Vault Matters | What kind of a cop should RBI be?

How effective has RBI’s annual supervision exercise been

For the longest time in Indian movies, the police were always late to reach the scene, invariably after the crime was committed. Since the early 2000s this trend started seeing a gradual change. Bollywood’s franchise, Singham, is a good example. An even better example is Mani Ratnam‘s less spoken about but an extremely intense family thriller Chekka Chivantha Vaanam. The cop passes off himself as a part of the family coterie to win their confidence and uncovers the crime. Tamil cinema has also given India one of the best cop-don movies, Vikram Vedha, where both are powerful and outdo each other. Now, which of these cop movies best describes the Reserve Bank of India?

Developments at IndusInd Bank, India’s fifth largest private bank, is likely to be tagged as fraud. What’s surprising is that it’s not just the accounting lapses that were uncovered in derivative trades, which has resulted in a possible fraud tagging, but even bigger procedural and accounting lapses came to light in the bank’s microfinance portfolio causing the trouble.

The recent report by the bank’s auditor suggests that there were lapses in basic aspects such as classification of non-performing assets. Interest income has also been inflated. In fact, the lapses in the microfinance book have sent shockwaves across the industry.

Problems which shouldn’t have arisen

For one, the RBI has since long made it mandatory for banks to automate the process of NPA classification. What this means is that if a loan is overdue for 90 days, the account has to automatically be classified as NPA. This push by the regulator essentially takes away human involvement or effort required in classifying a defaulting borrower as a non-performing borrower. But notes to accounts of IndusInd’s March FY25 quarter results revealed that there have been lapses in accounting for such NPAs, implying that there has been human intervention in a basic process which ought to have been automated.

Secondly, doubts surround how income has been recognised and whether income has been correctly recognised or overstated.

Questions for RBI 

One would assume that the primary objective of any annual supervision conducted by the Reserve Bank of India is to validate the number and process on income recognition and NPA accounting followed by a financial services entity, whether banks or NBFCs. If on both these fronts severe lapses have been uncovered in IndusInd Bank, how effective was RBI’s annual supervision exercise?

At this juncture, one is not even getting into the aspects pertaining to accounting lapses in the treasury side as treasury as a concept, even globally, is perhaps one of the most complicated pieces for an average banker to comprehend.

While this is no excuse for the regulator to have missed out on this aspect, especially considering that lapses have been there from FY16, the fact that there have been supervisory lapses in some of the more mundane and routine aspects raise eyebrows.

It would be unfair to compare today’s RBI with the cops of yesteryear Bollywood movies as the regulator has come a long way, particularly with respect to supervision. Many things are now automated and digitised. Yet, if such a slip has happened at IndusInd Bank, the process needs more scrutiny. That an occurrence like IndusInd Bank has happened within five years of Yes Bank debacle compounds the issue. What’s more, the microfinance book of IndusInd Bank was under rigorous scrutiny in late 2021 after a Whistle Blower complaint. Ironically enough, it is the same business segment which is once again causing pain for the bank.

Did the regulator give the bank a clean chit too soon after the complaint, or was the regulator even assessing the efficacy and overseeing the changes and overhaul done in the microfinance business to ensure that such lapses don’t occur in future?

Automation’s fine, but human decision making is indispensable

These questions can be answered only by the regulator, but one only hopes that instances like Yes Bank and IndusInd don’t become a new normal for the private banking space, especially when they industry may soon start approaching investors for serious capital. That said, such occurrences shouldn’t mean that RBI adopts a suspicion-led inspection process either.

Audit and inspection by nature are a very human intensive process to the extent of wearing a thinking cap throughout the journey of inspection. Automating the process can help in improving the sample size for audit or inspection; it cannot replicate human intelligence. The quest to improving supervision, however, lies somewhere in the middle - by eliminating human biases and improving human intelligence.