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Imagine this: there is a large hospital chain of national scale. Doctors are salaried employees and they’re found to be prescribing medical products that are harmful to their patients. They recommend these products as they carry higher kick-backs from the drug companies. For example, they prescribe drugs that are known to cause sugar in diabetics to rise -- not very different from bankers who sell life insurance products to those above age 60. They recommend expensive muscle enhancers instead of multi-vitamin to economically weaker patients suffering from poor nutrition, not very different from selling sector funds to fisherfolk who come looking for a bank deposit. What would you say if the regulatory authority that oversees hospitals said this: “If there was negligence in the medical care, we are responsible, but correct drugs are the responsibility of the drug makers – it is not our problem. Go to the drug regulator."

Well, Reserve Bank of India (RBI) deputy governor K.C. Chakrabarty seems to be saying exactly this. In an interview to Business Standard that you can read here: http://bit.ly/YSm6XI, he says: “There is no mis-selling of banking products in this case. Other regulators have to create their own guidelines in this regard." Chakrabarty was responding to a question on the Cobrapost news website’s investigation that found large scale evidence of violations of basic know your customer (KYC) norms in top private and public sector Indian banks. If we can agree that a deputy governor speaks for the institution, the message from the banking regulator is disturbing on many counts. First, there seems to be an attempt to move the discussion from money laundering to mis-selling of financial products. It is then easy to blame the regulators of product manufacturers and not the banking staff that sell the products. This, in fact, has been the RBI position for many years: “It is not our problem, the problem sits with product manufacturer regulators." But it is a strange argument, as the example of the hospital chain above shows, because an advised product is different from an over-the-counter product, where the seller globally bears responsibility for what he sells. And banks do report profits on their balance sheets from sales of such products. Is RBI saying that it is not responsible for what bank branches sell?

Second, there is an attempt to trivialise the extent of the problem by making it a ‘violation’ and not an ‘accident’ story. Says Chakrabarty: “There are some traffic-rule violations but no accident has taken place." It is surprising that the RBI is taking this stance when its own investigation has revealed (according to recent newspaper reports) large-scale violations in the three banks that have been investigated. These include cash transactions without a PAN number, credit card payments for gold purchases, splitting deposits to stay under the 50,000 radar, transactions totalling thousands of crores without a PAN or Form 60 (filled by those who do not have a PAN). The investigation, say reports, showed that banks suppressed alerts generated by the in-house surveillance system when these transactions were made. The question to ask is this: when should we worry? When there is evidence of terror funding through banks? Surely if KYC norms are loose, they are loose for everybody and not just for turning black into white money.

Expense Account has been red flagging the decay in the branch banking system for the past few years, but has found the regulator unresponsive. RBI’s unwillingness to effectively regulate banks has serious repercussions on the access to financial products. I paraphrase words said to me by an ex-banker: Access to financial products from all the regulators is being stifled because all regulators want money to be routed through bank accounts in the belief that KYC and anti-money laundering (AML) responsibility should be held by the banks. Unfortunately, RBI is sharply restricting access to bank accounts by insisting that non-banking financial companies, despite being regulated by it, should not be permitted to partner with banks in this area; banks are very reluctant to do so directly; and nobody else seems to have a viable model – a complete impasse! Now we are finding that even regular bank accounts are not meeting KYC/AML requirements. What an unholy mess!

Says an academic who shall remain anonymous: “Looks like increasingly the shift from, what I would call ‘harmless fraud’ (I know the term is an oxymoron), to ‘harmful fraud’ is complete. I use the term because businesses think that is what exactly it is. What is interesting (from a theoretical perspective) is the number of businesses where the line has been crossed or where it is being re-drawn."

This would be a great opportunity for the banking regulator to rework its stance on how it views its role as the regulator of banks that sell third-party products. The Securities and Exchange Board of India already has advisor regulations in place. Why shouldn’t RBI and the Insurance Regulatory and Development Authority join this and make the regulations an industry standard? It would also be a great opportunity to make the top management of banks responsible for what happens down the line. Or, as a country, we should be OK with people moving out of banking and financial products back to real estate and gold. And we should be OK with a surging current account deficit on account of these gold imports.

Monika Halan works in the area of financial literacy and financial intermediation policy and is a certified financial planner. She is editor, Mint Money, and Yale World Fellow 2011. She can be reached at expenseaccount@livemint.com

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