Another flaw in PSBs

Containing frauds will need wider reform

The Reserve Bank of India’s (RBI’s) Annual Report, released on Tuesday, highlighted several issues of concern for the financial sector. However, one of those issues — which might also impact the retail saver — has generated considerable attention. This is the question of bank fraud, which, according to the Annual Report, is increasing swiftly. In 2019-20, instances of fraud involving sums of Rs 1 lakh or above increased by as much as 159 per cent when compared with such incidents in 2018-19. The RBI pointed out this included frauds that were spaced out over time and discovered only in 2019-20. There were other characteristics of the distribution of such frauds that were of interest. For one, they were concentrated in the loan advances portfolio. Second, they clustered towards the higher-value end, with the top 50 such frauds accounting for 76 per cent by value. Such high-value frauds occurred particularly in state-owned banks. While state-owned banks are the location of just about half of all bank frauds by number, in terms of value they account for almost 80 per cent in 2019-20.

High-value fraud in loans and advances, which state-owned banks are susceptible to, are particularly hard to track down and trace under current systems. According to the RBI, while, on average, it took “only” two years between the initial date of occurrence of a fraud and its detection, for the largest such instances — those of Rs 100 crore and above — the average lag in detection was five years and three months. Clearly, there is a structural issue in cases of high-value fraud, in particular, and one that makes state-owned banks particularly susceptible. The RBI admits that the “early warning system”, or EWS, has been implemented poorly. There are other issues that are highlighted — internal audits have failed to note EWS markers, borrowers’ co-operation has been hard to enforce during forensic audits, auditors themselves have been submitting inconclusive reports, and joint lenders’ meetings have been deadlocked, slowing the detection process. While the RBI promises the EWS mechanism is being “revamped”, details of these improvements should be spelled out in a transparent manner so the general public can feel more confident. A “standing committee on analytics” has been set up with experts from prominent institutions — hopefully, there will be a better and more general understanding disseminated of how to use technological indicators to beef up supervision and warnings.

Yet the central problem will always remain the internal structure of public sector banks, in which operational efficiency and incentive compatibility will take the back seat to other considerations and criteria. State-directed lending contains within it the propensity for fraud, since it will weaken the oversight over any particular loan. Bureaucratic dependence on precedent allows for high-value fraud to persist over time, leading to particularly long lags in detection. An inability to accept past error also leads to minimal auditing, and deadlocked lenders’ committees. The growth of fraud in public sector banks is inextricably associated with their peculiar ownership and governance structure. It is this that needs reform.