A veteran officer of State Bank of India (SBI) since 1980, Thomas Franco has seen the Harshad Mehta scandal of the early 1990s and the Ketan Parekh scam of the 2000s from close quarters. In the last two decades, he has been a vocal critic of the liberal regime in banking, which, he believes, has laid the basis of the non-performing assets (NPA) scam. In the wake of the PNB (Punjab National Bank) scam, Franco, as general secretary of the All India Bank Officers’ Confederation, called for severe punishment to be meted to bank officers and employees who cheated the bank, and also highlighted the failure of both the Reserve Bank of India (RBI) and the Finance Ministry in supervising and safeguarding banks. Excerpts from a telephonic interview he gave Frontline :
As a veteran in the banking industry what is your understanding of how the so-called PNB scam hit the industry? The notion that a few rogue elements in the bank caused this appears facile.
The modus operandi that was used in the PNB case is well known. It has been used in the past, on different occasions, involving various banks. Despite this, the systems have not been corrected to prevent such things from happening. As a responsible union, we have taken up these issues with both the regulator and the Finance Ministry in the past. We had asked them on several occasions to strengthen the systems, ensure more effective supervision, and upgrade technology. It is not as if the SWIFT (Society for Worldwide Interbank Financial Telecommunications) system for international communication among banks is state of the art. It has been proved to be hackable, as was highlighted recently when hackers in Russia stole $6 million. [The Russian central bank confirmed on February 16 that hackers had taken control of a Russian bank and conducted “unsanctioned operations”. Reports quoted a central bank spokesperson as saying that this was “a common scheme”.]
Since when have you and your colleagues been aware of this?
I am aware of a case in 1999, which happened at SBI in Kolkata. Although core banking solution (CBS) was not in existence then, SWIFT was in existence. It had also happened in Union Bank of India and Bank of Baroda. So, we have been continuing with a system that has been known to get compromised. In some banks, the SWIFT system is linked to the CBS, but in many others it is not. It is the responsibility of the RBI to ensure that secure systems for financial transactions are implemented. As the prime supervisor of banking in the country, it is its duty to conduct periodic audits and monitor foreign exchange transactions. It is the RBI’s duty to enforce technical solutions that ensure security. Since this is a systemic issue that affects not just one bank, it is the RBI that must take responsibility for ensuring that this happens.
While we are all for taking stringent action against officers and employees who have caused losses to banks, the blame for all this cannot be placed on a few officers or employees at the lower level, as if those higher in the banks’ hierarchy did not know what was happening. That is not acceptable.
There are supposed to be so many checks and balances in the system. What happened to them?
ROLLOVER OF LETTERS OF UNDERTAKINGIt is obvious that the limits of the letters of undertaking issued to Nirav Modi’s companies, which started in 2011, could not have been established then. It must have been enhanced over time. How come this increase in the value of LoUs escaped the attention of higher officials in the bank?
The rollover of LoUs with enhanced limits must have happened over time. In this entire process, at least four different persons in the bank are involved. This is done specifically to prevent collusion. But in this case, the entire operation appears to have been handed over to the bank’s client. Since these were false LoUs, it is possible that it never came to the attention of senior officials.
But when the client went to the foreign bank to encash the LoUs, it would have been credited to PNB’s nostro account with a foreign bank. If that nostro account had been checked, the transaction would not have escaped the attention of PNB. It is possible that the other banks [counterparty] may have also been compromised. If these nostro accounts had been checked, this may not have happened. The imbalances in the nostro accounts is not a new problem; this has been a persistent problem which has been ignored by the RBI over several years.
Is it even clear, legally and financially, that the responsibility for the defaults in repayments by Nirav Modi and his related entities lies with PNB? Are we not in for a long legal haul before this is settled? Or, is it likely that the government may just force PNB to pick up the bill?
