PNB fraud: RBI guv Urjit Patel blames regulatory constraints for scam

We at Reserve Bank also feel anger, hurt and pain at banking sector frauds and irregularities, he said

RBI chief said on Wednesday that it had "very limited authority" over state-run banks and called for reforms in the wake of a $2 billion fraud to give the regulator the same powers to police state-run banks as it has over private lenders.

Reserve Bank of India (RBI) Governor Urjit Patel defended the central bank's role in the aftermath of the Punjab National Bank (PNB) fraud case and launched an indirect broadside against the Indian government, which has been critical of the role of the regulator and auditors in failing to spot the huge alleged scam.

In a speech at a law university in Gujarat, Patel said there were numerous limitations in the RBI's powers over state-run lenders, such as its inability to remove directors, replace management, push through a merger or initiate liquidation.

While the RBI regulates all banks in India, state-run banks are also regulated by the government, which owns majority-stakes in them.

This has, in effect, led to a system of "dual regulation", said Patel, adding that this "fault line is bound to lead to tremors such as the most recent fraud".

The unravelling PNB fraud, the biggest in Indian banking history, has stunned the financial sector and pushed the RBI and government to crack down on bank systems and lending practices.

Breaking silence over the near Rs 130-billion scam at PNB, he said: "I have chosen to speak today to convey that we at the Reserve Bank of India also feel the anger, hurt and pain at the banking sector frauds and irregularities."

"In plain simple English, these practices amount to a looting of our country's future by some in the business community, in cahoots with some lenders." Patel said RBI has in place asset quality review of banks and "we are doing all we can to break this unholy nexus".

Invoking mythology, he said RBI has undertaken the cleaning up of the country's credit culture as the Mandara mount or the churning rod in the Amrit Manthan or the Samudra Manthan of the modern day Indian economy.

Until the churn is complete and the nectar of stability safely secured for the country's future, someone must consume the poison that emanates along the way, he said.

"If we need to face the brickbats and be the Neelakantha consuming this poison, we will do so as our duty; we will persist with our endeavours and get better with each trial and tribulation along the way," the Governor said.

He also wished that more promoters and banks, individually – or collectively through their industry bodies, would reconsider being on the side of "Devas rather than Asuras in this Amrit Manthan".

He made a pitch for "making banking regulatory powers neutral to bank ownership and leveling the playing field between public sector and private sector banks".

Observing that there has been a tendency in the pronouncements post revelation of the fraud that RBI supervision team should have caught it, Patel said no banking regulator can catch or prevent all frauds.

"While that can always be said ex post with any fraud, it is simply infeasible for a banking regulator to be in every nook and corner of banking activity to rule out frauds by 'being there'," he said.

Referring to PNB, Patel said the RBI had identified, based on cyber risk considerations, the exact source of operational hazard – through which "we understand" now the fraud had been perpetrated.

In particular, he said the RBI had issued precise instructions via three circulars in 2016 to enable banks to eliminate the hazard.

"It turns out ex post the bank had simply not done so. Clearly, the internal processes at the bank failed in allowing the operational hazard to remain in place in spite of clear instructions to close it," he said.

Patel said the RBI will undertake actions against the bank that it is empowered to but this set is limited under its Banking Regulation Act powers over PSBs.

Noting that "success has many fathers; failures none", the Governor said there has been the usual blame game, passing the buck, and a tonne of honking, mostly short-term and knee-jerk reactions.

"These appear to have prevented the participants in this cacophony from deep reflection and soul searching that can help solve fundamental issues that are the root cause of such frauds and related irregularities in the banking sector," he said.

Patel also flagged the issue of rising bad loans (NPA) saying that the problems needs immediate attention.

"Its magnitude is larger than Rs 8.5 lakh crores of stressed assets on bank balancesheets and its significance stems from several practices in promoter-bank credit relationship that need immediate attention."

The RBI has been clamping down on the failure to recognise asset quality as non-performing as per its norms by requiring that banks, whose “divergence” exceeds by 15% of the true non performing assets (NPAs) as per the norms, disclose the divergence.

This should restore some market discipline against such practices, especially in the case of private sector banks, Patel said.