Wash Over of Recalcitrant Boards by the Rise in Financial Regulation

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After Yes Bank, RBI Can’t Be Trusted On Supervision: Time To Hive Off Policing To A Separate Entity

Snapshot

The case for retaining the RBI as supervisor of the banking and financial system is weak.

The job must be done by an independent board with strong powers to forensically audit banks and impose restraints on them when they are recalcitrant.

The Reserve Bank of India’s (RBI’s) decision to supersede the board of Yes Bank yesterday (5 March) is testimony to its abject inability to supervise the banking system firmly and credibly. It has put a moratorium on further lending, capped withdrawals at Rs 50,000 per month per account, and appointed its own administrator to run the bank in the short run. But these are no different from bolting the stable door after the horse has bolted.

The expectation is that the State Bank of India and Life Insurance Corporation will put in the funds to stabilise Yes Bank.

In a bland notification, the RBI said:

In exercise of the powers conferred under 36ACA of the Banking Regulation Act, 1949, the Reserve Bank has, in consultation with the Central Government, superseded the board of directors of Yes Bank Ltd for a period of 30 days owing to serious deterioration in the financial position of the Bank. This has been done to quickly restore depositors’ confidence in the bank, including by putting in place a scheme for reconstruction or amalgamation. Prashant Kumar, ex-DMD and CFO of State Bank of India, has been appointed as the administrator under Section 36ACA (2) of the Act.

If the RBI can act to safeguard the interests of a bank’s stakeholders, including its depositors, only one-and-a-half years after it had itself flagged problems with the bank’s asset classification practices, it is clearly unfit to supervise the banking system.

It is time to create a new prudential regulatory and supervisory authority outside the RBI, with the central bank’s ambit being reduced to managing monetary policy, open market operations, currency management and systemic stability.

Before we discuss the post-RBI supervisory framework, let’s look at how the RBI dropped the ball with Yes Bank. It all began in September 2020, when the central bank asked chief executive officer Rana Kapoor to leave by 31 January 2020. The reasons given were the bank’s “weak compliance” culture, its “weak governance” structure, and its “wrong asset” classification policies.

If this problem was seen as far back as September 2020, which means the supervisors would have known about it even earlier, what was the logic of letting the bank slide continuously for 18 months until it could no longer operate without a nanny?

It is worth recalling that the Yes Bank share peaked just a month before the RBI gave Kapoor his marching orders. In August 2020, the share price hit Rs 394. Today, it is at Rs 27.65 (mid-morning quote, 6 March). This implies that the RBI was sitting on its hands even as the markets destroyed over 90 per cent of investor wealth in the meanwhile.

This not only stymied the bank’s own ability to raise fresh capital, but raises questions why the central bank could not see what outside forces could see clearly?

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The RBI’s Yes Bank failure gives the lie to another claim it made in early 2020, when former finance minister Arun Jaitley talked about supervisory failure in the fraud-hit Punjab National Bank. The then governor, Urjit Patel, claimed that the central bank lacked adequate powers to take action against public sector banks.

The joke is clearly on the RBI, for the Yes Bank failure is a direct reflection on its own inability to supervise the banking system, whether public or private. It may know a thing of two about systemic stability, but it simply lacks the ability to police its own backyard.

So, where do we go from here? Two places really.

First, clearly the supervisory function on the banking and financial system needs to be hived off from the RBI and given independent powers.

Second, future prudential norms can be announced by the newly-hived off supervisor, but in consultation with the RBI. The other option is to let the RBI set the prudential norms and the supervisory board to take care of its implementation by vetting banks’ books and spotting problem areas before they worsen.

In the current RBI structure, it supervises banks through its Board for Financial Supervision, but board’s constitution is problematic. The RBI website has this to say:

The board is constituted by co-opting four directors from the Central Board as members and is chaired by the Governor. The Deputy Governors of the Reserve Bank are ex-officio members. One Deputy Governor, traditionally, the Deputy Governor in charge of supervision, is nominated as the Vice-Chairman of the Board.

Simply, this means that the supervisory board comes from the same stable as the banking and monetary policy establishment, when their roles are completely different.

One wonders how such an incestuous board can function effectively as policeman and whistleblower when the RBI’s primary role is to ensure financial stability no matter how bad bank finances are. There is an in-built bias towards covering up problems for fear of causing a crisis of confidence in the public.

How is this supervisory board supposed to police not just scheduled commercial banks, but also cooperative banks, financial institutions, non-bank financial companies, credit information bureaus and primary market dealers? There are simply too many entities to police with inadequate resources.

The case for retaining the RBI as supervisor of the banking and financial system is weak. The job must be done by an independent board with strong powers to forensically audit banks and impose restraints on them when they are recalcitrant.

The RBI can be kept in the loop all the time, but the supervisory board cannot be beholden to the central bank which has its own priorities.

As for Yes Bank itself, the best course may well be merger with a stronger private or public sector bank. Private banks could be given a few days to do due diligence, but the chances are public sector banks will have to step in.

It would be better for Yes Bank to merge with SBI instead of allowing it to be bailed out by two partners, SBI and LIC. Better control needs one boss, not two.

Will cash survive Covid-19?

People’s Bank of China (PBoC)

Covid-19 has sparked global panic. Central banks have cut interest rates to near zero, made billions available in liquidity, and urged markets to stay calm.

Meanwhile, leading the public health response has been the World Health Organization, which has been charged with providing governments and members of the public with timely information on the spread and progress of the virus. That has included comments on banknote safety.

At the beginning of March, in response to a question about whether banknotes could spread the coronavirus, a WHO spokesperson said: “Yes it’s possible and it’s a good question. We know that money changes hands frequently and can pick up all sorts of bacteria and viruses … when possible it’s a good idea to use contactless payments”.

