The daily revelations of the PNB (LOU) scam have shaken the people’s confidence in the banking system. Essentially, business canaries have manipulated the banking system, bypassing protective mechanisms. The Reserve Bank of India’s (RBI) circulars directed banks to connect the Swift Communications System with the Core Banking System. Failing to do so has exposed the vulnerability of our banking procedures. Collusion between bank officers and scamsters has revealed that institutional corruption is rampant.
Scamsters use public money to become millionaires. The public banking system in India helps them do that. Bank managers should, in principle, not be risk averse. But risks can only be justified after a proposed venture is properly scrutinised.The banker must ensure that the revenue stream during the course of a project is adequate to service the debt both in good and bad times. All bank advances should also be secured by adequate collateral to recover outstanding debt even if a project incurs losses.
When the economy is in an upswing mode, banks are happy to lend because they share the entrepreneur’s prosperity. Borrowers usually manipulate the value of the collateral to lure the bank to give large advances. Valuation reports are often tailor-made to suit the borrower’s need for capital. Occasionally, bankers look the other way, aware that the valuation of the collateral is suspect. Quite often the scamster, to increase the level of his borrowings, sets up dummy companies to buy and sell products just to convince the bank of his business turnover. The underlying transactions are seldom scrutinised by the bank. In this way, public monies are fraudulently siphoned. Sometimes corrupt bankers in collusion with the borrower take a percentage of the loan amount as bribe. Discounting bills relating to letters of credit, without ensuring the genuineness of the underlying transactions, is yet another way banks are put to loss.
One of the greatest weaknesses of our banking system is the pressure that is brought to bear on managements to make advances. Government nominees occasionally, instead of acting as watchdogs, put in a quiet word at the highest level. Those receiving advances through such manoeuvring then finance politicians and political parties. That is why attempts have been made in the past to persuade governments to nominate credible professionals as nominees on the board of banks. But these positions are used to extend patronage to those politically committed to the party in power; often party members are rewarded with these positions. Borrowers build relationships with politicians since many managers of the public sector banks also look for political patronage. This politician-business-banker nexus makes the functioning of the banking system opaque and subject to corrupt manipulation. In many instances, politicians may not be aware that in helping the borrower, the banker is failing to comply with the due diligence required before extending credit. There is yet another aspect that needs urgent attention. All advances made are required to be scrutinised within the bank’s hierarchy, especially where the credit facilities extended are of a certain magnitude.
Scams extending over several years will normally be detected if bank procedures are meticulously followed. If not, the assumption is that all officers within the system are culpable. That is not all; the internal auditors will also be presumed to be part of the cover up. External auditors will be hard put to explain why a scam of the magnitude that we are witnessing went undetected. The RBI was also clearly not vigilant enough. Regulatory procedures are clearly inadequate.
The extent of the PNB (LOU) scam is yet to be fully exposed. Public sector banks will now start looking at transactions of all borrowers with a fine tooth comb. This,in turn, will impact the flow of credit. An economy that is already badly bruised will suffer yet another body blow. The finance minister’s optimism about GDP, in the best of times, has not been well-founded. Economic activity will start limping with yet another dismal year of economic growth. Harshad Mehta and Ketan Parekh manipulated the stock market. The repercussions of manipulating the banking system are far more serious. It will take a long time to set things right. The finance minister has already started blaming the regulators for this mess. He must find out how the Department of Financial Services discharged its supervisory obligations. Was the Bank Board Bureau merely an ornamental setup functioning in the comfort of the extraordinary perks it enjoyed? Will Vinod Rai be kind enough to apprise of the steps taken to improve governance and new strategies devised for public sector banks? After 14 long months in that position, what steps were taken by him to liberate government-owned banks from the machinations of vested interests? Also the several audits conducted within the PNB were obviously ineffectual while the fraud was going on.
The rot runs deeper. The finance minister must acknowledge that there are structural issues that need attention. The promise of reforming the banking sector has come a cropper. Mission Indradhanush has failed miserably. The finance minister would have realised by now that mere capitalisation of the public sector banks will not overcome the endemic problem of NPAs. Absent that, I fear what we may witness will be a lot of sound and fury. In the midst of all the mayhem, the most expensive chowkidar in the world will blame the UPA and spew venom against the Congress party.