PNB crisis shows government banks should either reform or perish

Deep crisis plagues public sector banks, which need to overhaul system of monitoring and control

NumberTheory Updated: Feb 22, 2018 07:49 IST
Roshan Kishore
Roshan Kishore
Hindustan Times, New Delhi
PNB,PNB fraud case,Nirav Modi
The state-owned Punjab National Bank (PNB) on February 14, 2018 revealed that it had detected fraud of almost $1.8 billion at one of its branches.(AFP )

We do not know how much money Punjab National Bank (PNB) will lose due to the current fraud involving letters of undertaking (bank guarantees) issued to companies belonging to Nirav Modi and Mehul Choksi. We also do not know whether or not the people who gained from this will be punished. But there is one thing which we do know more than ever.

A deep crisis plagues the Indian banking system, especially government owned banks. The fact that nobody noticed a fraud of such scale at PNB is testimony to this. Blaming malfeasance by a handful of employees and other conspiracy theories will not take us very far in understanding the roots of the problem. Here are some statistics which can help us make sense of growing frauds in banking sector.

Big-ticket frauds

Unfortunately, the Reserve Bank of India does not publish regular statistics on banking frauds. A 2013 speech by then deputy governor of RBI Dr KC Chakravarty (who was chairman and managing director of PNB before moving to the central bank), gives some statistics on bank frauds. It shows that share of big-ticket frauds is rising in the Indian banking system. Average share of frauds worth more than Rs 1 crore between 2010-11 and 2012-13 was 90%. This value was just 73% between 2004-05 and 2006-07 (See Chart 1).

RBI’s Financial Stability report for June 2017 says that value of frauds worth more than Rs 1 lakh increased from Rs 9,750 crore to Rs 16,770 crore over the last five financial years.

The report also notes that share of frauds in advances (loans) portfolio continued to be high at 86% of the frauds reported during 2016-17 in terms of amount involved. The report is clear in blaming poor governance for the rising problem. It says, “While the fall out of adverse market conditions, recessionary trends, industry specific vulnerabilities and macro-economic risks on bank lending can be considered as relatively difficult to control and mitigate by banks, the same cannot be true in case of loan frauds. In a number of large value frauds, serious gaps in credit underwriting standards were evident”.

Vulnerable banks

As much as 90% of total value of reported frauds between 2009-10 and 2012-13 is attributable to advance related frauds in government owned banks (See Chart 2).

Advance related frauds are those where a creditor does not return the borrowed amount. Chakravarty’s speech referred to above is unequivocal in flagging governance concern in public sector banks for their vulnerability. He says, “While there is a pressing need to overhaul the system of monitoring, control, supervision and follow up of advances related frauds, their incidence in public sector banks in a large measure can also be trailed to comparatively poor corporate governance standards and lack of firm resolve by the Board and the Top Management in fighting this menace.”

This view is corroborated by the findings of The Committee to Review Governance of Board of Banks in India. The committee was chaired by PJ Nayak and submitted its report to the RBI in 2014. Public sector banks fare worse when compared to their private peers when it comes to both tabling and discussing risk and compliance related matters in board meetings, the report shows (See Chart 3). Given the fact that public sector banks (PSBs) had a much bigger fraud problem than private banks, the trend is disconcerting to say the least.

A 2015 Deloitte report on fraud in Indian banking also supports such arguments. It lists lack of oversight by senior management as the biggest reason for increase in incidents of frauds in banks (See Chart 4).

The crisis in PNB has re-triggered demands of large-scale privatisation of public sector banks. The issue is a deeply polarising one. Those who argue for bank privatisation from the why should the government fund their losses viewpoint would do well to remember that the state ends up bailing out even private banks when they face crisis. This fact however cannot diminish the importance of reforming governance and compliance practices in India’s public sector banks. The PNB crisis shows that the choice is very clear: government banks should either reform or perish.

First Published: Feb 22, 2018 07:48 IST