CAG seeks debate on auditing regulators

With regulators like the Reserve Bank out of its purview, CAG Shashi Kant Sharma today sought discussion on the need to audit financial sector regulators to check their effectiveness in dealing with frauds.
"The developments in the USA and the UK echo demand for more accountability and transparency of the financial sector regulators, as the spate of scandals the world over has subjected the world to unprecedented stresses and turmoil, and there are demands for a higher level of assurance of the functioning of the financial sector regulator," he said.
In India, the Comptroller and Auditor General (CAG) does not audit RBI whose auditors are appointed by the central government under the provisions of the RBI Act, he said at an industry event here.

"In the light of growing incidences of the financial frauds, it is a thought for consideration as to whether in future our audit should look into risk and vulnerability facing our financial sector and the ability and effectiveness of our regulators to mitigate such risks," Sharma said.
He further said that the developments in the USA and the UK will suitably inform such a discourse.
"Objective should be to achieve the desired level of assurance, with respect to the effectiveness and functioning of financial sector regulators," he added.

Emphasising that risks and vulnerabilities from financial frauds are substantial, the CAG said there should be a comprehensive strategy to deal with them in order to safeguard the integrity of the financial system as well as the enormous public interest.

In a country that is largely financially illiterate, the possibility of fraud is much higher and promoting financial literacy is a long term strategy for mitigating this risk, he said.
At the same time, he said, the regulators have to work together to not only enhance their capacity to deal with financial frauds, but also to remove any regulatory arbitrage.
(Reopens DEL 20)
CAG conducts audit of other financial sector regulators like SEBI, IRDA and PFRDA but does not conduct performance audits.
Sharma said that financial scandals thrive on some common strands such as, weaknesses in the systems and controls, a culture of exemptions and unwillingness to submit to the rule of law, a weak or ineffective sanctions regime, and the lack of power or resources with the regulators.

Most of the investors are gullible and take the promises made on their face value, without questioning the ability of the financial service provider to generate the returns promised, he said at Assocham event here.
"We all know that frauds are committed against institutions on a regular basis. In recent times, a lot of attention has been given to frauds committed against banks, especially the public sector banks that are struggling with enormous amounts of non-productive assets or NPAs," he said.
There is a belief that a significant part of NPAs could be amounts fraudulently obtained as advances from the banking system, he said, adding, there is also a belief that a large part of these amounts may have been transferred abroad and may never get recovered.

He noted that financial frauds often thrive in situations of weak systems and controls and the perpetrators are continuously looking for the regulatory grey areas, and if possible to avoid the regulation altogether.
"The legislative and regulatory regime in India is designed around financial products in specific sectors. We have different laws and regulators for different financial sectors and products - banking, insurance, capital market, chit funds etc," he said.
The perpetrator will attempt to design a product which enables him to avoid the stereotype of a regulated product, he added.
Regulatory arbitrage is another causative factor of fraud, he said, adding there are multiple regulators in India.

"In addition to the prudential regulators (RBI, SEBI, IRDA, PFRDA), there are different regulators for chit funds, nidhis etc. While there are no regulators for others e.G., MLM companies, and NBFCs that do not meet the 50-50 test of RBI," he said.
Even among the prudential regulators, there will be differences in terms of capacity, capability and competence. Regulatory arbitrage prompts a fraudster to shift operations to areas that are unregulated or poorly regulated, he added.