RBI needs to be a super regulator if corporates are allowed to open banks

One of the allegations against Rana Kapoor – the co-founder and former managing director of YES Bank – was that the loans extended to Dewan Housing Finance Ltd (DHFL) by the bank, was in turn given to companies promoted by Kapoor family. This is what is known as connected lending or camouflaged lending or mutual lending – whatever name one may wish to call. This is the main concern voiced by many former central bankers after Reserve Bank of India’s internal working group (IWG) recommended granting banking licence to corporate houses – the Tatas, Birlas, Ambanis and the Adanis of the world.

The key issue to monitor or prevent camouflaged or connected lending lies with the supervisory powers of the Reserve Bank of India (RBI). The current laws do not provide such powers to the regulator. As evident from the YES Bank case, there is nothing wrong in a bank lending to a particular entity so there is no way RBI inspectors could raise a flag.

“The issue here is once you allow the conglomerates then only supervising the banks will not be sufficient,” said SS Mundra, former deputy governor of RBI.

According to Mundra, supervision should be done at two levels – one on the non-operative financial holding company level and also on the group level.

“You will have to supervise all the activities of the conglomerates. And for that you need a consolidated supervision. Consolidated supervision means if the group has an insurance arm or a broking business – various regulators should be together and there should be one lead regulator. There has to be a format, there has to be a system. That is one,” Mundra who was in-charge of supervision of banks and non-banks as deputy governor said.

“The second is, since there will be a group involved, which may not be under the holding company, then supervisory capabilities are needed to know the flow of transactions, that is, from the bank whether it is going to related parties – not only in a direct way, sometimes these things happen indirectly also. So that kind of supervision will have to be maintained,” Mundra added.

The existing laws need to be amended to provide those special powers to the Reserve Bank of India. The IGW has said that necessary amendments to the Banking Regulation Act, 1949 would be required, to prevent connected lending.

Another former deputy governor of RBI, R Gandhi highlighted the need for forensic supervision.

“Supervision needs to be empowered because there is a need to inspect those group entities. You can only identify circular lending if you have a comprehensive supervisory authority. For such supervisory powers, statutory amendments will be required. Under the current law, it is not possible. RBI should be empowered to do that kind of investigation. That is a kind of forensic supervision,” Gandhi said.

“RBI should have the capacity to do connected supervision. There is no precedent anywhere in the world of such powers. Only investigative agencies have such power. It is a new thought; it needs quite a bit of debate,” he added.

While there is no doubt that the central bank will need to have more powers to monitor conglomerates, there is also a concern on the human resources front as they are stretched.

Staff shortage at RBI

In the last 15-20 years, recruitment of officers was far less than the requirement and recruitment of clerical staff was not at all made in some of the years. As the economy has grown leaps and bounds in the last two decades, the number of banks and shadow banks have also grown multi-fold. But the additions to human resources in RBI has not kept pace with the changing world. As a result, the same number of people was available to inspect more entities, which inevitably resulted in RBI inspectors spending lesser time on a particular entity.

“Many new banks started operations in the last few years, there were payments banks, small finance banks, universal banks. With all these I must say, supervisory bandwidth is quite occupied,” Mundra said.

The main focus of RBI supervisors is on commercial banks, and non-banking finance companies and cooperative bank supervision suffered. More importantly, it was the lending function of banks that received more attention from RBI supervisors while other important aspects like foreign exchange or prevention of money laundering were ignored. The Rs 14,000 crore Nirav Modi-scam that rocked Punjab National Bank, was related to foreign exchange, not credit.

There is also lack of interest from RBI officers to join the supervisory cadre, since there is no extra incentive to join the force. This was evident from lacklustre response by the staff to opt for specialised supervisory and regulatory cadre (SSRC) which was set up by RBI last year.

“Human resources are also needed to be beefed up. Supervisors cannot be created overnight. As I understand, there has been mute response to the new supervisory structure which was internally proposed by RBI sometime back,” Mundra added.

Without the RBI’s super regulator status, and stretched workforce, more episodes like Nirav Modi and Rana Kapoor surface, which could pose a threat to the financial stability of the system.

(The writer is Mumbai-based senior journalist)