Enforcement sees paradigm shift by RBI

Regulated entities should realise that the central bank's enforcement actions carry reputation risks, erode investor confidence, and impact the chief executive's tenure

The Reserve Bank of India’s (RBI’s) enforcement department was set up in April 2017 to separate enforcement action from the supervisory process. According to the RBI’s Annual Report 2022-23, enforcement action was taken against 205 regulated entities (REs) and an aggregate penalty of Rs 40.39 crore was imposed for contraventions and non-compliance.

This, in a nutshell, reflects the shift in the regulator’s approach to enforcement. What was earlier a slap on the wrist is now resulting in serious financial and non-financial penalties. Gone are the days when bank treasurers used to calculate the likely penalty for a cash reserve ratio breach with the opportunity cost of funds, and decide whether it paid to breach or not. We are also seeing increasing non-financial penalties which severely hamper business growth. REs should realise that such enforcement actions, besides carrying huge reputation risks and eroding investor confidence, also adversely impact the chief executive officer’s tenure and compensation.

Some leaders in the financial sector argue that the RBI should also be subject to an appellate authority like the Securities Appellate Tribunal, which hears and disposes of appeals against orders passed by the Securities and Exchange Board of India, and the pension fund and insurance regulators.

I do not find much substance in this argument, since the whole process of enforcement is well structured, rule-based and gives an opportunity at every stage for REs to make their defence. A careful analysis of what is in the public domain shows the consistency in the approach. The discussions before the Panel of Executive Directors, which is the final court of appeal within the banking regulator, are transparent and due consideration is given to submissions.

While some believe this is a mere formality, it is not so. Bankers have said there have been several instances where the panel as concluded that the charges were not substantiated, or lowered the penalty substantially after the submissions made by the RE in the hearing. Unfortunately, such information is not available in the public domain.

The RBI’s annual reports for 2021-22 and 2022-23 reveal that the grounds for penalties are almost similar — violation of exposure norms, income recognition and asset classification norms; know your customer directions, fraud classification and reporting, circulars on the cyber-security framework, monitoring end-use of funds, violation of interest-rate directives, and submission of credit information to credit information companies.

REs have to get these basics right. The RBI says the objective of enforcement is to ensure compliance by REs with laws, within the overarching principle of ensuring financial stability, public interest and consumer protection. To this, I would add: making India a trusted financial centre as well.

To improve enforcement, the RBI could:

• Consider publishing turnaround times from review, investigation to completion of enforcement actions
• Consolidate such moves by the Foreign Exchange Department, Department of Payments and Settlements, and publish the same in its annual report; and not restrict it only to the Enforcement Department’s actions
• Weigh publishing the number of instances where such moves were dropped, or their intensity reduced, based on the submissions made by REs
• Bring in a senior managers’ accountability regime and start penalising individuals for bad behaviour. Individual accountability is a must
• Consider linking the enforcement action proportionate to the risks posed to the RBI’s objectives of regulation and supervision
• Look at penalties like additional capital charge, specific expenditure earmarked by banks on improving  systems/processes/ hiring. This could be in the form of a monitorable action plan with accountability of the board/senior management
• Avoid duplication of processes between the Department of Supervision and the Enforcement Department.

In conclusion, REs should remember that you may not have control over your karma, but surely you have control over your dharma. 

The writer is founder and designated director, Duvvuru & Reddy LLP, and member, Regulatory Review Authority