 Hello and welcome to NewsClick. Today we are here with Prof. C.P. Chandrasekhar to look into the Punjab National Bank issue. By now everybody knows the details of the fraud that has taken place in PNB of 11,000 crores. But what the news or the news analysis is not going into is what is the reason for this crisis. Some people say that it is the technical problem of integrating Swift to the core banking system. Other people say it's a problem of internal checks and balances or the problems of audit. But what really is the problem, let us discuss today. Hello sir. What we have is a situation in which a group of companies, led of course by Nirav Modi and Choksi, are in a position to be able to get letters of undertaking which allows them to access credit from banks outside the country without any collateral when the requirement is that normally the collateral has to be complete because this is associated with purchases and imports into the country or some activity of that kind. So they get it without collateral. They get not one but they get multiple ones and they get a significantly large number of ones it appears from what one reads within a very short period of time. The third is that they not only get this but these are consistently repeated. So periodically they have sort of renewed because they are short term so that this allows short term credit to be transformed into long term credit. It obviously means that the banks to which the LOUs were being provided were willing to continue to keep offering this credit because they were the ones who were in the final analysis providing the credit abroad. So they should have been in the know that this process is going on. And of course there are what you mentioned there are the Swift transactions which is supposed to be a transaction which is layered checks and therefore it is unlikely that such a large volume of transactions would have gone unnoticed. So put all of this together and it is a bit difficult to actually say that just because there was no integration of Swift with co-banking this thing meant unnoticed for years together and therefore we had this large accumulation of what is undoubtedly a huge sum as far as the scam is concerned. According to a reply which was given in parliament to a question which was raised by one of the MPs in the Raj Sabha that if you take the annual average of frauds of the total frauds of all scheduled commercial banks in the period leading up to March 2017, four years leading up to March 2017, the average is in the range of about 14,50000, between 14,50000 and in fact 15,000 crores. So you can actually see that this one incident is equivalent to what is an annual almost what is equivalent to an annual average and that annual average itself is a significant step up. If you go back to a sort of speech with Chakravarty who was the deputy governor of the Reserve Bank gave, we actually find that in the four years ending 2012-13 which was the previous four years if you take the average it was much less, it was in the range of about you know I think 7,000, 8,000 crores or so. So what we are observing is that in recent years particularly over the last four, five years there has been a huge build up in the volume of scams in the banking system or no frauds in the banking system leading of course to different degrees of write off because we must admit this much that fraud is inevitable in banking in as much as human beings are complex but the point is a bank's role is to try and work to ensure that the number of these frauds in the volume involved is less and also to work to ensure that once detected you should be in a position to be able to recover as much as possible. As I said we can't just reduce this to a situation in which we say it's because of lack of linking because of so many points and locations and so many agents who should have had some information and so the idea that you would not be able to detect that something is odd even if you didn't think it was a fraud or that it was you know fraudulent transaction that there's something odd going on should have been visible and should have been detected particularly given the long period for which it is lasted. So what I think we need to do is to try and place this in the context of a whole change of the environment in which public sector banking is forced to function and I think we need to dissociate two components of that environment. One component of that environment comes from the changed sort of financial and economic and financial situation which comes with liberalization and the second component of it comes from the sort of the changed policy thrust of the government itself. I mean very clearly as far as the government is concerned being business friendly and by business friendly we don't mean all businesses being big business friendly which is sort of sort of concealed or you know put behind this motto of saying that we want to improve the ease of doing business. So the whole idea is if you go up in a few ranks in the ease of doing business scale however good that measure is that's considered to be a big achievement and to do that you know in a real sense you're willing to go out of your way to try and provide concessions these concessions could be land and resources provided cheap these concessions could be tax concessions and of course these could also be concessions of a kind in which you actually say that we'll reach you the credit to undertake the activities which we'd like you to undertake. So it might be infrastructural projects, it might be you know sort of prestige clients who are supposed to be champions in national champions in the world of business. I mean we can back somebody wanting to take over chorus and make it into a national battle with the Brazilian firm. We can back somebody who's seen as now emerging as one of the you know the top diamond merchants of the world and not just diamond merchant but the diamond designer who you know hobnobs with the elite has some of the best brand ambassadors possible etc. So these these are presented as these national champions who reflect where India is. If you move into a situation of that kind and you have these two components where the state is going to back these kinds of as I call them you know these sort of perceived champions and your know situation of financial liberalization in a situation of financial liberalization we know what really happened is banks were flushed with funds because of the liquidity which is injected into the system given the large inflows of capital they were under pressure to lend and the way they basically saw it is that if these were the entities which were being backed and of course I'm sure there was pressure from different sections of the state that you you know more of functioning like a public sector bank used to function in in an earlier period when it was not profitability which was the consideration what is the consideration was the degree to which you met certain social banking indicate I mean so the targets which which was set for you. So we've seen that transformation which comes not which basically means that the issue is not