Regulation is laudable but meek legislation would prove to be counter-productive

M P Shorawala 

Kneejerk reactions are either meant to divert attention or imply that an action is taken without much deliberation. In either case, the action taken generally fails or proves to be redundant, since an element of hastiness is involved in it.

A case in point is the Union Cabinet’s decision to set up the National Financial Reporting Authority (NFRA) to oversee accounting and auditing practices at all listed and large unlisted companies. Bank fraud and scams to usurp precious public money is a very old practice in India.

NFRA was being pondered upon for some time but it was hastened in the wake of diamantaire Nirav Modi, and his uncle Mehul Choksi, defrauding Punjab National Bank (PNB) of two billion dollars. Now the issue here is, would NFRA recover the money? If not, then why not strengthen or streamline the present system rather than creating another layer of red tape through NFRA? This would only go against the spirit of “ease of doing business”.

The NFRA's function is to oversee accounting and auditing practices in the country. If that is the case, then why not use the Reserve Bank of India (RBI) and the Institute of Chartered Accountants of India (ICAI) to strengthen the system to oversee the norms rather than creating another body? Let’s take a few examples from the past where institutions were created, but only to add to the files being piled up, and an additional layer being created in bureaucracy.

The Enron scandal is a very good example where the then government took two actions. One was to amend Clause 49 of the Listing Agreement, asking listed companies to reveal all and hide nothing. The second was to set up Serious Frauds Investigation Office (SFIO) to crack down on economic offences.

The amendment of Clause 49 was to strengthen the existing system, and by in large, it worked well. However, SFIO added another layer and it is still not clear why it was created.

Since March 2007, SFIO has investigated less than 100 cases and submitted less than 20 reports. None of these cases were taken up suo moto. So one wonders why SFIO was created when SBI, SEBI, and the excise and customs departments were already present.

India’s proposed NFRA is an attempt to copy the Public Company Accounting Oversight Board (PCAOB), which is not a big success any way. After the Enron scandal, the US passed the Sarbanes Oxley Act, which in turn created PCAOB. It only creates more confusion, which in turn leads to offenders being let off because of loopholes. It will take an epic to cite all such examples!

Coming back to the PNB-Nirav Modi scam, let’s see how the existing laws are good enough to handle similar cases and why NFRA would be a be an effort in the wrong direction, duplicating the present laws.

For example, take the RBI’s 2015 master circular/direction (RBI/FED/2015-16/15 FED Master Direction No 5/2015-16), which is about external commercial borrowings, trade credit, borrowing and lending in foreign currency by authorised dealers, and persons other than authorised dealers.

The RBI directive clearly talks about potential risk and loopholes.

“Letter of Undertakings (LOU) being a recently developed Indian banking industry specific instrument and unlike the internationally operated trade finance products like Letters of Credit etc., it is prone to many risks and loopholes,” the central bank said in the circular.

This is only one such observation. Many others are present in various notifications, circulars and other memos of present laws and institutions.

The point here is, when such laws are already present in the system, why can the government not use them to protect the financial system the way it did by amending Clause 49 of the Listing Agreement? Why can’t the government take steps to strengthen the present regulatory system the way it did by empowering SEBI to handle issues pertaining to the Forward Market Commission (FMC)? Why is the government resorting to a knee jerk reaction because of one case that is the result of ignoring signals from the present system?

Be it the PNB scam or the Kingfisher-Vijay Mallya episode, these are classic cases of banks sitting on the problem for far too long. And even if they did, how do they explain the procedural failures? Media reports said the scam was detected in the later part of 2017 but it was actually reported to CBI on January 29, 2018. Why such a lag?

And now there is this diversion where the government would probably waste precious public money in setting up a new regulator, rather than strengthening the existing system. Prime Minister Narendra Modi’s and Finance Minister Arun Jaitley’s advisors would do a disservice to the nation if they don't explain to them the reasons of the PNB scam in its entirety.

There has been a long-standing practice of making technical write offs by public sector banks to improve their balance sheets, and the government never prevented the self-cheating exercise. In literal terms, there is nothing like a technical write off. All write offs are real.

The truth is that Deloitte Haskins, the auditor of Firestar International Ltd (Nirav Modi’s firm), raised concerns two years ago over the weak internal control system. Why didn’t the bank or government act after that?

Overall, on the regulation front (in the present system), RBI forms panel of independent CAs every year in consultation with the ICAI. The panel should be handed over to any third party (other than the bank's management). This third party should appoint auditors from the panel, already finalized by the ICAI and the RBI together.

Similarly, internal auditors and concurrent auditors should exclusively be appointed from this panel. The objective of the whole exercise should be that the bank's management itself should not be placed in the position of determining auditors' authority.

When such a mechanism is already in place, it is difficult to fathom why a new layer needs to be added. PM Modi and his administration should ponder why reinventing the wheel by setting up NFRA is necessary when there are already empowered institutions to tackle the situation. Regulation is laudable but meek legislation for regulation would prove to be counter-productive, as it has in the past.