In 2020, Reserve Bank of India (RBI) imposed crippling restrictions on HDFC Bank, India’s largest bank by market-capitalisation, sending shock waves throughout the banking industry. RBI asked the Bank to stop all digital business generating activity and sourcing new credit cards until it fixed the recurring outages that disrupted operations at its data centre and harassed customers. After partial relief in 2021, the restrictions were finally lifted in March 2022, after clearance by the regulator’s tech-audit team.
HDFC Bank was not alone; a string of regulatory actions against RBI-regulated entities followed. Yet, on 24 April 2024, when RBI imposed nearly identical restrictions on Kotak Mahindra Bank Ltd (KMB), it again surprised investors, customers and bankers. Was it because of the harsh wording of the release, or because action against, Uday Kotak, a favourite go-to person for National Democratic Alliance (NDA) government, was unexpected? Mr Kotak headed the market regulator’s corporate governance committee in 2017 and was asked to salvage Infrastructure Leasing & Financial Services (IL&FS) in 2018. Or, as many allege, was it retaliation from RBI for KMB daring to sue RBI in late-2018? (Kotak Lawsuit: Will It Finally Make RBI Accountable?)
Let’s look at things more holistically. When Shaktikanta Das took over as RBI governor in December 2018, he inherited a giant mess as regards regulation and supervision. The collapse of IL&FS, a 341-entity giant, had caused a systemic shock exacerbated by undetected fraud at Yes Bank, Dewan Housing Finance Limited and Punjab & Maharashtra Cooperative Bank (PMC Bank) --which collapsed due to its corrupt nexus with Housing Development and Infrastructure Ltd. This was followed by the failure of Lakshmi Vilas Bank (LVB). In each case, RBI was caught off-guard and found lacking in tough and timely action. In IL&FS, the serious frauds investigation office (SFIO), for the first time ever, accused the regulator of failure to act. After the PMC Bank debacle, the government increased deposit insurance and ended dual-regulation of cooperative banks, making RBI solely responsible for supervising these banks, often run by shady politicians.
This placed a huge regulatory burden on RBI. As opposed to 12 public sector banks (PSBs), 21 private banks, six payment banks and 44 foreign banks (only two with significant deposits), there are 1,902 cooperative banks (including local area banks, regional rural banks, urban, district and state cooperative banks). Moneylife is perhaps the only publication that has been reporting RBI’s strict and relentless punitive action against these banks on a daily basis.
Another major challenge is the rapid growth in technology and the explosion in online transactions, after the COVID pandemic 2020. If major KMB and HDFC Bank claim that they are struggling to cope with technology, then RBI officials are in the same boat, with more constraints. Moreover, if there is a systemic failure, the buck stops at the regulator.
Where Mr Das’s predecessors—rockstar economists and bureaucrats—focused primarily on monetary policy and ignored supervision, he did not have that luxury. It was a tough initial period, but lessons were learnt from each fiasco and the action has been relentless, despite the pushback and pressure from powerful regulated entities. After the action against KMB, most publications have published a laundry list of RBI actions starting with HDFC Bank in 2020. These include: PayTM, Bank of Baroda’s scandalous app, IIFL Finance, JM Financial Products, Bajaj Finance, Mahindra Financial Services and others. It is important to examine these actions more closely.
It is evident that this is a new, tougher RBI than before, when inspection reports got diluted as they climbed up the hierarchy and ended with insignificant fines or futile warnings. The country paid a huge price for this laxity as is clear from over Rs14.56 lakh crore written off by PSBs between 2014-15 and 2022-23 (with paltry recovery of about 14%).
The best way to understand it is by asking: When was the last time that RBI initiated tough action against so many banks and regulated entities in such a short span? The answer might surprise you: It was 30 years ago, after the Securities Scam of 1992 engulfed the entire banking and financial sector. The establishment of a joint parliamentary committee (JPC) and a multi-disciplinary investigation team led to a crackdown against cowboy banking and dubious practices.
Consequently, a couple of small private banks folded, new rules caused large-scale closure of leasing companies and non-banking finance companies (NBFCs). This action was separate from the criminal action and lawsuits filed by the central bureau of investigation (CBI) that continue to drag on at the special court in Mumbai. Importantly, RBI’s punitive action, especially against foreign banks, was limited to a monetary penalty and change in top management. I have asked several senior bankers whether they remember another time when RBI penalised so many entities in a short span. They do not.
The Big Change
RBI's transformation is evident in its handling of bank failures. Previously, the typical approach involved a forced merger with a PSB. This has not occurred under Mr Das's watch. While State Bank of India (SBI) was a big contributor to the Yes Bank bailout, private banks chipped in and shared the burden for the first time ever. Internal resistance at RBI had then kept out foreign portfolio investors who were keen to participate in the bailout. But when Lakshmi Vilas Bank (LVB) needed a bailout, RBI did not hesitate to being in DBS Singapore, enabling a neater and quicker resolution. PMC Bank was significantly messier, since it was a cooperative bank; but this too has been partially resolved. In the past, there was no bailout or takeover for cooperative banks; they were allowed to wither away and shut down with depositors being fobbed off, many years later, with deposit insurance of Rs1 lakh.