It is not at all true that PNB’s counterparties [banks] overseas are absolutely innocent. Any banker would have to see the credibility of the borrower. The LoU that is presented to him/her overseas gives a background description of the borrower, including a brief account of the borrower’s business. But, at their end, they too have to check the status of the borrower when the LoU is presented to them. In fact, PNB is already arguing that counterparty banks ought to have done due diligence at their end. It is saying, “Don’t put all the blame on us.” Although the PNB Chairman has given an assurance that the bank will honour all its obligations, later, when the issue is contested, it could argue that responsibility also lies with the counterparty banks, especially if they have failed to act diligently in a commercial transaction.
Moreover, the government and the RBI are responsible for creating this situation. After all, the government has a policy to facilitate the jewellery industry through an import scheme. Nirav Modi was an importer of precious stones and metals. Normally, an importer is supposed to take buyers’ credit within the country. This would have been a costlier credit [because of high interest rates in India]. In any case, importers of raw materials in general already enjoy several concessions. Despite all this, the RBI formulated the LoU scheme in order to enable some importers to access cheaper credit from overseas. Why was this necessary, especially when it was clear that this facility was open to abuse in order to enable capital flight? The entire scheme of LoUs was flawed and open to abuse, for which the RBI is to be held responsible.
So, do you believe this will be a prolonged legal battle?
Definitely, this may prolong. Already Nirav Modi has told PNB that it has blown things out of proportion. He has contested even his liabilities, saying it is only about half of what PNB claims it to be. He will even say that he had done nothing to do with the fraud, which may have been perpetrated by some rogue employees acting in collusion with bank employees. He may claim that this happened without his knowledge. He now accuses PNB of tarnishing his reputation, which impairs his ability to repay his dues.
Do you see shades of the Harshad Mehta scam, involving SBI, when diligent bank officials were prevented from following the logical course of asking the scam mastermind to repay his dues? Many diligent officers suffered when the CBI came into the picture later.
It is exactly similar. I understand that among the PNB officers placed under suspension is the one who detected the scam. After all, the scandal was unearthed by an officer who refused to issue fresh LoUs without margin payments by the Nirav Modi companies. This officer not only refused to issue the LoUs but also alerted higher officials in the bank, which resulted in the unearthing of the scam.
Most of the large scams in India in the last quarter century have involved banks—the Harshad Mehta scam in the early 1990s, the Ketan Parekh scandal after that (2000), the scandals involving large-scale corporate borrowings that have turned delinquent and now the so-called PNB scam. What is different about the latest one?
The one you refer to as the NPA scam is different from the others. The losses on account of bad loans have more to do with government and RBI policies and are not, strictly speaking, banking scams. In the case of NPAs, I would prefer to call it an RBI-inspired scam because it forced banks to undergo a haircut while allowing large corporate entities to escape scot-free. It is the RBI norms on classification of NPAs that has brought PSBs [public sector banks] to the brink. I expect that at the end of 2017-18, the net loss of these banks will be about Rs.88,000 crore. This is mainly because the banks have to make provision for 50 per cent of the bad loans in the current year, and the remaining the next year. There is a big scam hidden in this because the borrowers are going to get away without a scratch.
The PNB scam is nothing new. It follows the same pattern as the Harshad Mehta and Ketan Parekh scams. All three happened because of negligence, not following due diligence, and the absence of checks and balances in the system. There is nothing new in the latest case. We do not appear to have learnt any lessons from the past.
Has the RBI learnt its lessons?
I think it is the RBI which should primarily take the blame for what has happened. As a supervisor of the Indian banking system, it has failed miserably. I said the same when I criticised demonetisation because it gave up all its responsibilities, which resulted in the exercise becoming a monumental failure. After all, the RBI’s main role is to supervise banking and prepare policies towards that end. It is responsible for carrying out statutory audits under the RBI Act. So, the question is this, What has been the quality of the audits it has done? Frauds in the banking sector are increasing. What has the RBI done to arrest the rising trend?
There are loud demands for privatisation in the wake of the PNB scandal.
