Banks have been making headlines for all the wrong reasons. If it is not a fresh surge in the level of bad loans, it is another allegation of fraud. Police this week arrested the head and a few senior officials of Bank of Maharashtra for allegedly colluding with a real estate developer to divert money. In an unrelated development, an internal probe at Punjab National Bank reportedly showed that as many as 54 employees, at different levels, were responsible for a breakdown in internal filters which allowed the bank to be defrauded by jeweller Nirav Modi.
The surge in bad loans over the last couple of years first raised questions about the quality of credit appraisal at banks. But now it’s apparent the problem is more fundamental: governance standards are appalling. Large private sector banks have fared better when it comes to bad loans but after RBI audits showed that they have understated their bad loans, doubts emerged about their governance standards too. Following allegations about ICICI Bank CEO Chanda Kochhar’s conflict of interest and subsequent events, the supervisory failures of bank governing boards are in focus.
Banks are unique institutions. They are, by nature, highly leveraged through public deposits and are part of a chain in creating money supply. Consequently, banking is prone to unusually intense regulatory micromanagement. Indian banking is in a mess today despite this – indicating that RBI, in its role as banking regulator, has not been up to the mark. In this context, a couple of things need to be considered. First, government, which holds a majority stake in public sector banks, has to play a more effective role in governing boards. Records show that government nominees on the boards of many public sector banks have been simply ineffective.
Second, RBI needs to be more effective in its regulatory role over public sector banks, perhaps armed with greater regulatory powers. And in the case of private sector banks, governing boards need to put the interests of shareholders at the centre of their agenda. Independent directors on these boards really need to step up their game. Unfortunately, on the face of it, apportioning responsibility for failures in public sector banks so far seems to be a case of scapegoating rather than a thorough cleansing process, which is what’s needed.