Urjit Patel blames regulatory constraints for PNB fraud

Facing flak over the regulator’s role in the Rs 13,645 crore scam at Punjab National Bank (PNB), Reserve Bank of India governor Urjit Patel has asked for more policing power over public sector banks which are also regulated by the government.

Defending the RBI’s role, Patel said that the system of dual regulation by the finance ministry and the RBI “has led to a deep fissure in the landscape of banking regulatory terrain”. This “fault line is bound to lead to tremors such as the most recent fraud”.

The Banking Regulation Act does not give the RBI enough teeth to take action against specially a state-owned bank due to duality of ownership, Patel said. He was speaking at the Gujarat National Law University.

Expressing deep anguish over a spate of banking frauds, Patel said that like the ‘Neelakantha’, the central bank will consume poison and face brickbats, but will persist with endeavour to become better with each trial.

Breaking silence over the scam at PNB, he said: “I have chosen to speak today to convey that we at the Reserve Bank of India also feel the anger, hurt and pain at the banking sector frauds and irregularities.”

“In plain simple English, these practices amount to a looting of our country’s future by some in the business community, in cahoots with some lenders,” Patel added.

Earlier, the government had been critical of the role of RBI and auditors in detecting the fraud at PNB.

Differentiating between public and private sector banks, Patel said the RBI’s powers over state-owned banks were limited as they could not remove directors, replace management, push through a merger or initiate liquidation.

“The Banking Regulation Act exemptions for PSBs mean that the one agency – the regulatory – that can respond relatively quickly against banking frauds or irregularities cannot take effective action. Hence, for example, MDs at PSBs find it comfortable to tell media that business will be as usual for them under RBI’s Prompt Corrective Action framework as even if they do not meet the stipulated restrictions of the framework, the ultimate authority over their tenure is with the government and not with the RBI.”

Bank nationalisation was to have complete government control over credit allocation to the economy. This had led to RBI’s regulatory powers over public sector banks being weaker than those over private sector banks.

He said that in private banks the real deterrence arises from the market and regulatory discipline.

“The point is that they could be readily cautioned through their Boards and even replaced by the RBI in case of large or persistent irregularities. Further, a private bank failing to meet bank solvency standards and under RBI’s ‘prompt corrective action’ (PCA) would find it hard to raise capital, whereby it would need to put the house in order at swift notice so it can raise funding from markets and get back to growth path.”

Patel said the market discipline mechanism for public sector banks is appreciably weaker compared to private sector peers.

“There is implicitly a stronger perceived sovereign guarantee for all creditors of PSBs, and the principal shareholder – the government – has not so far been interested in fundamentally modifying the ownership structure. From an economic standpoint, this weakened market discipline should imply that the government would prefer stronger regulatory discipline of these banks, not weaker.”

The RBI governor said that internal processes at PNB failed to check the fraud despite three instructions given to it by the regulator way back in 2016.

“In the specific fraud at hand, the Reserve Bank had identified, based on cyber risk considerations, the exact source of operational hazard – through which we understand now the fraud had been perpetrated.”