Failures of supervision

The Reserve Bank of India (RBI) took action last week on the ongoing crisis at Punjab and Maharashtra Cooperative (PMC) Bank, one of the 10 largest co-operative banks in India. The central bank argued that an inspection of PMC Bank’s books had uncovered problems; but, in fact, the co-operative bank’s management had itself come to the RBI last week with its problems, pointing out that they had discovered long-standing bad loans, in particular to Housing Development & Infrastructure Ltd, and would need a resolution plan. The RBI needs to be commended for its swift action after the problem was revealed to it. But the larger issue should not be lost sight of: That, as a regulator, the RBI is not performing as it should.


Regulators should be able to detect early warnings of such problems, not have to take drastic action only after they are told of them. The RBI must introspect on the fact that its auditors failed to detect the problem that has been festering for many years. Nor is this the first such time that the RBI has failed in its supervisory task. It did not detect an ongoing fraud at Punjab National Bank, for example, which misused the SWIFT inter-bank transfer system among other facilities. The regulator failed for years to either detect the fraud, respond adequately to red flags in the banking system, or correct a breakdown of normal practices at the bank. The IL&FS imbroglio, which thrust the non-banking financial sector into a crisis from which it is yet to emerge, is another such recent oversight.


There is no alternative to raising the RBI’s capabilities when it comes to banking oversight. In the last Union Budget, the RBI was given additional powers to regulate the NBFC sector and housing finance — when it has barely demonstrated the capacity for the oversight of the sectors over which it had full powers. While the RBI is right to argue that its powers to address wrongdoing at, say, public-sector banks are too limited, regulators need to focus on the quality and implementation of their regulations, and not just on their arbitrary powers for corrective action. Unfortunately, the latter has been the focus of the central bank far more than the former.


What sort of capacity increase within the RBI is required? First, form should follow function — and function should be clearly defined. Other central banks, such as the US Federal Reserve, have clear and public manuals on how it conducts banking supervision. The RBI should also expose its process to public scrutiny and discussion. When a final and acceptable process is arrived at, the RBI can structure its audit and enforcement capacity around that process. Similar rigour should be shown when it comes to drafting new regulations, which can currently be done by the central bank’s staff arbitrarily and non-transparently. Instead, new regulations — which, after all, must be designed in tandem with the capacity to enforce them — must be made after input from outside experts, in response to a clearly stated or foreseen need, and with the approval of the RBI’s board or a sub-committee thereof. Finally, the question of appeals to the RBI’s decisions should be re-opened. The quality of supervision by the securities regulator has been greatly improved by the presence of a relevant appellate tribunal. What is clear, certainly, is that matters at the banking regulator cannot be allowed to continue the way they are.



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