PNB fraud: Why are our public sector banks so vulnerable to scams and bad loans?

America has its shootings. India has her bank scams. Both happen with monotonous regularity. In each case there is pouring of outrage after every incident. Accusations and blame fly. So-called experts expound stridently in the media. The government and regulator promise no stone will be left unturned to bring the perpetrators to justice and fix the system. Within a few days, the nation’s attention will drift to another crisis. And then it will happen again. And again. And again.

Why are our PSU banks so vulnerable to fraud and bad loans?

The famous American bank robber Willie Sutton, when asked why he repeatedly robbed banks, replied with honesty, “Because that’s where the money is”.

So as long as fraudsters know that there is easy money and no consequences for stealing, our banks will be robbed repeatedly. Our banks are accident-prone by design and need fundamental changes.

The diagnosis, remedies and way forward have been laid out many times but with particular clarity by the PJ Nayak Committee in 2014; however the recommendations have been only partially and sometimes half-heartedly implemented.

Recapitalisation with half-measures and band-aids simply won’t work. They are tantamount to rearranging deck-chairs on the Titanic. Privatisation of at least a few big banks is probably the only solution despite the many vested interests that would oppose this.

At the heart of the problem is a broken model of governance which results in weak accountability. The bureaucratic model for governing the country is not an appropriate one for governing banks in a fast-changing environment. The Boards of PSU Banks are emasculated entities with little authority. Boards do not appoint the CEO or the executive directors nor do they have the authority to set targets and manage performance.

As a result, public sector bank boards do not have the single most important tool to perform their fiduciary duty. Boards themselves largely comprise of nominees of the government and often lack the experience and expertise to govern these complex institutions. It is not uncommon for nominee Directors to think through the prism of who appointed them rather than seeing their fiduciary duty to the institution. Many Board, whole time Director and even CEO positions remain vacant for significant period. An archaic system of rotating Executive Directors and CEOs across banks results in lack of continuity of direction and culture. As a result, it is a rare board that is able to drive a strategic transformation agenda; most lurch from quarter to quarter, crisis to crisis, reconciling multiple directions and perspectives from everyone including the Finance Ministry, RBI and Parliamentarians; banks de-facto have two regulators, the RBI and the government. The Bank Boards Bureau that was intended to address some of these issues has itself been marginalized.

Another major factor for high frauds and bad loans is an obsolete approach to controls.

Japanese companies like Toyota taught the world that quality must be prevention-driven not inspection-driven. A similar revolution is needed within PSU banks. There is no point in closing the barn-doors after each horse bolts.

The fundamental organization design has to change to create segregation of responsibility and eliminate the possibility of a couple of rogue employees creating havoc unnoticed.

Banks are fundamentally information processing entities and so they have to be re-architected with contemporary technology so that real-time monitoring and analytics can be used to detect anomalous behaviours and transactions and raise flags. The audit approach must shift from being manual, decentralized, transaction driven and ex-post to being preventive, analytical and intelligent. The current system of concurrent audit employing hundreds of auditors and driving very large fees for such firms has proven ineffective in detecting, let alone preventing, frauds. Such a transformation is not easy; it requires a change of mindset, structure, processes and capability. It therefore takes time and talent and this is where lack of continuity of leadership really hurts.

A third fundamental issue is talent and culture. An unpalatable truth is while public sector banks have lots of good, bright and hardworking people, the lack of investment in developing talent for a really long period of time, and constraints on changing the HR rules in fundamental ways has created an acute shortage of specialists with expertise in areas like technology, risk management, fraud control or internal audit and an even bigger scarcity of leaders who are able to drive performance and change. Lateral hiring is not a solution for even select lateral hiring faces major resistance and challenges of integration.

Weak leadership and culture make it a monumental challenge to create a meritocracy or hold people accountable for performance and compliance. This is why despite tons of policies and rules and the fear of CVC/CBI/CAG, punishing the perpetrators is hard. As in the case of the 2G Scam or the Arushi Talwar murder, no one is ever to blame. Fixing this requires a very fundamental overhaul of the HR system.

Sadly, all of what I’ve said is an open secret in the banking system. The answer is not more accountants, more audits, more direction and more supervision but more decentralization with more accountability.

The multibillion dollar question is whether such fundamental changes can be made without privatizing some of these banks.

In theory it might be possible but public sector ownership puts a nearly-unsurmountable handicap in human resources practices, procurement and governance. This is why eminent experts ranging from Arvind Subramanian, to former RBI Governors and senior bureaucrats advocate privatization. India’s public sector banks are accident-prone by design. Another giant fraud, and hundreds of smaller ones, are inevitably being planned and executed at this very moment. There are only three things we don’t know. Where will it happen? When will it be exposed? How big will it be?

Time is running out. Past mega-scams by Harshad Mehta, Ketan Parekh and Jignesh Shah provided the impetus for many important reforms in our capital markets. The Nirav Modi-Choksi scam must serve as the catalyst for decisive banking reform by the government. In the words of our Prime Minister, it is time to reform, perform and transform.

(Ravi Venkatesan is a business leader and philanthropist and currently Chairman of Bank of Baroda. These views are personal)