Razor’s Edge
Although deposit insurance has increased to Rs5 lakh, the danger of social media rapidly amplifying potential financial failure has meant that the regulator is constantly walking on the razor’s edge. Regulators may no longer have the luxury of salvaging banks by imposing a moratorium on deposits. The speed of online transactions can trigger a collapse, based on rumour alone. This happened in March 2023, when Silicon Valley Bank in the US collapsed in just 48 hours as scared depositors withdrew a staggering US$42bn (billion) dollars (25% of its total deposits) on the news that it needed US$2.25bn to shore its balance sheet. It was called a ‘twitter-fuelled bank run’.
This could easily happen in India, where tech outages already cause panic among customers. It happened at KMB on 15th April (perhaps precipitating the RBI action) and happened frequently at HDFC Bank until the RBI action. ICICI Bank also faced a big glitch on 24th April when 17,000 new credit cards were mapped to the wrong users. It was quickly contained without any losses.
Internal fraud poses another threat, as seen in United Commercial Bank (UCO). A CBI investigation discovered that fraudulent engineers had created Rs820 crore by manipulating systems to electronically credit 14,600 account-holders in six private banks without debiting the originating bank.
Hitting Where It Hurts
Given the high risks, RBI has correctly decided to ensure compliance by hitting where it hurts, in addition to imposing monetary penalties. Barring banks and financial entities from on-boarding new customers until they fix their systems imposes reputational damage and also impacts financial performance. It directly affects performance evaluation of top management and impacts the value of their stock options, thereby instilling greater urgency in ensuring compliance, investing in appropriate technology and talent and plugging loopholes.
Former RBI deputy governor, R Gandhi says, “When penalties did not bite financially and regular actions led to no dent on reputation, RBI had to think differently to make its actions effective. Parallelly, banks became fully digital and any correction of regulatory violations needed system-wide impact.” It is clear that this is working well and needs to be imbibed by all other regulators.
But the transition in supervisory action has not been easy. Private banks have political clout and the new-age fin-tech entities even more so. We saw this in action when fin-tech leaders ganged up in support of PayTM Bank and complained to the finance ministry that RBI did not understand the sector. This happened despite ample evidence that PayTM had failed to read the seriousness of RBI warnings for four years after it was asked not to on-board customers in 2018.
When his term ends this year, the affable and accessible Mr Das may be remembered as the toughest and most effective governor in recent times, overseeing drastic changes in the technology and financial landscape amidst a once-in-a-lifetime global pandemic.
Another issue is NPCI which is private company of private banks is found some monitoring tasks, supposed to be done by RBI. The callous attitude of govt. in not making a AADHAR like authority or subsidiary of govt./RBI, has resulted in violation of laws. Banks are thinking themselves Supreme! This has to change, hope governor sir will take corrective action before the tenure gets over.
Another issue is NPCI which is private company of private banks is found some monitoring tasks, supposed to be done by RBI. The callous attitude of govt. in not making a AADHAR like authority or subsidiary of govt./RBI, has resulted in violation of laws. Banks think themselves Supreme! This gas to change, hope governor sir will take corrective action before the tenure gets over.
In the midst of rising bank yields globally which resulted into some banks collapsing in US and Europe, I think it was a very smart and deft handling by RBI which saved us from such nightmare. As a banking regulator, RBI has to improve its supervisory role and make it tough, which is actually in the overall interest of the banking sector and economy as a whole. Why banks do not listen to RBI's supervisory mandates? My belief is that there is a serious change in the attitude of the bosses of RBI boss in the economy management.
This is the best article from your pen Suchetaji. Regulatory resilience improved the financial stability when the whole world is gaping at failures. My hearty compliments to the excellent narrative.
I still remember this paper and all others sneering at Mr Das when he was appointed and slavishly adoring Raghuraj Rajan. Still do- he and his other ancien regime pal Kaushik Basu, fill the airwaves with their bitter and scornful criticisms.
You are surely confused. This publication is perhaps the ONLY one that was critical of Raghuram (that is his name) Rajan . You also seem more informed than we are as journalist about who his other "ancient regime: pals are. I also cannot figure out whether you are satisfied by this article or have a problem with it too??
The practice of window dressing & 'bubbles ' are continuing as usual more particularly in PSBs for projecting rosy pictures of performance. The lapses in loan disbursement leading to fraudulent loans as unearthed after a lapse of period of times continuing without any check. There is no improvement or any other measures in changing the patern of Audit & Inspection being practiced since beginning.The same is now covered up by imposing some penalties at regular intervals. Mr. Das could have been remembered for all the times as champion in protecting country's financial sector had he been cared to stop a few individuals in fulfilling individual lusts of a section deliberately using banking system. The same could have been easily achieved by relying more on external observations on performances instead of relying exclusively on internal Audit & Inspection reports practiced for years without any remarkable change.
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