The doubts about trust in banks that have arisen in recent months could be attributed, among others, to mounting non-performing assets on account of defaults by the very rich; a proposal to change the law relating to resolving the issues of problem banks by making depositors share the burden of insolvency; large criminal frauds committed in select banks; and the investigations launched and raids conducted on some Board members and CEOs, according YV Reddy, former Reserve Bank of India Governor.
Referring to several policy actions taken by Government and RBI in response to the global financial crisis, Reddy observed that the banks benefitted from fiscal stimulus, monetary stimulus and regulatory forbearance including higher exposure limits to corporates, groups and industries.
“In retrospect, perhaps, the extra-ordinary measures taken were more than needed and, were continued for longer period than necessary. Banks had also been encouraged to lend to infrastructure, which was not the core competence of the banks, apart from creating asset and liability mismatch.
“Disclosures of real position were delayed. So, the accumulated problems came to the open in 2013-14 and in subsequent years,” said Reddy, who was the RBI Governor from September 6, 2003 to September 5, 2008. He was also Deputy Governor at the central bank from 1996 to 2002.
This affects the depositors if a bank does not have enough money to pay the depositors, that is, when the capital is not adequate, he said in his speech on ‘Keeping Banks Safe’ at Shivaji University, Kolhapur last evening.
Reddy, however, emphasised that bank deposits continue to be as safe as they have ever been, as far as private sector banks are concerned. They have adequate capital. “The public sector banks do not have adequate capital to take care of the depositors interest, but since the majority ownership is that of the government, the deposits are safe. These are not limited liability companies, but institutions established under the law. However, the depositors are protected with the tax-payers money.
“People know this instinctively and, therefore, do not rush to withdraw deposits. The uncertainty and delay in Government's injecting of capital as required by the RBI is a source of discomfort, no doubt. In any case, the tax payer has to pay for high NPAs since Government as owner has to bear the burden,” he explained.
PSBs: confidence at a historic low
In this regard, the former RBI Governor observed that “the confidence in the working of the public sector banks is at a historically low level. The future of the public sector banking which accounts for a major part of the banking system is uncertain. They are functioning without knowing where they would be.”
The former RBI Chief opined that there should be clarity on the future of public sector banking towards which the government should move. The objective for public ownership of banks should be clarified and simplistic comparisons with the private sector banks avoided.
Bail-in proposal
Referring to the 2017 proposal to amend the law relating to resolution of banks and financial institutions, Reddy said the objective was to equate the bank depositor on par with other creditors.
He opined, “this caused nationwide concern, and rightly so. Fortunately, the law has been deferred or dropped. In any case, private sector banks are adequately capitalised and, therefore, there is no issue now. Yet the (bail-in) proposal has itself created a panic, and some withdrawal of deposits took place. To an extent, some permanent damage has been done to the trust in safety of bank deposits.”
Bank Frauds: Owner should be worried
Referring to the PNB scam, the former RBI Chief said it is clear that it is a fraud. The focus of all institutions should be to punish those who indulged in fraud and benefited most from the fraud. It is a crime and investigation of the crime should be the top most priority.
“Who should be worried most about the fraud? The owner of the bank who stands to lose most. The owner is the Government. The owner should be worried about what the Directors it nominated in the Board, were doing. The owner should be worried about the Managers it appointed. The owner should be worried about the system of monitoring and control of its own investment. That should be the focus of the owner,” he added.
Underscoring that tax payers end paying for the losses due to the fraud, Reddy felt that the tax payers who have entrusted their money to the Government owned banks should be asking the government to explain why as the custodian of their money it failed to prevent the fraud.
Is RBI responsible?
Though its main responsibility is financial system stability and the depositors protection, the central bank cannot escape responsibility for maintaining the trust of the public in the banking system, emphasised Reddy. “The fraud is of such a magnitude that it affects the credibility of RBI in ensuring the trust of people in banking. To this extent, it has to review its own regulatory and supervisory practices,” he said.
Despite criticisms in some segments of media, Reddy felt that RBI is held high in peoples esteem. However, he underscored that actions taken by Government and official statements should ideally reinforce confidence in the RBI at this juncture.
RBI should be seen to command respect and backing of Government to continue to effect mergers to protect depositors interest...effectiveness of RBI will be enhanced with demonstrable support from the Government,he added.
Raids and Investigations
Terming the recent large scale operations undertaken by the Central Bureau of Investigation (CBI) as unprecedented, Reddy observed that most of them are based on conspiracy and implied loss to Government than bad motive or pecuniary gains.
“Raids and investigations may be intended to (a) punish the guilty, and (b) act as a deterrent. Whether the really guilty have been booked; whether they will be punished finally; and whether they act as a deterrent are questions that remain.
“But, what is certain is that there is loss of confidence in the integrity of the banking system. It is not clear whether this by itself enhances the trust and whether there is anything on the anvil to show that the future system will be different. But, depositors are safe, no doubt,” he said, adding the government has shown determination in initiating punitive actions, but there is no confidence that they will end up with any convictions.
All punitive actions that are taken do not necessarily or by themselves result in positive outcomes. However, there should be a dual approach of simultaneous punitive action and system improvement, he added.
Reddy elaborated, “the government has shown determination in initiating punitive actions, but there is no confidence that they will end up with any convictions. An important initiative taken in regard to improvement of the system is the law relating to company insolvency. Some preliminary results are appearing.”
He concluded by stating that confidence, coherence, consistency and clarity should be maintained in official pronouncement (read; banking regulator and Government) on banking recognising that banks are special and deposits in banks are very special.