The not-so-peculiar link between bank frauds and political funding

It is now more than two weeks since the Nirav Modi-PNB scandal came to light. During these two weeks we have heard a lot of angry expostulation, sly innuendo and both sensible and impractical suggestions. That’s par for the course when most debate is conducted by well-meaning but poorly informed citizens. This includes TV anchors and commentators in the print media. But banking fraud is not a peculiarly Indian problem. Banking and other financial fraud happen all over the world. Remember Nick Leesson who single-handedly brought down Barings Bank which was sold for a dollar after its collapse? Remember Bernie Madoff who was charged with a fraud of $50 billion? He too was operating a ponzi scheme. Clearly, even in the most stringently regulated and supervised banking jurisdictions, from time to time there are gigantic frauds. The list is depressingly long. For an excellent discussion of bank fraud in India, however, read this 2013 paper by the former chairman of PNB and deputy governor of the RBI, K C Chakraborty. After the initial rage attention is now beginning to shift towards the structural problems that afflict our banking system, where the public sector is the gorilla in the room. A key question in this regard is: does this huge government ownership of banks -- which in reality means control by politicians -- inherently encourage fraud? Or is the intent to defraud independent of ownership? This question, of ownership and fraud comes up each time there is a problem of this nature. All sorts of solutions are talked of. And as always in India, to each solution there is an equal opposite problem and nothing, or very little, gets done. The real reason It is now clear that there is increasing incidence of these frauds in the public sector banks. There are at least a dozen reasons for this. But if you ask me the main reason for this is that bank frauds have become a way of funding elections. It’s the Indian version of state funding of elections. Furthermore, as the cost of elections has increased so have the amounts involved. This is because the number of voters in each constituency has been steadily increasing and candidates have to spend more.

The per capita expenditure per voter in a Lok Sabha election is now around Rs 2,000, compared to Rs about Rs 100 in 2004. What happens now is this. A large borrower is allowed -- after being coerced -- to take a loan in excess of the project’s needs. The excess is then passed on to some political party or politician. The businessman also keeps a bit for himself. But when the time comes to repay, this excess becomes a non-performing asset. If you analyse the NPAs you will see that a large portion is because of accumulated interest on the whole loan because of the extra that has been foisted on the borrower. The whole thing is a political boondoggle. What about plain incompetence in which the PSBs have a huge comparative advantage? How far is that a factor in generating and sustaining malpractice, if not actual fraud? And are there problems of internal incentives for senior management that prevent fraud from being punished even when detected? Many former bankers say they are. Has this encouraged a lax culture? Political coercion, incompetence, wrong incentives, bad technology and a host of lesser factors contribute to make frauds in PSBs easy. Indeed the surprise is that they are not more pervasive and larger in size. Or are they and we don’t know? The solution That is why it is necessary to privatise the banks or at least bring down government shareholding to less than 50 per cent. One level could be 33 per cent as suggested by the Narasimham Committee in the mid-1990s. But ideally it should be less than 26 per cent, say 25.9. True, this will not prevent periodic frauds. But it will at least prevent politicians helping themselves to bank funds which are then made good by the tax payers via recapitalisation. It is also true that fraud is an integral risk in any business and strive as you will, 100 per cent protection against them is impossible. But 90 per cent protection is possible and worth striving for.