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The proper functioning of regulatory institutions is central to our economic stability

While we debate the need for an independent banking regulator any knee-jerk reactions must be avoided

analysis Updated: Feb 28, 2018 19:25 IST
Isn’t it inexplicable that while the PNB fraud was a result of a systemic mismatch between SWIFT and the core banking functions of the bank?
Isn’t it inexplicable that while the PNB fraud was a result of a systemic mismatch between SWIFT and the core banking functions of the bank?(REUTERS)

The financial malfeasance of the Punjab National Bank (PNB) has regrettably overshadowed the ongoing discussions on the budget proposals.

There is no doubt that the governance failure in the PNB case raises serious concerns about the health of India’s public institutions. Prime Minister Narendra Modi has emphasised that paramount diligence is needed by those assigned with regulatory functions. Finance minister Arun Jaitley spoke of regulators having a third eye. Even if that requires more than extraordinary powers, the regulators cannot take their eyes off the ball.

The role of regulators raises several issues.

First, isn’t it inexplicable that while the PNB fraud was a result of a systemic mismatch between SWIFT and the core banking functions of the bank, it escaped the attention of five supervisory entities within the bank: adequacy audit, compliance audit, internal audit, external audit and extrinsic audit? This casts a serious doubt on the credibility of the internal processes in the bank and the functioning of these specialised audit institutions. The mandate of the newly-constituted Malegam Committee by the Reserve Bank of India to investigate the Nirav Modi case will hopefully come up with a credible explanation.

Second, there is the issue of an independent banking regulator: The financial sector already has several sub-sector regulators such as SEBI for capital markets, IRDA for insurance markets and PFRDA for pension funds. RBI is the obvious financial regulator, given its mandate for banking soundness as a pre-condition for an effective monetary policy, and also the lender of last resort.

The First Narasimham Committee on Banking Sector Reforms in August 1991, which looked into all aspects of the financial system, emphasised on the strengthening of RBI’s supervision capabilities. The Second Narasimham Committee Report in 1998 suggested the segregation of the role of the RBI as a regulator from the owner of the bank. RBI, thereafter, transferred its respective shareholdings of public banks such as the State Bank of India, National Housing Bank, and National Bank For Agriculture And Rural Development to the Government of India.

In 2007-08, the Centre decided to acquire the entire stake of RBI in these three banks. More recently, the Shri Krishna Committee Report on Financial Sector Legislative Reforms Commission (FSLRC) emphasised on rewriting and harmonising the financial sector legislation, spread over 60 Acts. More important, it suggested the creation of a unified financial sector agency as a regulator for the financial sector.

RBI performs its banking supervision functions under the guidance of the Board of Financial Supervision (BFS). This entity aims at upgrading the quality of the statutory audit and also oversees the functioning of the department of banking supervision (DBS), department of non-banking supervision (DNBS) and financial institutions division under a designated deputy governor.

The full import of the Narasimhan Committee Report did not result in strengthening the human resource capability, domain knowledge, and RBI’s supervisory entities. It was partly stymied given the fact that it synchronised with the Harshad Mehta scam of 1992. It was felt that a structural reform by way of creating a separate entity would cast a shadow both on RBI as also on the credibility of the governor. It is ironic that the debate on an independent banking regulator synchronises with another fraud.

There is little doubt that RBI acting as a banking regulator has some conflict of interest. It may be tempted to operate lax monetary policies to keep banks healthy, but more important, the risk towards reputation and in the event of a bank failure, which can undermine the credibility of RBI itself.

To avoid this reputational contagion, should RBI keep supervisory functions at arms’ length? Regulatory entities must ensure several dimensions of independence namely regulatory independence, supervisory independence, institutional independence and budgetary independence. Even while we debate the need for an independent banking regulator any knee-jerk reactions must be avoided. The full spirit of the Narasimhan Committee in creating an independent and separate entity within RBI, which performs its regulatory functions could be reconsidered. It must have domain knowledge, skills, expertise and manpower to undertake the detailed on-site inspection and verification, which are necessary for this close oversight.

Second, is there a need for a super regulator as an overarching function? Most countries have accepted a hybrid regime. If the central bank is to be the super-regulator any conflict of interest must be avoided. Besides, in the event of a conflict between two financial sector regulators who is to act as the ombudsman?

Finally, I wrote an article on September 22, 2015, in Mint that dealt on the issue of “regulating the regulators”. The finance minister is right that politicians are accountable but regulators are not. Enhancing greater parliamentary superintendence over regulatory functions must be considered. The present practice of sector regulators being, in some way, accountable to the parliamentary standing committees is inadequate.

The parliamentary standing committee is overburdened and has shown little time or disposition for a more systematic review of the functions of regulators. Innovative mechanisms which enable greater parliamentary engagement would strengthen both accountabilities and the democratic framework. It would serve the twin purpose of consumer protection and a framework to buffer the excesses and failures of market instruments. This is a good time to carefully consider all viable options while segregating the issues of immediate concern. The functioning of regulatory institutions is central to our economic stability.

NK Singh is a member of the BJP and a former Rajya Sabha MP

The views expressed are personal