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Is the PNB fraud an operational failure or a auditing failure or a regulatory failure is the question (leaving alone the political slugfest) in the people mind and there are lot of claims and counter claims on the basic reasons for such a massive scam to have happended.

No bank is without operational risks and the nature of business it is in, it has naturally operational risks and a bank without operational risks is an utopian thought and it is like expecting a society without crimes despite the various preventive criminal laws and hence a fraud in a commercial bank is a natural corollary and it is a question of the frequency and the enormity which is to be reckoned.

Further these types of frauds are not peculiar to public sector banks alone and it does more frequently happen in private banks and ownership is inconsequential. The classic example is the Lemon Brothers episode, LIBOR manipulation which are all out and out  private banks frauds and the entire 2008 subprime crisis is because of the private sector banks in USA which had a catastrophic effect on  the world over  and the theory of too big to fail got shattered in these episodes. Not far away from home is the Harshad Mehta scam which was essentially a banking scam , though public perception was made out to be a stock market scam, involving a public sector bank (SBI) and a private sector bank (ANZ Grindlays).  Another case in example is the case of Global Trust Bank Limited which was a private sector bank that was eventually merged with a public sector bank thereby giving credence to the theory that all losses are socialized and all profits are privatized.

There is no merit in the argument that is being propagated by various people including the trade bodies that the fraud perpetrated would have been avoided if the ownership was in the private hands and the ideological arguments are being pushed forward which is essentially a operational risk problem, be it a private or public sector management and frauds are being used to espouse the cause for eventual privatization and to eventually marginalize the market share of the public sector banks.  To extend the argument further that the whole NPA mess we are facing today is because of the private sector business enterprises and their unethical behavior in fudging the financials, stock, inventories and gold plating the project cost  that has led to so many cases  being referred to NCLT under the IBC code. There is not even a single case of any public sector undertaking that has been referred to the NCLT for loan default and the whole argument for privatization of the public sector banks is illogical and does not deserve any merit. Further such episodes in the private sector banks are buried under the carpet and one can hear whispers of ever greening of loan assets in private sector banks to avoid the NPA classification.

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Then where does the buck stop?

Any operational risk is best avoided only by proper and efficient audit and supervisory system. In the present PNB episode both the audit functions as well as the supervisory function have failed. A handful of staff were able to manipulate the system for so many long years is a classic case where all the systems and procedures have given way to fraudsters and the indication of sorry state of affairs in the bank’s audit and supervisory functions.

There are at least three to four audit checks in the banking sector and the last gate keeper/chowkidar in the scheme of things is the supervisory role of RBI which seems to be wanting. As per the words of Mr. S.S. Mundra, Retd. Deputy Governor of RBI that the non integration of SWIFT and CBS was flagged off as early as 2016 and advisory was sent to all banks thorough a circular. I fail to understand whether the role of RBI is restricted to a mere advisory role through a circular without getting the same implemented across the banks immediately  and does it not look childish to say that it has been already flagged off . Does not RBI know that non integration of SWIFT and CBS is a grave error and it should have been done then and there without waiting for such a humongous fraud to take place. Further all LOU/LC transactions should have hit the NOSTRO accounts of the banks over which the RBI has total control since this involves the foreign exchange balances of the country. Any large movements in the NOSTRO accounts should have given enough of indication to RBI that all is not well and that too in a matter involving the foreign exchange balances of the country.  Further all the NOSTRO accounts should have mirror image entries in the CBS which has nothing to do with the SWIFT system and it is hard to imagine that the persons concerned had let it go. Added to this is the huge commission/service charges that should have been collected for such issue of LOU and such unexplained credit to the income of the bank should have given enough of indication to the auditors and the regulators. Have all the commission amount accounted for or that also was swindled by the employees? Does this not tantamount to callous attitude of the regulator if not the involvement? RBI is not only the lender of last resort for all commercial banks and it is also the final and last gate keeper/chowkidar which is supposed to take utmost care of the banking business in the country.

The RBI started the system of AQR (Asset Quality Review) in the year 2015 because of the fact that the banks were not giving a true and fair picture of the NPAs to the regulator and the auditors from the RBI went to all banks to check the actual figure of NPAs which happen to be the beginning of systematic and actual recognition of NPAs in banks. Even during such AQR inspection RBI missed out on the fraud perpetrated through the instrument of AOU (Incidentally  AOU was introduced by RBI to facilitate the Gem & Jewelery  exports and  to take advantage of the interest arbitrage in the year 2004)

Right from the Harshad Mehta days, was there any punishment awarded to the regulator for their lapses and any responsibility fixed on the persons concerned and instead a small time employee of SBI getting punished for such a huge gilt securities scam which was essentially a problem at the regulators end.