just ownership the issue is if the if the state which owns you has itself transformed the way in which it visualizes what should be the role of banking and wants to use it as an instrumentality for promoting big business then you create an environment in which you which banks flush with funds then decide that these you know these are these are prestige clients placing a bet on which is good because they seem to be doing well they seem to be having the back end of the state and they seem to be in areas which they claim are growing etc so we we saw two kinds of things one of course we saw that this resulted in the provision of huge loans to projects which should not have been funded so what's really happening is that instead of you know due diligence and proper appraisal of projects things like the prestige of the client the size of the loan the extent of state backing for for the client these things become more important in loan decision-making then actually looking at the the nitty gritty of course you look at it but but you know you actually are far more lenient because of the fact that that these these are the kind of entities you have so we had a set of loans large loans which went to projects which wouldn't have been funded and the result of that we are seeing now once you actually began to demand or the central bank began to demand recognition of and better recognition of non-performing assets we have this huge spike in NPAs as the rules get tighter the spike is expected to increase far more so we have in a situation in which we have this huge NPA burden and a large part of it some 70 percent 80 percent incrementally is due to these large corporate borrowers who have been backed as part of this liberalization policy and I think the other component of that is when you're in an environment of that kind then it becomes very much easier for people on the basis of of of this prestige of the fact that they've got the backing etc to get loans for things which in which are not even projects which really about funding and they're getting loans we don't even know whether the implicit or explicit specification of why this loan was being taken and the guarantee being provided was actually met was that money being used for this purpose was it being used to just set up these fancy you know stores in the most expensive real estate in all the top metropolitan cities of the world you know was it was it actually being squandered in that fashion and to a certain extent so so the whole relationship between the banking system and these prestige clients becomes very unequal in favor of the client and you know that creates this environment you know in this really the the reason why these people have that strength is is because of the support which comes from you know very levels it comes from the state possibly right from the Prime Minister's office in the case of some of them it comes of course from the top management of the banks who think that you know that this is what they should do given the state's perception and given the fact that they're public sector managers and this goes down and it goes down to you know officers who are responsible for implementing all of this and maybe some of them didn't even see any payoff they got as something which was what was responsible for them doing doing what they did it almost like getting a bonus for what you would have anyway otherwise done you know because that was the environment so the way I see it is that as I said you know fraud is not something which is avoid completely avoidable in market economy with even with public banking there would be some fraud and losses due to fraud these are operational risks you need to provide for them you try to reduce them and you try to recover as much as possible but what we actually observing is a spike in the volume of each of the frauds involved and therefore this the value of total frauds which the banking system is going to carry and I think that comes from this environment of this combination of financial liberalization plus a sort of obsession on the part of this government to identify itself as being the most reformist within inverted commerce which India has ever seen and that leads to the NPAs as you put it on one side and it leads to the possibilities of fraud of this kind and therefore I don't think this is this is going to be the last wheel here in any case already there's another one which has come up and all of them start with small sums and then the sum involved keeps increasing so I see it as systemic problem it's these are these are you know this is systemic fraud of a kind which comes from an environment with which you have a certain policy and a certain kind of aggressive state what is also reflective of this status this sort of systemic thing is the bank management's want to say that oh it's a isolated problem in a couple of branches and a few officials the finance ministry want to say that it's you know the I'm sorry the central bank wants to say that it's a failure of internal systems and scrutiny the finance ministry wants to say no it's also a failure you know Arvind Subramaniam goes and says also a failure of the regulatory authority which is the central bank so you know and so everybody actually wants to to pass the buck and say that you know this is so in you know so the easiest thing is to find a fall guy and say that oh you know these are public sector and you know as such I was already said that you know this is a case for privatization which is which is absurd I mean you know this is a case for changing of course you need to ensure that guidelines which already exist and need to be implemented of due diligence prudential regulation etc must continue but the point is we also need to see how an environment a larger neoliberal environment of this kind is is completely dangerous for a banking system and which is why I think we have to place both together the non-performing assets which is not a case of pure fraud I mean that is a case of bad decision-making coming from the fact that you're backing your backing I mean you're getting a banking sector which is backing ports roads civil aviation steel you know these you know obviously you if you go in for these kinds of projects there's likelihood that you'll have an NPS very a large NPS very high so I think that's that's the way I'd like to look at it from what you're saying I get the sense that as long as the policies of liberalization and and as long as the state is not really investing on its own this problem might continue yeah the way I'd put it is that even let's let's let's keep fraud aside for a moment but even if for example you say that I'm going to put so much money and recapitalize the banks so that whatever haircut they have required to take I'll be able to clean their books put put the balance sheet back in shape ensure the the capital adequacy norms not that we need to at all meet those basal norms there's no treaty there most international banks think twice before they get there but anyway you know it's assuming you do all this and then you have a next round you know and you have a next round of NPS