RBI Caught Napping

Updated: Apr 25 2002, 05:30am hrs
If the Reserve Bank of India goes ahead with its plan to ban co-operative banks from dealing with brokers in the securities market or G-Sec, it will be guilty of an over-reaction aimed at covering up its own supervisory failure. Ten years ago, the RBI’s archaic Public Debt Office had failed to keep pace with the boom in the G-Sec market and set the stage for a massive securities scam. This time the alleged, Rs 125 crore problem at the Nagpur Cooperative Bank and other issues, again exposes RBI’s poor systems and lack of market intelligence. The continuous decline in interest rates has led to the boom in the G-Sec market. Trading volumes shot up to an unprecedented Rs 6,000 crore per day and rising securities prices made all bankers look like savvy traders. Profit on treasury operations seemed such a sure thing that every bank was reporting hefty increases in their profits. A smart regulator would have realised that such irrational exuberance was bound to attract the rogues and the scamsters. Small co-operative banks with confused supervisory structure were their obvious targets and the RBIs inadequate systems only facilitated their exploitation.

Essentially, the RBI is faced with two issues. The first is outright fraud, as is allegedly suspected in the Nagpur Cooperative Bank case. A broker, who does not even hold a debt market membership is understood to have picked up several hundred crore of bank funds for the purchase of G-Secs. The broker avoided delivery by claiming to have sent the physical securities for transfer. While this may involve collusion between the bank and the broker, it exploited poor supervision and antiquated systems in the G-Sec market. A proper clearing and settlement system would have prevented this happening. The obvious question is: why are physical trades permitted in the G-Sec market when 99.7 per cent of widely distributed equity trading is in dematerialised form Don’t banks have proper empanelment rules for brokers What are the RBI’s procedures for inspecting and supervising the trading activities of banks, especially co-operative banks

The second issue is the possibility that cooperative banks have sometimes acted as fronts for brokers in G-Sec auctions with buy-back arrangement at pre-determined rates. Although this has not led to any real losses, it harks back to the lawless 1990s where banks often danced to the tune of savvy brokers with better trading skills. But the answer is not to throw out brokers or to start a witch-hunt just when the G-Sec market is dangerously poised for a bloodbath, if the interest rate cycle turns. Instead, the RBI needs to wake up to a few ground realities.

The first of these is that brokers help make markets more efficient, but they need to be regulated and supervised effectively. While the RBI may have set up its own Negotiated Dealing System that is meant only for banks with SGL accounts with the RBI, it cannot attempt to kill the debt market segments of the existing stock exchanges.

RBI’s rejection of the existing system stems from its deep aversion to any overlap of regulatory jurisdiction with the Securities and Exchange Board of India. This will not help and RBI must learn to share power gracefully.