Media outlets around the world picked up on the comments, triggering fears over the safety of cash. There have since been reports of people attempting to microwave their banknotes in order to sterilise them.

The WHO has now clarified its comments, stressing it is not advising people to abandon the use of cash. Instead, it is advising the public to wash their hands after handling money, especially before handling or eating food. But the comments have done little to soothe concerns.

So how much will cash usage, and the wider banknote industry, be impacted by coronavirus?

Paper (cotton) vs polymer

In 2020, scientists from the Institute of Genomics and Integrative Biology in New Delhi researched what particles of dirt were evident on different Indian rupee banknotes. The banknotes were collected from street vendors, grocery stores and money exchanges.

Their analysis revealed fungi (70%), bacterial populations (9%) and viruses ( WHO says “the virus will not survive for very long on surfaces, particularly on a dry surface like a banknote”.

A study released on March 17, 2020 revealed the current strain of coronavirus was more “stable” on plastic and metals than on softer fabrics including cardboard. This would suggest that while polymer notes are less likely to harbour bacteria, viruses live longer on them.

However, the coronavirus would therefore also live longer on debit and credit cards, and mobile phones, which are being encouraged as payment option by many of the world’s central banks. “Cash is just one of a number of frequently touched surfaces we encounter. The same is true for any other payment device whether it’s a card, phone or watch,” says Reserve Bank of New Zealand assistant governor, Christian Hawkesby.

There are some strains of coronavirus that are a little more persistent. A study in the the Journal of Hospital Infection 1 finds coronaviruses persisting on paper and polymer surfaces for up to five days. Another study, by Vincent Munster and a team at the National Institute of Health Virology Laboratory in Hamilton, has them lasting as long as three days on plastic.

But these results are not directly comparable to polymer and cotton banknote substrates.

“It is certainly possible that coronavirus could be present on cash and be transmissible, but I would expect that to be a very minor proportion of transmissions,” McLean says. Simply touching an infected surface will not give someone Covid-19, however; it will still need to be passed to your mouth, nose or eyes.

A 2020 Europe-wide Mastercard study found two-thirds of people think touching or using money is unhygienic, but only one in five Europeans wash their hands after coming into contact with it. More than 9,000 consumers from 12 countries were surveyed.

So while banknotes could increase the reach of Covid-19 (as could payment cards and mobile phones), it is unlikely to increase the transmission if people continue to abide by suggested hygiene standards. “This reinforces the need for good hand hygiene regardless of the way you pay or accept payment,” says Hawkesby.

The risk of banknotes spreading the coronavirus is small “unless someone is using a banknote to sneeze in”, says Christine Tait-Burkard, an expert on infection and immunity at the Roslin Institute at the University of Edinburgh.

Central bank action

Despite the scientific evidence, negative sentiment surrounding coronavirus and cash has persisted. In South Korea, a man was found to have microwaved 1.8 million won ($1,500) in an attempt to sanitise the banknotes. He was left with only 950,000 won after his attempt – many notes were left singed and unusable.

So what can central banks do to calm the public and ensure all payment channels remain open? In Singapore, the Monetary Authority of Singapore is advising members of the public to use contactless payments where possible, and to wash their hands after handling cash.

“People should wash their hands with soap and water after handling cash, and avoid touching their faces with their hands. These are good habits to practise, whether or not there is Covid-19,” a spokesperson from the MAS tells Central Banking. There has also not been increased demand for new banknotes in Singapore, Central Banking understands.

In addition to encouraging electronic methods of payment, central banks have implemented somewhat extreme measures to restore confidence in banknotes and coins.

In China, where Central Banking understands there has been an increased demand for disinfected cash, the People’s Bank of China has implemented a disinfectant regime which exposes banknotes to UV light and high temperatures in order to sterilise banknotes.

The China Banknote Printing and Minting Corporation says it has not been asked to print new banknotes. The only exception has been for hospitals, which have demanded new bills, Central Banking understands.

Similarly, the Bank of Korea is ensuring banknotes coming out of circulation are superheated to 150 o C before they re-enter the economy. The Central Bank of Hungary is quarantining banknotes for 14 days prior to sending them through a tunnel heated up to 170 o C.

“All banknotes returned to the vaults of the note-issuing banks will be sorted by machines automatically under a stringent standard, with filthy or unfit notes destroyed immediately,” a spokesperson from the Hong Kong Monetary Authority tells Central Banking.

“To prevent the spread of the virus, members of the public should follow the advice of the health authorities to maintain good personal hygiene, such as washing hands properly and frequently,” the spokesperson adds.

Expert advice

Central banks have also sought advice from their banknote suppliers. De La Rue, the globe’s largest banknote services provider, has been issuing information packs to worried customers. Each pack includes research conducted during the bird ‘flu ( H5N1 ) outbreak of 2006.

H5N1 was also a strain of coronavirus. During the outbreak, De La Rue’s research suggested that as little as 10% of coronaviruses were still present after four hours. It concluded overnight storage was likely to be adequate to ensure that the virus was no longer present.

Some central banks have already chosen to quarantine banknotes for a prolonged period of time. The Central Bank of Kuwait is reportedly quarantining banknotes for four weeks. The US Federal Reserve is also quarantining banknotes received from epidemic countries.

The research appears to indicate banknotes will not transmit the virus any more than using a debit card or mobile phone. Due diligence in terms of personal hygiene therefore appears to be the key to preventing the spread of the virus when using any payment method.

Notes

  1. G. Kampf, D. Todt, S. Pfaender, E. Steinmann, “Persistence of coronaviruses on inanimate surfaces and their inactivation with biocidal agents”, Journal of Hospital Infection, Vol. 104, Issue 3, p246–251.
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