Quick Take | With so many frauds in PCA banks, why take the risk of allowing them to lend?

People walk past a barricade inside the Reserve Bank of India (RBI) headquarters in Mumbai, India June 7, 2017. REUTERS/Shailesh Andrade - RC18B616FD00

Frauds in banks are increasing by leaps and bounds. The Reserve Bank of India’s Financial Stability Report says the total amount involved in frauds of Rs 1 lakh and above was Rs 18,698.8 crore in 2015-16 which went up to Rs 23933.9 crore in 2016-17, which exploded to a massive Rs 41167.7 crore in 2017-18.

In the first half of 2018-19, the amount involved in bank frauds was a hefty Rs 3042.02 crore, which suggests the full year numbers will be much more than in 2017-18, if the fraudsters keep up their first half performance.

Public sector banks account for 89.5% of the total frauds, with private banks accounting for 9.6% and foreign banks 0.8%. Of the 89.5% share of public sector banks, 36.5% pertains to banks under the Prompt Corrective Action (PCA) framework, while 53% are in non-PCA public sector banks.

The RBI report points out that the proportion of capital dedicated to operational risk in the PCA banks is a mere 18.9% of the total operational risk capital in the banking sector. This is much lower than its share of frauds, which is 36.5%. It’s a powerful argument against relaxing the restrictions on lending for these banks. As the RBI report says with remarkable understatement: ‘A more judicious alignment of realised operational risk with allocated capital, specifically with regards to PCA-PSBs, is desirable.’

For non-PCA public sector banks, their share of operational risk capital is 43.3%, also lower than their share of frauds which is 53%. In sharp contrast, private sector banks and foreign banks account for 28.9% and 8.9% respectively of total operational risk capital, well above their share of frauds.

It’s a clear indication of the higher risk in public sector banks. The RBI report says, ‘the predominance of frauds among PSBs point to possible inadequacy of risk mitigation processes. The assessment and inculcation of appropriate Risk Culture in an organisational milieu assumes importance in this regard.’

The sharp rise in frauds in public sector banks indicates that merely recapitalising them is not enough---at the very least, a wholesale change in their governance structures is called for.