Toxic loans mount: Banks' day out in India

Indian banks, known for their robustness and dexterity have traditionally commanded respect and trust of their customers across the board. In 2008, when the global financial crisis spared none, it was the sharp foresight of RBI, which caused it to issue an advisory to banks against excessive exposure to high risk sectors like real estate. Indian banks survived the trans-national crisis on the back of strong fundamentals and adherence to procedural requirements of the regulator. This further enhanced confidence of customers in the banking system. However, for the past few months, the Indian banking system has been in news for all the wrong reasons. Right from depositors indulging in unwanted speculation over the FRDI Bill, swindlers like Nirav Modi cheating the system to alleged misadventure involving ICICI Bank Chairman Ms. Chanda Kochhar, it has clearly been an ignominious period for the banking industry.

These incidents of impropriety are primarily mutually exclusive, involve different principals and agents, and emanate from separate sources of influence. This further heightens the complexity of crisis. Had the nature of scams been similar, investigative analysis would have been simpler; however due to the exclusivity of variables and actors involved in each setback, it is difficult to identify a definitive approach. However, since we know the habitat of banking ecosystem, let us list down the multiple interactions that would have provided for the deceit and deception.

Blurred lines of responsibility
The current framework provides the board, shareholders and the regulator, multiple routes to pass the buck and excuse oneself from the crisis. This is exactly what transpired in the Nirav Modi scam at Punjab National Bank. Every bank is encouraged to link its core banking framework with SWIFT to ensure, the books are always in sync. However, that was not to be. PNB did not link its SWIFT with its core banking system. While the RBI can blame the bank for overlooking its directives, shareholders can blame RBI for not doing enough to ensure compliance; RBI in turn will read out its role aloud - limited to detecting and highlighting the deficiencies, not treating the same. This is an endless loop, which leads to nowhere. One of the reasons, both private and public banks get away with such indulgences is this hazy matrix of roles and responsibilities between management and regulator.

Systematic loopholes
The Indian bureaucracy has a tendency to leave gaping holes in every governance policy or regulatory framework it injects in the system. For example, there is no rocket science, that members of a credit review committee should not have any conflicts of interest with respect to the proposal in question. It defeats reason, why the regulator did not mandate linking of SWIFT to core banking system, within a specific period of time. The liquor baron whose very mention makes people across organisations uncomfortable was doled out money, despite the airline business recording losses, quarter after quarter. The Banks Board Bureau, set up to refurbish quality of managerial workforce and enforce a code of conduct and ethics is conspicuous by its absence. The Bureau has failed in delivering on its primary objective of appointing organisation heads, and no one has bothered to call it out. Committee reports and panel observations languish in offices, waiting to be replaced by yet another committee report. While there is merit in phased governance, there is none in procrastinated governance.

Contract design
There are four primary actors in any banking system i.e. depositors, borrowers, management and the regulator out of which it is the management that enjoys a contract with all three actors. Since very contract is vulnerable to moral hazard, adverse selection, and signalling, there is an immediate need to place self-regulating procedures, adopt RegTech, and increase the cost of decision making. Till recent past, there was a misplaced notion that public sector banks play hand maiden to bureaucrats and succumb to political pressure. With increasing number of private banks coming under the scanner, there is a consensus, that the problem is sectoral and not limited to ownership alone. Be it public or private banks, in most high-profile scams that grapple with copious amounts of money it is observed that a mid-level banker is made the scapegoat. To a large extent, this is a convincing reaction to restore customer confidence. But, do we believe this is a sufficiently warranted reaction? Can a mid-level officer be the sole decision maker in designing a contract, worth crores of rupees? Are we really being true to ourselves, by agreeing that a branch head enjoys the power to sanction loans of systematically important size?

Realistically, there is no way to ensure a fraud-free banking system, for the miscreants will inevitably find a way. However, we need to appreciate that there is a fourth stakeholder, the depositor, who chooses to deposit her money with the bank, because she is convinced that her savings are more secure at the bank, than under her mattress. It has taken decades for this depositor to bring herself up to be a part of the banked community.

As per a World Bank Report, bank account penetration increased from 35 percent to 53 percent between 2011 and 2014; for these strata, the change has been nothing short of leap of faith. The order of business today is faced with two challenges - one external and another structural. The external challenge is to retain customer confidence - both domestic and international. The structural challenge is much broader and requires multiple variables to engage with one another, in a well-meaning way.

The choice is rather simple — A strong banking system, which will reward the economy or a susceptible framework, prone to malicious attacks and arm twisting by its own custodians. The complex bit is, who is making this choice.

(The columnist is an Associate Fellow at Pahle India Foundation, a not for profit policy and research think tank based in New Delhi. She is also an active panellist in economic policy related debates and discussions on the mainstream media)