RBI regulation is ‘Unpredictable’ only when it should be

It uses a rigorous process before taking hard decisions, engaging in a two-way dialogue with its regulated entities (REs) to articulate its concerns and provide opportunities for issue resolution. Before taking any action, the regulator carefully considers relevant submissions from the entities involved.

Yet, penalized entities often express surprise, contending that RBI was satisfied with their responses before harsh steps were taken. Many of these entities happen to count former RBI officials among their advisors, consultants and board members.

While RBI remains broadly predictable and steadfast in its adherence to macro policies, regulatory frameworks and supervisory objectives, it appears to avoid predictability when it comes to specific supervisory outcomes. 

This approach works, for it prevents undue influence on the regulator from within the financial sector. Its independence stems from the rules it goes by, although key aspects of its role being under the ambit of legislation can subject this ostensibly independent body to political forces.

Looking back, RBI’s resolve became clear soon after the 2018 collapse of IL&FS, with its knock-on effects reverberating throughout the financial system. This crisis was compounded by frauds that came to light at entities like Yes Bank, DHFL and PMC Bank. 

In response to the PMC Bank crisis, the government bolstered deposit insurance and terminated dual-regulation of cooperative banks. Subsequently, Lakshmi Vilas Bank also collapsed. In each instance, RBI faced criticism for being caught off-guard and failing to act decisively and promptly.

In recent years, RBI has being putting REs to extra scrutiny. Its recent strictures on Kotak Mahindra Bank followed action taken against several others. It placed curbs on HDFC Bank back in 2020, with its dragnet extending to PayTM, Bank of Baroda’s app, IIFL Finance, JM Financial Products, Bajaj Finance and Mahindra Financial Services, among others; fintech players and asset reconstruction companies (ARCs) have not escaped its lens. 

While some may argue that some executives involved received lenient treatment, it’s crucial to recognize that RBI did take a firm stance that befits its institutional stature and reputation of integrity.

There has been considerable market discussion on concerns of collusion among lenders, non-bank financial firms, ARCs and other entities in the practice of “evergreening” loans or “balance sheet washing.” Can RBI confront all of them simultaneously? 

This is not advisable and RBI’s pattern of regulatory action shows that it has opted for a systematic approach instead, targeting each class of REs separately. By focusing on one industry category at a time, RBI sends out signals that offenders will be held accountable without causing panic across the sector.

Further, RBI has explicitly been communicating its expectations to the boards of REs, including their independent directors, making it clear these can’t be taken lightly.

Considering the risks that need mitigation, RBI has aptly chosen to enforce compliance by targeting areas where breaches could have a significant impact. While it has been imposing monetary penalties, it’s worth noting that such fines are often too light to serve as effective deterrents. 

A bigger worry for REs may be the reputational blow delivered by the publicity of punitive curbs being imposed for failing to meet RBI norms. Stopping REs from onboarding new customers until system deficiencies are rectified, for example, not only alerts customers to potential hazards, but also adversely affects the entity’s financial performance. 

This directly impacts the top management’s performance and diminishes the value of CXO stock options, thereby fostering a sense of urgency to ensure compliance, invest in remedies and address loopholes. 

Another tool at the disposal of RBI, albeit under-utilized thus far, is the authority to prevent the continuation of key management personnel in entities that are repeat offenders or exhibit lax practices. This mechanism enables RBI to hold boards accountable, particularly their nomination and remuneration committees.

In all, the regulator has adopted a combination of specific and broad-based tools. Its imposition of higher risk weights for unsecured lending is an example of systemic risk mitigation, while its Kotak Mahindra Bank curbs are mainly aimed at cyber safety.

All this should be welcomed, as a robust and effective regulatory framework is beneficial eventually to individual REs as well as the entire financial sector. An alert RBI also enhances investor confidence in the ability of REs to generate revenues and profits in a risk-controlled manner.

Credit is due to the institutional responsiveness of RBI and the leadership of its governor for implementing stricter oversight and taking stringent measures in a sector grappling with disruptive technological changes and shifts in consumer behaviour. 

The central bank has displayed a willingness to take decisive action against large institutions, even those with significant influence. If tea leaves are to be read of its regulatory role, it’s conceivable that RBI will toughen its stance against any risk of regulatory capture through a network of personnel.

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