Corporates In Banking: Debate Overhaul Of Supervision And Enforcement First

A suggestion by a Reserve Bank of India working group to consider the entry of corporate groups into banking has set the proverbial cat among the pigeons.

Views on the subject are binary.

Those who are against it say that the entry of corporates will add to risk in the banking system. There is no way a regulator already struggling with supervision can hope to keep track of money flowing through complex corporate structures and so it must not tread that territory.

Those who favour it say that India needs a deeper, wider, better capitalised banking sector. They leave open the question of supervision and risk, perhaps, to the hope and prayer that the regulator will find a way to keep up with a wider and more diverse set of banking entities.

These processes need to be overhauled in a way that financial misadventures can be detected early, rules enforced and, where needed, strictures imposed with a strictness that also acts as a deterrent.

Enablers For Stronger Supervision

To improve supervision, a set of enablers must be put in place, irrespective of whether India permits the entry of corporate houses into banking or not.

First, is a highly-specialised supervisory cadre. RBI governor Shakitkanta Das has already announced that he intends to set up a supervisory cadre but the suggestion has seen some opposition. The need for trained sleuth-like supervisors and on-site inspectors is critical, as the existing processes of annual inspections and concurrent audits have missed much. This supervision must be combined with razor-sharp market intelligence to be effective.

Second, is data. The central repository of information on large credits or CRILC is one of the most useful efforts from the central bank in recent years. It would do well to keep strengthening that database and even open it up to a wider set of agencies such as rating agencies that may be able to study it to detect any risks. If not, the regulator should be mining this data constantly.

As an extension, the proposed public credit registry, which hoped to bring together data from across sources, such as lenders, SEBI, the Ministry of Corporate Affairs, GST Network, the Insolvency and Bankruptcy Board, should be speeded up. Once in place, it can prove to be a powerful supervision tool for the RBI.

Third, if India decides to go down the route of permitting corporates into banking, then legal enablers would also be needed. Among them will be an amendment to the Banking Regulation Act permitting consolidated supervision of non-financial entities within a group that holds a bank license. This is what the internal working group has suggested but rules would need to be framed clearly and unambiguously.

SupTech Can Help

Once these enablers are in place, the RBI should look across the world and draw ideas from the evolving work in supervisory technology or SupTech.

An October 2020 report by the Financial Stability Board, of which India is a member, offers some insights on this. The report included a survey of members on what is driving the demand for SupTech and the supply of it. The availability of artificial intelligence and machine readable data were the key supply-side drivers of SupTech. On the demand side, regulators felt the need to enhance efficiency and effectiveness of supervision and to improve insights from the supervisory process.

These tools, when put together with the tried and tested market intelligence and on-site inspections can improve regulatory oversight, the report said.

The report details some interesting examples, which, while specific to individual regulators, may spark some thinking for Indian authorities.

The Monetary Authority of Singapore is among those experimenting with SupTech in a number of areas. One such area is money laundering and terrorism financing risk management. The MAS has built a suspicious transaction network analysis tool, which is used to identify concerning clusters of individuals/entities that exhibited suspicious behaviour as well as the financial institutions involved. “This helped sharpen their ability to prioritise and target risks in their AML supervision,” the report said.

Another tool developed at the MAS dealt with predictive modelling to identify representatives at higher risk of misconduct. This was done to curb mis-selling. “Using the model, the MAS is able to identify representatives and transaction samples for scrutiny during onsite inspections.”

The European Central Bank has focused on developing an Early Warning System for 2400 smaller financial institutions falling under its purview.

The model used a machine learning technique which studied bank specific variables coming from quarterly supervisory data, together with banking sector variables and macro-economic indicators. This helped identify institutions that might need to be followed more closely, and therefore allowed regulators to prioritise supervision towards the banks which might potentially enter into financial distress.

Another tool developed by the ECB is used to assess the ‘fit and proper’ status of managements, board members and other key officials across financial institutions. The tool partly automated this assessment using Natural Language Processing and Machine Learning techniques.

In its 2019-20 annual report, the RBI said that a standing committee on analytics was set up to “engage in adopting industry standards in SupTech, best practices in business intelligence and data analytics for risk modelling that would deliver improved inputs to supervisory managers.”

The regulator would do well to prioritise these efforts.

Iron Hand Enforcement

The final piece in the puzzle is enforcement.

Former RBI governor Urjit Patel had tightened the enforcement processes, ensuring that regulatory violations are brought to book quicker. But authorities need to go much further.

Instances have come to light, such as in the case of IL&FS and Punjab National Bank, where supervisors raised had red flags. These were not enforced immediately, allowing malpractices to go unchecked.

Enforcement must be swift. It must also not be painless. At present, the RBI imposes fines which are pocket change for the institutions being held guilty of regulatory infractions. The fine must be commensurate to the nature of the infraction and the size of the institution. They must force shareholders to sit-up, take notice and implement correctives.

Finally, the regulator, within limits, must be willing to disclose more clearly the investigations into malpractices and its findings. Its belief that a one-para say-nothing statement and a slap-on-the-wrist fine is enough of deterrence is a pie-in-the-sky.

Ira Dugal is Editor - Banking, Finance & Economy at BloombergQuint.