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The recent spate of banking frauds at various PSBs including Punjab National Bank (PNB), State Bank of India (SBI), Bank of Baroda (BoB) has raised the concerns among the depositors in country, and has left them wondering ‘What is happening to the banking industry in the country?’ The answer is: ‘It is the same old wine in a new bottle’.
The bank frauds have been a part of the Indian financial industry since a long time. The first prominent bank failure occurred with the closure of Presidency Bank of Bombay (PBB) in 1868. Established in 1840, established by the East India Company, the bank started to recklessly giving out loans to cotton companies, which suddenly mushroomed after the cotton supplies from the US dried up due to a civil war. The loans were extended even on personal security. As soon as the civil war ended, the state of euphoria in the cotton industry turned into gloom and the PBB shut down subsequently.
There is nothing too much different in today’s banks, except the fact that they might not be headed in the same direction as that of PBB.
Are the Public Sector banks the main culprits?
The history is replete with failures in both the private and the public sector banks. An interesting case in this respect is that of Indian Specie Bank. In 1910s, it started lending heavily to a prominent pearl merchant, and as the business of the merchant failed, the bank’s fate was also doomed.
This trend continued its journey, when 350 banks failed all over the country between 1910 and 1934. The blame was mainly put on the lack of regulation of these banks. Subsequently, central bank was established in 1934.
Was the Central Bank able to subdue the bank fallouts?
Not really, as 900 more banks failed between 1935 and 1947. It was believed that the RBI Act did not give the central bank enough powers to regulate the banking sector. It was in 1949, that the Banking Regulation Act was enacted which gave the RBI additional regulatory powers. At this same time, Statutory Liquidity Ratio (SLR) was introduced to keep liquidity for safety purposes.
After 1969, the RBI became highly conservative in issuing new bank licenses, highlighted from the fact there were no new licenses issued between 1969 and 1994. This period coincided with a push towards more financial inclusion for the banks leading to accumulation of bad loans starting from 1980s.
Who’s responsible for the recent banking frauds in the country?
The current frauds and failures are somewhat puzzling, as the RBI has become even more stringent, and also the banks are not only regulated by the domestic norms but also by the international regulations such Basel norms. On the face of it, it seems to be a problem coming from the lack of regulation by the RBI, but a deeper analysis would reveal that it is not just the fault of RBI or the internal regulation by the banks, but the corporate borrowers also. This is referred to as the ‘Twin Balance Sheet’ problem.
Big corporates have time and again forced the banks to bend their rules for sanctioning loans or change the repayment terms. For decades, the money deposited in the banks by the one strata of the society has been considered the personal fiefdom of a select few. In 1991, post liberalization it was expected that the norms would be stricter. But, in the wake of globalization, the appetite for capital grew bigger, which motivated the companies to window dress their accounts to raise loans from banks.
So, when the Chairman of the Syndicate Bank is arrested for taking bribes from promoters of Bhushan Steel, both the parties are to be blamed. But the even bigger problem is when the act by Bhushan Steel becomes a guiding behavior for the other industry players to follow, and it becomes a norm.
NPA issues eroding the bank’s capital
The gross Non-performing assets (NPAs) in India are about 10.5% of the total loan advances. It is no surprise, therefore, that the share of Gross Capital Formation (GCF) in the GDP has fallen from 38.2% in 2011-12 to 32.3% in 2012-13. This has created a situation wherein the big corporate trees receive the maximum sunlight, and the smaller corporate plants underneath are left grappling for loans which they need and deserve.
How do the authorities plan to nuke this menace of bank frauds?
The solution to resolve this menace includes some obvious points which should have been taken care of now till now, and some others which have been coming up in the changing environment.
The first is building a safeguard in the internal controls of individual banks. The technology could aggressively be used in this context. A robust technology system could make it extremely difficult, if not impossible, to manipulate the control systems of the banks.
Secondly, fraud monitoring agencies could be established within banks, including people who are specifically trained in detecting frauds.
Third, Insolvency and Bankruptcy Code, 2016 (IBC) is the bankruptcy law of India which unified few existing frameworks under a single law. It empowered all classes of creditors to initiate a resolution process in case of non-payment of a valid claim. This Act ensures a balance between rehabilitation and recovery and provides for compulsory liquidation of corporate debtors in the event the resolution has not been agreed within 180 days of the resolution process.
Recent development suggest that the IBC code was modified to include home buyers as financial creditors, enabling their due representation in the Committee of Creditors (CoC) and making them a vital part of the executive process.
Fourth, a historic step towards eliminating inefficiencies and reducing the NPA amounts is the signing of Inter-Creditor Agreement (ICA) by public and private banks as part of ‘Project Sashakt’. The bank with the highest exposure (lead lender) will be authorized to formulate a resolution plan and submit it to an Overseeing Committee after 2/3rd of the lenders in terms of aggregate exposure approve. Dissenting lenders will have an exit route, either through selling their exposure at a discount or buying exposure of other lenders at a premium.
How can technology play a role in fraud prevention?
The rapidly developing blockchain technology could be used to make the transactions more transparent. This would ensure that all the bank’s transactions come into the public limelight, reducing the risk of frauds therefore. The most recent case at PNB where a deputy branch manager and his subordinate allegedly falsified 150 letters of undertaking and there were no records of the same on PNB’s record-keeping software. This could’ve have been eliminated if blockchain or distributed ledger technology was used. The immutable records kept at a decentralized database and accessible to multiple users makes fraud detection an easier job. The smart contracts could’ve taken care of the audit trail and compliance issues, whereas, the entire hash code ecosystem would ensure collective intelligence.
In the current scenario, the country needs a safe and an efficient banking system. The government and the central bank must ensure that the current worrisome situation does not turn into a panic situation wherein the citizens lose trust and become concerned about their deposits in the country’s banks.
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