stated that the fraud in PNB “is a case of operational risk arising on account of delinquent behaviour by one or more employees of the bank and failure of internal controls.”  The solution is also announced in the same release in the very next line: “RBI has already undertaken a supervisory assessment of control systems in PNB and will take appropriate supervisory action.” No less amazing than the fraud, which is now categorised as the biggest in Indian banking history, is the fact that the regulator has the gall to make this statement and get away with it.

We must not forget that the RBI has a seat on the PNB board. In any case, the supervisory machinery by RBI should have caught on to this mismatch across the banking system. If they have not been aware of such a high magnitude of transaction happening repeatedly, then the whole supervisory machinery put in place is superficial.

The regulator is waking up only now and has reportedly instructed banks to link their core banking solutions to the SWIFT messaging system that was used to issue Letters of Undertakings in the PNB case.  The RBI has offered a deadline of April 30, 2018. But never mind the technical link, an immediate and top priority audit of all LoUs must certainly be called for. The window till April should not be to offer time to clean up books that are reportedly similarly soiled in the case of several other banks and businesses.

In the second press statement issued on Feb.20, the RBI made this motherhood statement that “the risks arising from the potential malicious use of the SWIFT infrastructure, created by banks for their genuine business needs has always been a component of their operational risk profile.”  The central bank then says it “confidentially cautioned and alerted banks of such possible misuse, at least on three occasions since August 2016.”

In RBI’s own admission, banks have been at varying levels in implementation of such measures, which largely means that the instructions were ignored or violated by some players.  The RBI’s steps to fix the problem are not known. One wonders what it means by “confidentially cautioned and alerted banks”? What is the confidentiality in asking banks to follow simple instructions? This appears more like a “save your skin” kind-of memo that enables the sender to later say: “We told you so”. This is criminal negligence and accountability must be fixed if the message has to go out that India will not allow playing with the peoples’ money. If this is the central bank’s quality of regulation, then such regulation must be damned.

Another important aspect is the functioning of the Board for Financial Supervision (BFS). The BFS was constituted in November 1994 to act as an integrated supervisor over the financial system covering commercial and cooperative banks, local area banks, All India Financial Institutions (AIFIs), Non-Banking Financial Companies and Primary Dealers.  As reported by RBI during July 2016 to June 2017, eleven meetings of the BFS were held to review the results of supervisory assessments of 96 banks and four AIFIs. Besides prescribing the course of action to be pursued for institution-specific supervisory concerns, the BFS also provided guidance on several regulatory and supervisory policy issues. This evidently did not include fraudulent LoU transactions as the RBI report has not commented on it.

The whole financial sector function is based on credibility leading to the building of trust. The regulatory failure of RBI is one important stop in a string of failures from the lowest to the highest levels in the RBI and government. It has eroded the system’s credibility. In primary school, we are taught that a stitch in time saves nine. The RBI top brass needs to relearn this primary school lesson.

(Pattnaik is a former Central banker and Rattanani is a journalist. Both are faculty members at SPJIMR)