The Reserve Bank of India’s investigation report into allegations made by news website Cobrapost has shows digression of a number of RBI rules and regulations across the banking system. But the central bank says the nature of transgressions has not created any systemic risk. In a conversation with Ira Dugal of The Financial Express, KC Chakrabarty, deputy governor, RBI, explains that the central bank has already initiated system level corrective actions. RBI has also sought clarifications from the banks following which action will be taken, if required. Excerpts.
Q: The RBI has said that there is no systemic problem but it certainly looks like there were system level malpractices. What is the RBI going to do about this and why have we not seen action so far?
A: These practices have been found across all banks. I am glad you have asked this question. The purpose of any regulatory or supervisory action is to improve the system. I don?t think in such a short time corrective action of this magnitude has ever been taken before. You see the Governor’s Annual Policy Statement. Several policy measures to improve/tighten the entire system have been announced. We have already undertaken a thematic study across a large cross section of banks. We have found that there are certain transactional errors in contravention of our rules – not following KYC guidelines, non- filing of the suspicious transactions report, etc. These are all traffic rule violations, but no accidents have taken place. We have told banks that digressions should not take place. Even with best of technology, the systems cannot be fool proof. Transactional errors are unavoidable. What we need is better control and compliance systems at bank level.
As far as punitive action is concerned, I am not in a position to say at this stage what action needs to be taken against banks because these are all transactional errors. On the basis of transactional errors whether we should take action or not, the competent authority will decide; but it has to follow a process. The report that is being quoted is a preliminary investigation report by our inspectors. The banks have to be given an opportunity to respond to the findings. The banks may have objection to some findings and we would need to consider their response before firming up the final view. It is a formal process which cannot be bypassed. Some banks have sought more time for responding to our findings. We have asked banks to establish and certify that no wrong transactions have taken place. Then only a final view may be taken. The primary objective of a penal action is to ?name and shame? the bank. That has already been achieved, partly due to media coverage. However, when something is not followed by many market players, penal action might not be able to achieve the objective of ?name and shame?.
Q: Are you saying that the nature of transgression is not serious?
A: It is not serious. These are transactional errors but there is no evidence that anything wrong has happened due to these errors. At least, we don?t have any evidence as our inspectors have not found out. As a regulator, we have to closely look at the consequences of what has happened. If no accident has taken place, it is a matter of supervisory discretion and supervisory judgement. If an accident has taken place, then we would be definitely more concerned and consequent actions would be more stringent.
Q: What about the cash transactions that are not getting reported?
A: Cash transactions are getting reported but there may be lapses at unit level. You have to consider who does smaller cash transactions – the poorer people. On the one hand you want to encourage inclusion and on the other you are so concerned about cash transactions. Not much black money transactions can be done by splitting transactions below Rs 50,000. The people indulging in such activities will be depositing larger amounts of cash, which would invariably be reported. The smaller instances of splitting transactions may not be captured until the banks assign a unique identification number to each customer. We have been asking banks to complete this process of assigning unique customer ID and the banks have initiated necessary steps. ?
Q: The government seems to be pushing for higher penalties on these banks. What is the RBI’s view? Do you think the penalties typically imposed are adequate?
A: We have no such feeling or impression. If one or two banks are violating rules, we penalize them and that is fine. But if we end up penalizing all market participants, the whole system would become dysfunctional. Transactional errors are unavoidable in transactional banking. That does not mean we are saying that it is to be tolerated. What we would say is that banks must detect such errors themselves and correct them.
As far as system level improvement is concerned, there are certain areas like selling of third party products, where more clarity is needed and we are looking into those aspects. Some of these issues require inter-regulatory dialogue and action.
Suffice to say that action has been amply initiated, including the thematic study, including system level improvement and bank level discussion where we have asked banks to improve their systems and procedures. Rest of the part is process driven. Once the process is complete, we will take a view.
Q: On the system level changes, is there a problem in banks selling third party insurance products?
A: We have been saying that for a while, specially from stability point of view. Banks can sell insurance through the bancassurance model but why should they sell under the agency model? Under the agency model the incentive becomes the dominant factor. Why should the staff receive incentives for selling individual products? Those are the issues we are trying to address and plug the loopholes. We also have to define mis-selling. All these things will eventually happen but they will take time. It is an evolutionary process, especially when multiple regulators are involved.
Q: Does the same logic apply to sale of gold through banks?
A: Yes. Gold has been around for ages but banks were not selling gold coins earlier. My question is why the banks need to sell gold coins. Personally, I have been talking about this for a long time but now everyone seems to be coming around to the same view. Moreover, it is not in the banks? own interest to sell gold coins as the savings are getting diverted into gold and the banks? deposits are not growing. I have been telling this to banks in my meetings with them. Also, an individual who might have purchased gold coins from the bank at a higher value earlier and gets a lower value later upon selling, would feel that the bank has cheated him. Such instances would eventually hurt banks? reputation.
Regarding purchasing gold through credit cards, I am not sure what is the problem with that. Maybe if the regulatory guidelines don’t allow, we have to specifically convey that to banks. As of today, we don’t find anything wrong with that practice.
