For the first time ever, a government investigator has had the courage to call out to the Reserve Bank of India’s (RBI) weak supervision. The Serious Frauds Investigation Office (SFIO) has blamed RBI for its failure to detect what turned into a massive systemic scandal at Infrastructure Leasing & Financial Services (IL&FS).
The financial sector continues to reel from the repercussion of the IL&FS failure, what with Dewan Housing Finance Ltd (DHFL), finally, defaulting on its interest payment on bonds and the consequent downgrade decimating net asset values (NAVs) of a slew of debt mutual fund schemes. The deleterious impact of IL&FS’s failure even extends to pension fund investments by several private companies.
In the past three decades or more, this is the first time that RBI has been seriously questioned for its lapses even though the damage inflicted on our financial system, because of its repeated failures as a regulator, have been huge. Way back in 1992, the securities scam was primarily about the way RBI ran the government securities (G-Sec) market and failed to upgrade turgid systems and manual processes for trading in government securities.
A decade later, RBI was sleeping at the wheel during the Ketan Parekh scam as well. Every entity that colluded with Ketan Parekh and other scam accused had set up overseas corporate bodies (OCBs) in tax havens with $10 capital and were using them to pump money into the Indian capital market. RBI was blissfully unaware, mainly because it does not ever seek market feedback or engage with stakeholders.
And, yet, every time a major financial scandal erupts, RBI quickly gets into high gear and begins to hand out punishments and penalties. Nobody has questioned how it goes about doing that either.
So here are some interesting aspects to SFIO’s action.
The SFIO charge-sheet filed in the IL&FS Financial Services (IFIN) case says, “Action at the right time may have prevented ballooning of the matter… RBI had repeatedly pointed out non-compliance with group exposure norms and wrong calculation of net owned funds (NOFs) in inspection reports from 2015 onwards. But no penalties were imposed and IFIN was allowed to continue operations without corrective measures. It is only in 2017 that RBI even bothered to increase the pressure and seek classification of group companies to arrive at net owned funds.”
Interestingly, SFIO has attached RBI’s inspection report to the detailed 800+ page charge-sheet filed against IL&FS Financial Services (IFIN) last week. For transparency activists, this is a breakthrough development, since RBI continues to defy Supreme Court’s orders and has flatly refused to provide inspection reports. This time, it is partly in the public domain.
Although SFIO has drawn attention to RBI’s failure, its actions seem tentative. It has merely asked RBI to probe officials in the department supervising non-banking financial companies (NBFCs) for not having acted against IFIN, although major discrepancies were noted in its books as early as 2014. It also asked RBI “to take appropriate action and also initiate suitable policy measures to prevent such fraudulent actions.”
This is like the Securities & Exchange Board of India (SEBI) repeatedly asking the National Stock Exchange (NSE) to appoint its own forensic auditors and conduct investigations in the algo-trading, or co-location scandal. The outcome, not surprisingly, was a weak and wishy-washy report, which SEBI tried to cover up with a biggish penalty.
Will the outcome of SFIO’s directive be any different? Well, see for yourself. Over a month ago Moneylife filed an RTI application asking RBI for the names and designation of officials responsible for monitoring and inspection of IL&FS, action taken against them, if any, as well as a record of any discussion or meeting since July 2018 with regard to the failure of this systemically important shadow bank.
RBI responded by asking us to direct the query to its regional office and the department of non-banking supervision (DNBS) – as if to suggest that the top brass has not even taken cognisance of its own failure in this debacle.
We filed a second RTI application with the DNBS only to get another rejection. RBI refused information under Section 8(i)(j). Under this clause, it can refuse to part with information unless the matter pertains to an issue of larger public interest to justify the disclosure.
Apparently, RBI’s public information officials (PIOs) are still not aware that there is a larger public interest involved, although major infrastructure projects are at a standstill and the entire financial sector is reeling under the impact of IL&FS’s defaults. If that weren’t enough, the information was denied under Section 8(i)(h), which permits denial if the information “would impede the process of investigation.”
When Moneylife filed a first appeal, the matter turned into a farce. The appellate official now chose to deny information under Section 8(i)(g) of the Act, which justifies denial of the names of inspecting officials if it is likely to “endanger the life or physical safety of any person.”
However, the PIO has been asked to reconsider the earlier denial on the ground that it would impede investigation.
I suspect there is another reason why RBI is stonewalling us about information on its failure to rein-in IL&FS. And that is because protection for IL&FS came all the way from the top. Remember a former governor as well as the IL&FS board ignored persistent letters
from a whistleblower. This included pseudonymous ones as well as those from known sources and foreign institutional investors.
In December 2018, I wrote about The Destructive Impact of RBI’s failure to Act
in the case of New Tirupur Area Development Corporation (NTADCL), where RBI mysteriously and brazenly buried repeated pleas by AIDQUA Holdings (Mauritius), Inc (AIDQUA), a global investment fund which has a 27.89% shareholding in NTADCL.
AIDQUA’s letters in 2013-14 were addressed to an RBI executive director and RBI’s refusal to intervene is also documented. Had it looked at the forensic audit, IL&FS’s dubious method of working and egregious flouting of rules would have been exposed long before its actions led to a collapse. NATDL continues to operate with the same management and without a proper managing director.
As is the case after every major scam or sting operation, RBI begins to investigate after the damage is done and responds with bans and penalties. After the SFIO filed an 840-page charge-sheet, RBI has threatened to cancel IFIN’s licence to operate as a non-banking finance company (NBFC). It has also barred SR Batliboi & Company (associate of Ernst & Young) from handling audits of commercial banks for just one year, starting 1st April.
It is important to note that the only stakeholder entity that RBI engages with is the Indian Banks Association (IBA), which is an unregistered, voluntary association of banks, with doubtful legal standing. Yet, RBI empowers it to take all decisions pertaining to banks, right from deciding service charges for depositors, to negotiating wages and now, even appointing forensic auditors to banks.
This time, however, an accounting firm from Chennai has written to the finance ministry and the RBI governor, among others, to record its objection. It says, “IBA, being an unregistered, unauthorised body, has neither any responsibility, nor any accountability, considering the fact that it is not a body formed under RBI, to be conducting empanelment of firms for the purpose of forensic audit.” In fact, being unregistered, IBA does not even have to follow Central Vigilance Commission’s guidelines of ensuring a level playing field. Will the government or RBI respond? We will be watching the developments.
Unfortunately, as long as the RBI governor’s job remains a much desired posting for our secretaries, nothing will change and the country will keep paying for the regulator’s repeated failures to supervise and stop the corrupt nexus between banks and big business leading to systemic failures and massive defaults that cost India a few lakh crore of rupees every few years.