Incremental policy progress, one fraud at a time
Science is said to progress one death at a time. Public policy makes progress, one fraud at a time. Yes, amid all the anger and hand-wringing over the scam involving Punjab National Bank (PNB), it is important to recognize that frauds help systemic improvements. In a country of 1.3 billion people, with systems and incentives rife with exploitation, fraud is inevitable. When it is exposed, one more loophole is plugged even as several others remain open for exploitation.
In a recent speech, Y.V. Reddy said the problem of non-performing assets (NPA) was not a banking crisis. He said there was no run on the banks and, second, with the owner and capital provider being the state, bank solvency was not in doubt either. Hence, he said, NPA was a problem but not a crisis. Fair enough. But the PNB scandal might make him rethink. Even if the fraud and the amount involved are not of crisis proportions, public anger suggests that it be deemed a national crisis.
Predictably, many have spread the blame-net wide and some have concentrated their firepower on specific stakeholders. There are axes to grind. The Reserve Bank of India (RBI), being the regulator, is one of the targets of criticism. There is a view that if a fraud occurred in a company, it is a problem for the management, the board and the owner, in that order. In this instance, can the regulator change the owner? No. The state is the owner. The board? No. The owner appoints them. Can the regulator order the chief executive officer (CEO) replaced? No. Public sector banks do not need the regulator’s approval to appoint CEOs, whereas private sector banks do. The regulator is responsible for financial stability and consumer protection.
However, it may not be so simple. Former RBI deputy governor S.S. Mundra had said in a speech in 2016 that the RBI had come across instances of fraudulent messages, confirming documentary credits being transmitted using Society for Worldwide Interbank Financial Telecommunication (SWIFT) infrastructure. He added, “Although the latter incidents were mainly a result of failure of internal controls and non-adherence to ‘four eyes principles’, it is also on account of reliance on disparate systems whereby SWIFT transactions could be done without originating a corresponding transaction in the CBS (core banking solution).” So, the RBI was aware of this gap in controls. If it was aware, it was its job as the regulator to ask the auditors to double-check, and its own supervisors to check that this lacuna was fixed. In fact, even before this scam broke out, Reddy, in his speech, had suggested that the RBI hold an internal inquiry “to fix the responsibility for excesses in NPAs in recent years”.
Does this fraud nail the argument for ending government ownership of the banking system? Yes, it does. In fact, the government should have used the NPA problem (in deference to Reddy) to make systemic changes to the banking system. It was a political economy question and it chose to skip it. It was not entirely a cop-out. It formed a Banks Board Bureau to infuse top private sector talent to head government-owned banks. But the infusion did not happen. One reason is that there was not enough blood available for infusion. Two, in the NPA problem, private sector banks had their own share of skeletons. Some may not have come out yet.
There is also the valid view that had it been left to private sector banks, India would have had a household leverage crisis; for the privately owned banks have shied away from lending to corporations and courted the retail consumer, egging them on to gratify themselves instantly. Very little of capital formation would occur in the economy. Further, private sector banks are guilty of misselling and over-selling financial products. Even during the mini stock market correction in the last few weeks, banks were sending messages through WhatsApp that it was the right time to buy stocks. Maybe. But that was not the right way to advise the retail investor.
Private banks in advanced nations brought the global economy to the brink of collapse in 2008. They, rather than the borrowers, were bailed out. Policymakers in those countries still remain captive to the interests of financial institutions. In any case, not all the NPAs in government banks were due to fraud. Some were consequences of excessive optimism. A McKinsey report (“Private Equity In India: Once Overestimated, Now Underserved”, February 2015) disclosed that India beat consensus growth forecasts in all but one of the nine years from 2002-10. Hence, extrapolation of good times was easy.
Clearly, a different banking architecture is needed to finance India’s economic aspirations. That said, just as a political crisis pushed Indira Gandhi to opt for nationalization, the NPA crisis should not result in knee-jerk calls for privatization without a sound regulatory architecture. Free markets and finance do not go together. India may end up with too much finance.
Further, politicians will know that there cannot be job reservations in private sector banks. Nor can there be loan waivers. Patronage politics will become difficult without government control of the banking system. An all-party consensus is necessary but with the national election approaching, it will be as elusive as it would be wise. Equally elusive are statesmen-leaders and politicians who are content with lasting achievements and ephemeral tenures.
Therefore, in the absence of scope for systemic changes, one is content to welcome frauds, for they result in incremental improvements until the next fraud comes along.
V. Anantha Nageswaran is an independent consultant based in Singapore. He blogs regularly at Thegoldstandardsite.wordpress.com. Read Anantha’s Mint columns at www.livemint.com/baretalk
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