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The Daily Fix: Would privatisation of banks have prevented the PNB-Nirav Modi scam?

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The Big Story: Private problems

The story might be novel and, in the case of the Punjab National Bank-Nirav Modi scam, staggering in terms of numbers, but the response from much of the commentariat is the same. Public Sector Banks should be privatised. The Chief Economic Adviser said so. The Federation of Indian Chambers of Commerce and Industry has called for it. The Associated Chambers of Commerce and Industry of India has demanded it. And, of course, reams of comment pages have been filled with diatribes against the state of public sector banks and how they are to blame for the woeful state of the banking sector.

The argument goes that public sector banks are badly managed, with top leaders that are paid much less than their counterparts in the private sector and so have fewer incentives to improve functioning, with no shareholders to hold them accountable while also being heavily susceptible to demands from bureaucrats and the government. This, the argument goes, creates a situation with a perverse incentive structure, where bank managers are frequently scurrying around to do what is demanded of them rather than core banking functions such as, in this case, risk mitigation.

Those arguments might make sense for the industry at large but they miss two points: They simply diagnose the problem in public sector banks without asserting that private banks would be any better, and the PNB-Nirav Modi scam might well have happened anyhow. Remember, the allegations involve Nirav Modi and others conniving with officials at Punjab National Bank to send out fake bank guarantees to other banks, from which Modi was then able to get credit.

The more information that emerges about the scam, the more it becomes clear that PNB’s attempt to pin the blame on a few employees looks like a cover story. For the fraud to have been successful all this while, since PNB claims it began in 2011, it looks likely that more than a few top leaders would have been involved or, at worst, turned a blind eye to the scam. What was missing was regulation, which could have acted as a check against such actions, forcing the bank to reconcile its accounts in a manner that would have revealed the criminal action.

Evidence from many other parts of the world regarding banking structures, public or private, suggest that weak state capacity and bad banking regulation will result in banks working with companies to game the system. As Ajay Shah argues, “public sector banks are easier to regulate... In contrast, senior managers of private banks are unruly... They will tenaciously look for and exploit loopholes in rules. Regulating private persons requires greater state capacity.”

In other words, if the only response to the PNB scam is to simply privatise banks, the problem might end up getting worse. There would be less oversight of the private banks and, considering the woeful state capacity both at the government and the central bank level, not nearly enough regulation of banking activities. There are many reasons to be unhappy with the functioning of public sector banks and more than a few arguments that suggest the private sector needs to be a bigger player in the lending market. But all of these should come after enhancements to regulatory and oversight capacity. Privatisation without regulation would mean simply shoving the dirt from under one rug to another.

The Big Scroll

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  1. “It is indeed tragic that India-Canada relations have become a political hostage to the Khalistan question. What a fall from the exalted tradition of liberal internationalism that once bound Delhi and Ottawa,” writes C Raja Mohan in the Indian Express.
  2. “It is crucial that India maintain a steady course on its strategic interests with Iran, a key source of energy, and as Mr. Modi put it, a “golden gateway” to Afghanistan and Central Asia,” says a leader in the Hindu.
  3. V Anantha Nageshwaran in Mint says that the Reserve Bank of India’s decision to issue new guidelines regarding the classification and restructuring of Non Performing Assets is the right move.


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