The problem of increasing non-performing bank assets has been simmering beneath the surface for many years. Until now, it was possible to sweep the bad news under the rug. But the pressure resulting from bad debts going through the bankruptcy mechanism made it difficult for the expansion and simulation game to continue. The recapitalization of banks is not, however, a reform. It uses taxpayers’ money to cover up failing institutions. To prevent such a failure from happening again, it is important to reform not only governance, but also regulatory oversight.
The problem of bad hidden assets is pervasive throughout the banking system. Public and private sector banks are history. If a bank had practiced fraudulent accounting practices and covered up problems, it could have been blamed and its management punished, as in the case of Satyam and the conviction of Ramalinga Raju. If the problem were limited to public sector banks, we would have found solutions in their governance. Private banks also hide bad assets. The current NPA crisis seems to be as much a failure of the banking regulator. For many years, despite its unchallenged powers to regulate, supervise and inspect banks, the regulator took no action against banks that hid their bad assets. Instead, he came up with one loan restructuring plan after another. None of the programs like CDR, SDR, S4A succeeded and stressed assets increased in number and value. It is only now, when credit growth has collapsed, that solving the problem can no longer be postponed and the regulator has become strict.
There has been a lot of talk about restructuring public sector banks. However, this ignores the fact that private sector banks are in a similar situation as well. The question to ask is: why did the banking regulator not take action against banks that were hiding bad loans? The RBI is a regulator that interferes with banking operations more than any other banking regulator in the world. Given its policy of granting virtually no new banking licenses, the RBI has only a small number of bank books to review. So why did he fail in this basic function?
A charitable explanation could be that its staff are of poor quality. He is ill-equipped to inspect bank books. Why didn’t the RBI see the issues, like late payment of interest and principal, loan renewals, the mechanisms that banks have created to prevent bad loans from being classified as such until in 2015 ? Many regulators, especially overseas and some in India like SEBI, hire industry practitioners to be part of oversight teams. Does the RBI lack adequate side entry and depend on people who have not been on the other side, and therefore continue to be foiled?
A second, less charitable, explanation could be that the bank inspection revealed the bad asset issues. But the inspectors were silent. Minister of Finances Arun jaitley said the problem was hidden under the rug until 2015. In other words, the regulator knew there were bad assets, but did not pressure banks to declare them non-performing. The regulator took no action when the banks continued to pretend. The loans were not declared NPA despite non-payment of interest or principal. Bank inspectors looked the other way when banks extended additional loans to defaulting customers to service those loans. If that was the problem, shouldn’t one wonder why the regulator behaved in this way? Bad credit is an asset that depreciates rapidly. The RBI was the sole authority to exercise control over the banks, and allowing expansion and simulation increased the cost to the taxpayer of bank recapitalization. Who was responsible, who is responsible?
Whatever the correct explanation – incompetence, complicity or an attempt to hide its own inadequacy – there is no doubt that the banking regulator, by not doing its job, has imposed higher costs on the taxpayer. The cost of fixing the NPA problem has increased every year since the RBI hid it, and the burden on the taxpayer has increased.
The RBI currently has an annual expenditure of Rs 13,000 crore. It is the only regulator that is not subject to a CAG audit. In the name of independence, the RBI has become irresponsible. All institutions that spend public money must be held to account, and one that fails in its work cannot be excused for any reason. A mistake as serious as one requiring 2.11 trillion rupees of taxpayer money should be followed by an analysis of the failure of the government agency explicitly charged with preventing this very situation.
Taking into account previous recapitalizations of the PSB and regulatory failures of banks in the past, the Financial Sector Legislative Reform Commission (FSLRC) had proposed changes to governance, regulation, supervision, inspection and to data collection in all regulators, including the RBI. The FSLRC also proposed a resolution firm with the power to inspect banks. While the bill on financial resolution and deposit insurance which aims to create a resolution company for banks has been tabled in Parliament, it does not give it the power to inspect banks and therefore to create checks and balances on the power of the RBI. Without additional supervision, and without checks and balances, the RBI will continue to be the sole supervisor of banks. The resolution firm will only step in after the RBI declares that a bank has gone bankrupt.
Regulatory failure across the world has led to changes in regulatory regimes, laws and institutions. The creation of checks and balances is a necessary part of the reform process. Independence and responsibility are two sides of the same coin. Regulators must have both.
In conclusion, in the discussions on the reform that must accompany the recapitalization, it is important to remember that it is not enough to reform public sector banks. The problem of hiding APNs is also present in private sector banks. Failures in banking regulation must be corrected and checks and balances must be created.