The Daily Fix: Has RBI failed to adequately oversee the scam-ridden banking system?

Damned if you bank, damned if you don’t. That seems to be the dilemma facing Indians after the events of the last week. Back in 2016, Prime Minister Narendra Modi’s disastrous demonetisation decision forced Indians to put their money into banks, with provisions in place that made it illegal to carry out transactions above a certain value with currency notes. The government made it clear that Indians would be better off using the banking system.

Three years later, one prominent bank – the Punjab and Maharashtra Cooperative Bank – seems half-dead because of allegedly fraudulent actions by the management, potentially leaving thousands of customers out in the cold without their money. That development, in conjunction with concerns about the wider economy, the stress on the banking industry and the belief that there are more scams waiting to be unearthed have made Indians are genuinely worried about the safety of their money in the banks.

For the second time in a week, the Reserve Bank of India, which regulates the banking sector, issued a statement describing rumours about banks as “baseless” and insisting there is “no need to panic.”

Unfortunately, because the Reserve Bank has failed to offer more detail about what is actually going on, its very acknowledgment of the rumours has enhanced the anxiety. Meanwhile, concerns about yet another major housing finance company – Indiabulls – led to a sell-off in bank stocks across the board. The decline was led by the troubled YES Bank, which has already been facing severe pressures.

In many cases, the banks are in trouble because they hid or did not fully acknowledge loans to companies that could go bad. In the case of Punjab and Maharashtra Cooperative Bank, as much as 73% of the loan book was allegedly made out to various companies of a single group, the Wadhwans, which now seem unable to pay the bank back.

Double whammy

There is a double whammy. The economic slowdown has hurt real-estate companies, which, when unable to pay banks back, end up revealing cases of massive fraud or inaccurate categorisation of assets in the banks.

The Reserve Bank cannot be held responsible for the economic slowdown or even necessarily the state of real-estate companies, though it recently took on itself the responsibility of regulating Non Banking Financial Companies. The blame for that goes to the government, which bears responsibility for its vilification of cash.

But the central bank’s job as a regulator is to ensure that events such as those that occurred at PMC bank, or Punjab National Bank earlier this year, do not happen. The current panic has emerged because of the events of the past few years have given Indians little reason to trust the government, the banking system or the banking regulator.

RBI capacity

The Reserve Bank hasn’t done much to restore faith in itself. It doesn’t help when, in PMC’s case, the Reserve Bank imposed an arbitrary limit of Rs 1,000 in withdrawals for a whopping six months, then, seemingly under public pressure, raised that to Rs 10,000, still leaving about 40% of depositors out in the cold. It certainly didn’t help when customers learnt that another similar institution, the Rupee Cooperative Bank, has been kept in limbo like this by the Reserve Bank for six years now.

The central bank needs the capacity and inclination to adequately oversee the cooperative sector, which has experienced tremendous volatility and is otherwise also generally believed to be a less professional sector that is exploited by politically connected players.

But beyond cooperatives, the Reserve Bank has struggled to lay down the law even with core, scheduled banks, at a time when the entire system is under stress. To its credit, the central bank forced Asset Quality Reviews upon banks, revealing the rot on their books. But it still needs much greater capacity for bank supervision and the ability to enforce the norms that it mandates.

With Indians already on edge, the country can ill-afford another massive scandal that the central bank has failed to unearth, which leads to more depositors being left without their cash as well as more people taking their money out of the system.