The public backlash after every financial scam usually puts the authorities under pressure to do something. The government has already asked public sector banks to investigate all bad loans above Rs50 crore to detect potential frauds. The Reserve Bank of India has begun sending officials to examine the letters of undertaking issued by public sector banks. The investigative agencies are bound to be brought into play on a wider scale at some point of time. A couple of public interest litigations will also draw in the courts.

There is no doubt that action is required after the Nirav Modi case. There is also a risk of regulatory overreach that will create a culture of fear. Bankers will be extremely wary of lending. Civil servants will play safe rather than take decisions. India needs better regulations to deal with financial scams—but it would be a mistake to believe that regulation is all that matters. Incentive design, internal controls and technology are as important. Care should be taken to ensure that investigations do not become witch hunts that freeze decision-making in banks.

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