Now coming to the point that PNB is a listed entity and all the rigors like LODR 2015,  SAST 2011 etc. are applicable to all listed PSBs. Excepting a few PSBs , most of the listed PSBs  do not have the mandatory public float as prescribed by SEBI and the appointment of Independent Directors . SEBI also treats the listed PSBs with kid gloves and here again the regulator has not been neutral and this does not mean that adherence to free float etc., would have mitigated the operational risk. Having a uniform rules for all the listed entities would at least take care of the corporate governance issues in the PSBs .

To be fair to RBI, it does not have any role in the appointment of CEO. MD, Directors and to expect a regulator to supervise the entities which are under the administrative control of the government (read politicians) is a tall order. But the rules of the game are set by the RBI and hence should have the necessary muzzle power to supervise and control the PSBs. All the PSBs have the RBI nominee on their boards and RBI representative is also on all the credit sanction committees and if these nominees of RBI play an effective role , then most of such episodes can be avoided. Further it should be made mandatory that all the boards of the PSBs including the CEO/MD should be appointed with the concurrence of RBI  and if need be and if situation warrants the government can think of having a different independent regulator for the banking operations alone under their exclusive domain and leaving the Central Bank of the country to take care of monetary policy, forex policy and inflation management .

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  1. venkataramanan says:

    now what is to be discussed is recovery from the defaulters .Crying over split milk can be left to the fault finders.But how r you going to make good the loses , without hurting the taxpayer is the question.

  2. Banker says:

    Article is really gripping and presents many dimensions and more insightful.

    Another point of operational risk is the selection of software. Single CBS solution software should support all facets /departments and have audit functions with efficient data integrity inbuilt in it or at least achievable thro its mainstream.

    Unfortunately majority of the CBS solutions deployed in Indian Banks ( private/PSB) do not cater this.

    Also it reminds me the 1993 agitation by banking unions and associations against the “Computerization and mechanization in Banks”.

    The present fraud can definitely be attributed (though not fully )to CBS solution as workflow, controls, compliance, reporting which are as designed and executed thro the CBS software has been taken for a ride. Such a hollow system is deployed?.

    CBS software not having a feature should not restrict the bank have effective control, meaningful MIS.etc. may prove counter-productive.

    It is imperative that such frauds and flaws should not leak thro software as we boast ours is a EVERWIN banking system in the financial world.

  3. A L Chaudhary says:

    i feel major lapse is non rotation of staff and sharing of passwords.Lack of segregation of duties/standard maker-checker procedure not followed.GM(HR) who kept him at one place and the CVO who should have objected to such postings should all be held responsible alongwith the Branch Managers and SWIFT/FOREX incharge at Branch, Zonal Office, and Head Office.
    Rotation of employees in core functions as required by the policy. Not following of this was known to all i,e, management, and all auditors. .They should be made accountable,.

  4. shravan kumar vishnoi says:

    Great insight by learned author. Very informative and free frank view. Indeed it was nice to read the contents of the Article

  5. prasannakumar says:

    Everybody knows, Bombay Stock Exchange has been consecrated , through its emancipation from the brokers.When will India’s professional bodies accept that they have a duty to perform in terms of ensuring that their members encourage ‘ compliances’ rather than avoid ( and / or provide a cover to) non-compliances.

  6. CA A N V Ramani says:

    First and foremost – Bring back the internal audit department of the banks. They are normally given full training of all nature of transactions and they would be able to track it from this end to the other end. If something is missed out they (IA staff) know action would be taken against them. External auditors are only visitors and not full time employees. Thus things would escape their attention
    Now comes punishment. Sedn all those(including politician, if any) and thier family(souse(s) and children) to jail. Make suitable ligislation, if required. This MAY bring fown corruption.

  7. prasannakumar says:

    I am a commoner. Still, I find , I am not able to restrain myself from sharing my impressions,I dare not call them views, in the context of the above commentary.
    PNB should take the prime responsibility for the debacle.That its management does not appear to have taken any serious action on the erring officials, the owner should have acted on the top management team, followed up by genuine exemplary deterrent actions on the erring officials.
    Next, auditors, internal and external, should also be made accountable for their omissions and commissions and certainly,for their connivances, thr’ severe punitive measures.

  8. Rohit Gidwani says:

    Its just that requlator(RBI), Owner (Govt.), Employees (Govt Employees), all belong to the Government. If a mark is put on these entities, the mark would be on the reputation of Country.

  9. Rohit Gidwani says:

    Sir, you mentioned that no PSB has gone to NCLT, thats true. But had there been no government funding to these PSB, then scenario would be different.

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June 2024