After Yes Bank, RBI Can’t Be Trusted On Supervision: Time To Hive Off Policing To A Separate Entity

by R Jagannathan - Mar 6, 2020 11:02 AM +05:30 IST
After  Yes Bank, RBI Can’t  Be Trusted On Supervision: Time To Hive Off Policing To A  Separate EntityA Yes Bank branch. (Picture via Twitter)
  • The case for retaining the RBI as supervisor of the banking and financial system is weak.

    The job must be done by an independent board with strong powers to forensically audit banks and impose restraints on them when they are recalcitrant.

The Reserve Bank of India’s (RBI’s) decision to supersede the board of Yes Bank yesterday (5 March) is testimony to its abject inability to supervise the banking system firmly and credibly. It has put a moratorium on further lending, capped withdrawals at Rs 50,000 per month per account, and appointed its own administrator to run the bank in the short run. But these are no different from bolting the stable door after the horse has bolted.

The expectation is that the State Bank of India and Life Insurance Corporation will put in the funds to stabilise Yes Bank.

In a bland notification, the RBI said:

In exercise of the powers conferred under 36ACA of the Banking Regulation Act, 1949, the Reserve Bank has, in consultation with the Central Government, superseded the board of directors of Yes Bank Ltd for a period of 30 days owing to serious deterioration in the financial position of the Bank. This has been done to quickly restore depositors’ confidence in the bank, including by putting in place a scheme for reconstruction or amalgamation. Prashant Kumar, ex-DMD and CFO of State Bank of India, has been appointed as the administrator under Section 36ACA (2) of the Act.

Simultaneously, it also placed deposits under a moratorium.

If the RBI can act to safeguard the interests of a bank’s stakeholders, including its depositors, only one-and-a-half years after it had itself flagged problems with the bank’s asset classification practices, it is clearly unfit to supervise the banking system.

It is time to create a new prudential regulatory and supervisory authority outside the RBI, with the central bank’s ambit being reduced to managing monetary policy, open market operations, currency management and systemic stability.

Before we discuss the post-RBI supervisory framework, let’s look at how the RBI dropped the ball with Yes Bank. It all began in September 2018, when the central bank asked chief executive officer Rana Kapoor to leave by 31 January 2019. The reasons given were the bank’s “weak compliance” culture, its “weak governance” structure, and its “wrong asset” classification policies.

If this problem was seen as far back as September 2018, which means the supervisors would have known about it even earlier, what was the logic of letting the bank slide continuously for 18 months until it could no longer operate without a nanny?

It is worth recalling that the Yes Bank share peaked just a month before the RBI gave Kapoor his marching orders. In August 2018, the share price hit Rs 394. Today, it is at Rs 27.65 (mid-morning quote, 6 March). This implies that the RBI was sitting on its hands even as the markets destroyed over 90 per cent of investor wealth in the meanwhile.

This not only stymied the bank’s own ability to raise fresh capital, but raises questions why the central bank could not see what outside forces could see clearly?

The RBI’s Yes Bank failure gives the lie to another claim it made in early 2018, when former finance minister Arun Jaitley talked about supervisory failure in the fraud-hit Punjab National Bank. The then governor, Urjit Patel, claimed that the central bank lacked adequate powers to take action against public sector banks.

The joke is clearly on the RBI, for the Yes Bank failure is a direct reflection on its own inability to supervise the banking system, whether public or private. It may know a thing of two about systemic stability, but it simply lacks the ability to police its own backyard.

So, where do we go from here? Two places really.

First, clearly the supervisory function on the banking and financial system needs to be hived off from the RBI and given independent powers.

Second, future prudential norms can be announced by the newly-hived off supervisor, but in consultation with the RBI. The other option is to let the RBI set the prudential norms and the supervisory board to take care of its implementation by vetting banks’ books and spotting problem areas before they worsen.

In the current RBI structure, it supervises banks through its Board for Financial Supervision, but board’s constitution is problematic. The RBI website has this to say:

The board is constituted by co-opting four directors from the Central Board as members and is chaired by the Governor. The Deputy Governors of the Reserve Bank are ex-officio members. One Deputy Governor, traditionally, the Deputy Governor in charge of supervision, is nominated as the Vice-Chairman of the Board.

Simply, this means that the supervisory board comes from the same stable as the banking and monetary policy establishment, when their roles are completely different.

One wonders how such an incestuous board can function effectively as policeman and whistleblower when the RBI’s primary role is to ensure financial stability no matter how bad bank finances are. There is an in-built bias towards covering up problems for fear of causing a crisis of confidence in the public.

How is this supervisory board supposed to police not just scheduled commercial banks, but also cooperative banks, financial institutions, non-bank financial companies, credit information bureaus and primary market dealers? There are simply too many entities to police with inadequate resources.

The case for retaining the RBI as supervisor of the banking and financial system is weak. The job must be done by an independent board with strong powers to forensically audit banks and impose restraints on them when they are recalcitrant.

The RBI can be kept in the loop all the time, but the supervisory board cannot be beholden to the central bank which has its own priorities.

As for Yes Bank itself, the best course may well be merger with a stronger private or public sector bank. Private banks could be given a few days to do due diligence, but the chances are public sector banks will have to step in.

It would be better for Yes Bank to merge with SBI instead of allowing it to be bailed out by two partners, SBI and LIC. Better control needs one boss, not two.

Jagannathan is Editorial Director, Swarajya. He tweets at @TheJaggi.
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