beginning to come and you know then then what you're going to go for a now what the government is initially did because it thought that it had sorted the problem out between 1991 and round about 2004 5 because yet it collapsed in the in the ratio of non-performing assets to gross advances but we now know that after that they they hid behind the stressed assets definition a lot of the non performing assets which came because of the new lending associated with liberalization and that's now reason so supposing you clear this up what's the guarantee that and there is no guarantee in fact will happen you'll actually have once again an increase in in in in in in the NPA volume and I do think what the government is you know thought in this in this round they thought that they could actually sort the problem out by setting up asset reconstruction companies going in for some disinvestment of equity in public sector banks maybe use the occasion to actually reduce you know public holding below 52% by by changes in laws and you know and then go go for some disinvestment which is actually privatization and then use that money but obviously what they realized is who's going to buy all of this equity if the banks has burdened with all of these NPAs you know so then first there was all these ideas how do you take it take these NPAs out and dump it in some bad banks is the government will own and you then sell off these these are the entities but that wasn't working so they've gone for this you know this 1.2 lakh crore recapitalization exercise and the way I see it is that the way it's being presented is this is the last time you're going to do it now if you say this is the last time you're going to do it but you're not changing the policy environment which generates large NPAs the next time around what's going to happen so you basically are trying to say is that okay I'm not I'm going to get into a situation where I've wiped the books clean now please I'm going to let you go and you know disinvest and privatize yourself and then it's the private party's decision we are not we'll change the rules we won't put any you know we won't put any pressures on you you new function as you are but it's not that private banks don't fail I mean you know in 2007 8 private banks which are failing in the government and nationalize them in countries where there wasn't public banking so I I basically think that all this FDR DI and so on this old resolution authority this whole idea of trying to say that we should we should have bail ins and not bail outs is trying to create a situation where private operators will say that okay now the books are clean we can take these people over we'll have a certain degree of freedom to function the way we want because the state will change the rules and we are going to be given new ways of socializing losses including through depositors you know to say that you know anybody who you know who's actually a creditor to the bank which and depositors and subs is you know partly taking a risk and therefore has to be responsible so you say up to you know whatever one lakh or whatever it is you have deficit insurance beyond that you take a haircut too which is basically giving those would be holding the bank either the state if it continues to hold it for the private sector a way of actually socializing losses so that you're actually all of this is seems to be a way of and you know creating this environment where you can hand over public banking system to the private sector and that will give control over the nation savings to the private sector and therefore this attack which is coming saying this is all public banks and that's why we are having all this fraud and so on is is I think part of that that larger agenda and exercise finally just one more question that does it make sense for public sector banks to reorient their credit in the sense maybe do more like private sector banks into consumer credit and the kind of credit that private bank private banks do you know the way I would look at it is they they are under pressure to lend if you have and they increase in deposits which we saw and deposits you can you know can take it relative to the size of the economy to GDP and look at the deposits to GDP ratio which it just piked hugely after 2004 because there was so much capital coming into the country creating liquidity in the system and banks can't sit on liquidity you know so because they're paying depositors interest so they have to earn something so they did diversify into retail banking and from something like if I remember the figures you know maybe seven eight percent it went up to almost a quarter of total advances which is quite a lot and other than for most of it of course went for housing but if you look at the distribution of non-performing assets other than for educational loans which of course because of the job market being what it is you know we've seen we're beginning to see significant defaults it hasn't performed maybe they haven't performed badly at all in the retail market despite the fact that they were apprehensions but that's because they stopped at 25 I mean whatever 23 or 24 percent but if you actually keep on bringing in more and more people because you want to expand this so there has to be a way in which these entities should be able to buy into bonds etc of specialized financial institutions which have government and central bank backing which can finance all these capital intensive projects because we do need to finance those projects but the banks at least will be putting their monies besides lending to some to some you know investment projects would also be generating a portfolio given the large volume of deposits in which they can have a higher degree of safety with this perhaps a you know slightly better rate of interest than what they get on government securities today but even government securities is not too bad you know so given all of that I think that it's that unless you get rid of the push on the public banking system to use the liquidity it has to do things which the state things should be done it should be done to the private sector and it won't be done by the state because they believe in all their you know fiscal consolidation conservatism which is you know which is not warranted to the extent that they've gone and therefore you end up with creating this position you must be able to break the public banking system out of that give it a larger portfolio but just going more and more into retail might not be the answer because they have diversified in favor of detail maybe a little more but finally I don't think it'll have to be a situation in which they might be the port of call of these savings but when the savings actually gets allocated in terms of the risk which is taken they must be state sponsored or state owned entities as intermediaries in between who carry the risks and give a recent decent return such that the banking system which has many other you know social functions and externalities would would not be put under the stress thank you process and the shaker we hope to get back to you on this issue again