Q: The third systemic issue seems to be the link between commercial banks and cooperative banks and the money coming in via that route. What exactly is the problem there?
A: The problem is that the internal control systems and inspections at cooperative banks may not be as strong as the rest of the banking system. Instances of violations may be far more there because we don?t supervise cooperatives as closely as commercial banks. We don?t have enough people to monitor the cooperative banks intensively. The managements and boards of these banks also may not be that capable to handle these things. In certain instances, more transgressions may have happened but compared to the total number of transactions taking place through cooperative banks, this number may be insignificant. Yet, if something wrong is happening, we will get into a discussion with the banks. Let me clarify that it is very easy for us to shut down a business but that must only be the last resort. The regulator?s job is not to prevent people from doing business; the regulator?s job is to allow people to do good business and obstruct bad business. Yes, there may be more dilution of controls in cooperative banks due to inferior standard of managements and boards but we will look into how the system can be improved.
Q: At a more macro level, given the extent of malpractices ….isn’t that also a failure of the supervisory process?
A: Rather than terming these as malpractice, I would term them as a transgression of guidelines. Nothing in our investigation has shown that wrong transactions have taken place. Our job as a regulator/ supervisor is to prevent accidents. If we find that accidents have taken place, we would take harsh action.
Believe me, if there was inadequate supervision, we would never have found these errors. If we find an error, you say supervision is lax, if we don?t then also you say supervision is lax. But the fact is that worldwide there is an effort to strengthen bank regulation and supervision. We can?t be an exception.
Q: Have you found any laxity at the board level or the bank level?
A: We have no such evidence. At some places, at the implementation level, things have gone wrong. But what is the percentage of transactions where things have gone wrong? Believe me, if there was inadequate supervision, we would never have found these errors. If we find an error, you say supervision is lax, if we don?t then also you say supervision is lax. But the fact is that worldwide there is an effort to strengthen bank regulation and supervision. We can?t be an exception.
Q: But in this case the error came to light through a third party?
A: No. I am repeating that in the Cobrapost allegations, there is not a single new thing that has come to light which our supervisors did not know about. But, let me also tell you that KYC transgression happens worldwide as transactional errors in any high volume system is unavoidable. What is needed is the presence of a strong self correcting mechanism.
Q: But you are looking at moving the supervisory system to a risk based system. Can you explain how that will help?
A: Under the new system we will be focusing based on the risks associated with activities. We will leave the transaction level issues to the bank. However, if we feel that these issues escalate and start posing a risk to the bank, we will focus on them. The new system will focus on the major wrong doings in the banks, the issues that create risk for the bank.
Q: But isn?t that dangerous? Because you are far removed from the systems on the ground?
A: If you focus on transactions, you may end up looking at only mundane wrongdoings in banks while serious wrong things will get ignored. The regulator has to make a choice – whether to focus on the risk or on smaller transactional issues. Globally, all supervisors are moving towards a risk based system.
Q: Talking about new bank licences, we believe a lot of queries have come in regarding the financial inclusion parameters. NBFCs in particular want more time to meet the criteria?
A: They can’t come and seek a licence saying that we will not meet these guidelines. They have to agree to follow the guidelines. As stated in the policy, if the purpose of giving new licences is financial inclusion, then the interested entities have to start doing financial inclusion from the very beginning. If they are not capable enough then we shouldn’t consider their application. Those institutions who feel they can do – and I am confident that there are a large number of such entities – should be given preference.
Q: On to another topic, banks are insisting they can’t pass on rate cuts even though transmission is taking place through other avenues like the bond market. What is your perspective?
A: If banks don’t cut rates, their customers will suffer and, in the process, they will suffer. Banks have to understand that their survival depends on the survival of the customer. One of the reasons, of course, is the high deposit cost which is not coming down due to high inflation. That is why the RBI is focussed on inflation control. Now that inflation is coming down, maybe banks will be able to bring down deposit costs. We have to enter into a dialogue with banks and build a conducive environment and make it possible for them to cut rates. It is partly carrot, partly stick and partly environment. However, we need not be overly concerned about banks not being able to cut lending rates because people getting money from banks are a privileged lot. Please bear in mind that their alternate costs are much higher.
Q: But if the central bank is cutting rates for a reason. What is the point if it?s not getting transmitted through the banking channels although it is getting transmitted through the bond markets?
A: Competition will bring down rates. Central bank can only give a signal. Rates may not come down immediately but they will, eventually. Transmission process has weakened globally.
Q: What about the way bond markets have reacted and how quickly yields have come down? Is it excessive?
A: It is market. If someone is getting money very cheap, someone else will get it expensive. No one is asking why the bond yield is less than 8%. It is low as compared to the interest rates offered by the banks.
Q: Bond yields are too low? Why do you say that?
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A: Because if banks are giving a return of 8-9% on their time deposit, then how they are investing in 8% bond. These are structural issues. But I am worried, if bond market yields are coming down too quick, then other areas, transmission will be difficult. It’s cross-subsidisation in some ways. If you combine it all together, banks? overall return on funds is coming down. At the same time, banks are not able to manage their NPAs. Those are the issues. Transmission will be more effective if banks can manage NPAs better and if they can bring down their costs.