Raghuram Rajan offers a warning to the current government on the banking and financial system


 NEW DELHI: Former RBI Governor Raghuram Rajan, in a written note a Parliamentary panel stated that a list of high profile cases of banking frauds was sent to the Prime Minister’s Office.

In the note sent to the Chairman of Estimates Committee Murli Manohar Joshi, Rajan warned that the size of frauds in the public banking system was increasing and this was a cause for concern. During his three year tenure as the RBI Governor, Rajan mentions that under him, a fraud monitoring cell was set up which coordinated with investigative agencies. He stated in part, “I also sent a list of high profile cases to the PMO urging that we coordinate action to bring at least one or two to book. I am not aware of progress on this front”.

In light of the high profile cases in the past few months, involving Nirav Modi and Mehul Choksi, the Mumbai branch of Punjab National Bank issuing fraudulent Letters of Undertaking (LoU) since 2011. Rajan states that the nature of system is such that banks are slow in the aftermath of citing a transaction as a fraud as it will draw the attention of investigative agencies and there won’t be much progress in catching those who committed the fraud. The Times of India editorial points out Rajan’s central argument - “His explanation spans fundamental flaws in the banking architecture, particularly the lack of incentives to bank heads to be transparent about NPAs, and governance challenges in public sector banks”.

The NDA introduced the insolvency code, which was a big reform measure which appeared to have bought a balance between banks and large borrowers. The one branch of the government where more capacity is needed here is the judiciary. Rajan’s warnings include the piling up of bad loans after the 2008 global financial crisis.

Rajan offers a blunt assessment when he brings in politics into the fold. According to him, when it comes to commercial lending, the RBI is a referee not a participant. Those RBI directors on bank boards do not have commercial lending experience and hence there is a false impression of the regulator being in control. He said in part, “Public sector bank boards are still not adequately professionalized and the government, rather than a more independent body, still decides board appointments, with the inevitable politicization”.

His suggestion is that an independent bank boards bureau should handle appointments to bank boards. He also suggested outside hires and talent to be brought into top management. He bemoans the slow decision making processes in both the previous UPA government and the current administration.

The fundamental flaw in the system still holds. Too many loans have been given to high profile and well connected promoters who have a history of default. The system has also failed to bring any of those who have defrauded to task in any meaningful way, hence there isn’t any deterrence. Another important point made by Rajan has to do with loan waivers; lending to farmers through Kisan Credit Cards. The risk here is that many of these small loans might drop under the radar and build into a large credit crunch over a period of time. Rajan’s advice hasn’t been heeded as the programs have been popular.



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