PNB fraud: Damn the banking regulations

R K Pattnaik Jagdish Rattanani

The common citizen is today a victim of false hopes. On one hand is the narrative of India as the bright spot in the global economy with growth numbers that in simplistic calculations are presented as looking better than any place else. 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 is concerned or does anything and there is no attempt to stop the fraudsters. No one quits at the bank. The CBI begins an investigation while the top brass work on unscathed. At the PNB, the top management reports to work as usual.

At these times, it is important to ask some simple questions again and again. Who has plundered the deposits of the common man? Is the deputy manager involved in this fraudulent transaction? Is it the PNB top management? Are the board of directors of PNB to be held responsible? Is the finance ministry and the government of the day not to blame? The answer is of course ‘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 not too many questions asked on discharging the most elementary of responsibilities.

Let us consider what the RBI has itself stated on its roles and duties: 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.” The RBI also announces that 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/goals”, the big picture view of an eco-system that we must rely on, trust and support so that our banks may not runaway with our money.

Now, consider in this light the two press statements issued by the RBI after the PNB revelation. The first press release by the RBI issued 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 the 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 and allegedly 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 have 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 the RBI’s own admission, banks have, however, been at varying levels in implementation of such measures, which would reasonably translate to mean that the instructions were ignored, violated or trampled. We have no word on how the RBI took the next logical steps to fix the problem. One wonders what the RBI means by “confidentially cautioned and alerted banks”? What is the confidentiality in asking banks to follow simple instructions? This appears more in the nature of “save your skin” kindof memos that are often put out only to enable the sender later say: “We told you so”. This is criminal negligence and accountability must be fixed and heads must roll if the message has to go out loud and clear that India will not allow playing with the peoples’ money. If this is the way of the central bank, this is the quality of regulation, then it is not surprising that people might conclude that such regulation be damned.

Another important aspect is the functioning of the Board for Financial Supervision (BFS). The BFS was constituted in November 1994. The purpose was to exercise the role of an integrated supervisor over the financial system covering banks (both commercial and cooperative), local area banks, All India Financial Institutions (AIFIs), Non-Banking Financial Companies and Primary Dealers. As reported by the 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. It is expected that in the BFS, there should have been some discussion on the fraudulent LoU transactions. But, it was not done as the RBI report has not commented on this aspect.

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