If the Congress-led UPA government left behind a big mess in Indian banking with its huge load of non-performing assets, the BJP-led NDA government, as it approaches the end of its five-year term, is leaving behind an even bigger mess.

The Narendra Modi government began with a grand design to run the country’s state owned banks professionally by strengthening governance processes and picking the right people for senior positions. For this it created the Banks Board Bureau and put it under the leadership of the highly respected former CAG, Vinod Rai.

If what has been reported turns out to be true, the final nail will be driven into the coffin of hope for better governance when Rai’s term ends next month and the bureau is allowed to die.

Systems unravelling

Over time the bureau has been systematically undermined. Its scope of action was narrowed by it not being allowed to have a role in the selection of chiefs of public financial institutions. Plus, the government changed appointments contrary to the bureau’s advice and even made appointments without consulting the bureau. The result is that political leaders and senior bureaucrats have continued to call the shots, with what kind of calamitous consequence is now there for all to see.

First came the shocking news that the biggest and supposedly the healthiest public sector bank, State Bank of India, with which was merged all its associate banks to create a big strong entity, clocked up its first third quarter loss in 17 years of over ₹2,400 crore.

One of the reasons why this has happened is the bank having to provide for higher levels of non-performing assets by the Reserve Bank of India than what it did on their own. This process, initiated in 2015 under Raghuram Rajan, has caused the bank’s gross NPA ratio to go up from 4.25 per cent in financial 2015 to 10.35 per cent at the end of the same third quarter.

But the biggest bombshell to hit the banks is the next largest among them, Punjab National Bank, reporting a massive fraud of ₹11,400 crore. Two key factors led to this. One is a person centric fraud perpetrated mainly by a senior officer, who has since retired, issuing bank guarantees, without collaterals, to overseas counterparts to facilitate the business empire of Nirav Modi. The other is misusing the ‘Swift’ system of money transfer between banks. One proximate reason for the latter is the bank’s own software driven core banking accounting system not being synchronised with Swift.

Such reconciliation, which matches a transaction by one bank with a counter-party bank transaction, being delayed even when it deals with large foreign exchange transfers, is unbelievable. (This used to be a bugbear for banks with large branch networks until core banking systems came along.)

The surfacing of the fraud which has been building up over several years has revealed serious systemic deficiencies —inferior technology, weak risk management and insufficient regulatory oversight. The banking regulator RBI has now constituted a committee to look into two aspects. One is the divergence between the asset classification and provisioning by banks on the one hand and the RBI and its auditors’ sense on the other.

If this has more to do with a symptom, the other aspect of the committee’s enquiry goes to the root of the matter. It is to find reasons why there is an increasing incidence of fraud in banks and what can be done to address it. The Banks Board Bureau was to usher in a new era of governance, but it was not allowed to do so.

Declining morale

The RBI will take its time to come up with findings but anecdotal evidence collected from interactions with bank officials points to the following.

Too many new tasks like selling insurance and mutual funds, backed by incentives, have undermined the need to be good at basic tasks like garnering deposits and lending prudently. Tellingly, ensuring correct documentation under KYC is more important than actually knowing and assessing the integrity and expertise of your borrower.

The decline in commitment to the organisation among youngsters has dovetailed with falling morale among older employees who see no future for public sector banking. Unlike successive Congress governments which swore by nationalised banks, the present government, whose commitment to the public sector in general is low, is seen to be only tactically committed to the status quo in banking.

So what is to be done? Arvind Subramanian, chief economic adviser, has in the last few days publicly voiced the feeling that the present situation is untenable and suggested two pathways: one, bring in a private partner or transfer control to a private entity.

Creating a substantial role for the private sector in nationalised banks needs a well thought out roadmap and commitment to seeing it through. This can hardly happen in a pre-election year.

What cannot wait is reassuring the public that its money is safe in public sector banks. The middle class in particular needs to be reassured that deposits over ₹1 lakh will not have to take a haircut when these banks are rapidly declining.

The writer is a senior journalist

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