Private banking has not failed [anywhere] as spectacularly as it has in India. NPAs are also increasing in these banks. The old generation private banks are already in crisis. The new generation banks may appear to be better off, but I believe that is an illusion. Closer scrutiny will reveal a much bigger mess in these banks. All over the world, the collapse of entire banking activity and of economies has been triggered by private banking. It is perverse to argue that privatisation is a solution to the banking industry’s problems.
AFTER-EFFECTS OF DEMONETISATIONYou will recall that 2017 was a traumatic year not just for banks and their employees but for the banking regulator following the trauma that was demoneti- sation. It is well known that banks were so saddled by this task that they could do little else. Could it be possible that banks, their employees and the regulator were just too preoccupied with this gigantic operation that they could not focus on the requirements of basic diligence that would have prevented such a fraud?
Definitely. Monitoring within banks and supervision by the RBI noticeably slackened after demonetisation. The situation in Indian banking is grave. Bank employees and officers are entrusted with so many other tasks that are beyond their normal line of work that they are distracted most of the time from their main work. The joke among us is: We also do banking!
For three-four months after demonetisation, bank employees did nothing but collect and disburse cash; we kept putting all the money in government bonds and other instruments. The latest results of the PSBs show losses, mainly because of these investments. In the case of SBI, almost 80 per cent of these deposits were invested in the market. In one quarter alone, the bank lost Rs.4,400 crore.
Bank employees could not attend to fresh lending after demonetisation, NPA follow-up collapsed, and prudential norms also were compromised because everybody in a bank was collecting and disbursing cash.
But another major scam is lurking in the banks. The cross-selling business that banks are indulging in, especially selling policies issued by insurance companies to bank customers. Most of the banks are now also in the insurance business; many others are collaborating with insurance companies. On almost every loan today, there is pressure on the borrower to also take an insurance policy. And, many of these policies do not get renewed after a year, which indicates that the customer is not interested in the policy; he/she only opted for it under pressure. Simply put, it is no different from a bribe.
But, this is not all. “Incentives” are paid to bank officers, right up to the top, for indulging in this kind of cross-selling. In fact, there is a hierarchy of rates, depending on the ranks of these officials. This has created immense pressure on bank officers and employees to attend to such tasks, at the cost of their regular banking work. How can they exercise due diligence in such a situation?
Bank managements have argued that cross-selling boosts “other income” in their balance sheets. This same argument may have appealed to the managements in the case of LOUs because banks earn fees and commissions on such instruments. When the focus is on boosting such incomes, it invariably results in the dilution of lending norms. I know of cases where delinquent borrowers with a poor track record have been given loans simply because they have also opted for insurance sold by the banks. I have written to the RBI, the IRDA [Insurance Regulatory and Development Authority] and the CVC [Central Vigilance Commission] about this pernicious practice, but nothing has happened.
Senior RBI officers have told me that they are overburdened by work pressure. They say they are given a very short time to conduct their inspections.
If you were to apportion responsibility, or lack of it, for the fiasco among the bank managements, the regulator and the owners (the government), how would you do it?
The first to be blamed is, obviously, the regulator, the RBI. It has clearly neglected to adhere to systems and procedures. In particular, its failure to ensure the integration of SWIFT with banks’ core banking solution proves its negligence. Its failure to rein in the mounting foreign exchange balances in nostro accounts is another count on which it ought to be held culpable. Its failure to check cross-border flows by the jewellery industry constitutes another count on which it has failed.
The Finance Ministry, which controls the PSBs, has also failed utterly. It is supposed to get periodic reports of happenings in banks. The Ministry has its representatives sitting on banks’ boards as well as the RBI board. What were they doing when all this was happening? Instead, the government’s focus has only been on making banks do things that are way beyond their normal line of work: pushing Jan Dhan accounts and the Atal Pension Yojana and, now, given the task of enrolling people under Aadhaar. I would say that this [Aadhaar enrolment] is precisely what a bank ought not to do. The bank is supposed to enrol people for Aadhaar and also link their bank accounts to Aadhaar. How safe is that? And, of course, there is no doubt that bank managements, too, are responsible for things coming to such a pass.