Just a few days into his role as the acting Indian Finance Minister, Piyush Goyal, took on a major task – to try to clean up the country’s beleaguered banking system.
Mr Goyal, whose usual role is as the Railways and Coal Minister, last Thursday gathered together the heads of 11 of India's ailing public sector banks in New Delhi, as the industry continues to reel under the impact of the country's largest ever bank loan fraud that came to light this year and the weight of bad loans.
"I am extremely confident that we will be able to overcome the banking sector legacy issues in a very short period of time," Mr Goyal posted on Twitter following the meeting. Known in political circles as a troubleshooter, he is standing in for Finance Minister Arun Jaitley, who underwent a kidney transplant last week.
Meanwhile, India’s banks are also in poor health. And the Nirav Modi scandal – in which the celebrity diamond jeweller in February was accused by one of India’s biggest state-owned lenders, Punjab National Bank (PNB), of defrauding a single branch of $2 billion – is forcing authorities to take a closer look at the sector and work on its regulatory overhaul, analysts say.
“I think we still have a long way to go,” says Abhimanyu Sofat, the vice president of research at IIFL, a financial services company headquartered in Mumbai. “From a regulatory angle, better risk management, accountability of people making decisions, as well as accountability of board of directors, these things need to be looked at.”
There are signs that regulators are cracking down.
Last Thursday, PNB was slapped with a warning letter by India’s markets regulator, the Securities and Exchange Board of India (Sebi), for delays in making disclosures to the stock exchanges in relation to the alleged Nirav Modi bank fraud.
Sebi, in the letter posted on the stock exchanges by PNB, said the bank’s delayed disclosures “are viewed seriously and PNB is hereby warned and advised to be cautious in future to ensure compliance”.
In the case of Nirav Modi, the fraud is alleged to have been carried out at a single branch in Mumbai, with letters of understanding, or bank guarantees, being issued without any collateral behind them.
India's banking regulator, the Reserve Bank of India, reacted by setting up a committee to look into the problem of banking fraud in the country and demanded that banks tighten international mechanisms.
"The issues in the banking system started off much earlier than Nirav Modi and are a much bigger problem of bad loans, the issue of loans not getting serviced, and how non-performing assets are being classified and recognised," says N Chandramouli, the chief executive of TRA Research, a business advisory company. "That's becoming more rigorous now. When things come to light, one thing is that the scrutiny system has become better. These are not scams that have started today. These are going to be good measures in the long run."
But the central bank is held back from having full control over regulation of the sector, according to its head. In a lecture given by Urjit Patel, the RBI governor, at the Gujarat National Law University in March, he highlighted that there were “fundamental fissures that exist in the regulation of banks, in particular, public sector banks”.
He said RBI's regulation over public sector banks is limited by the fact that these banks are also regulated by the Indian government.
"RBI's regulatory powers over public sector banks are weaker than those over the private sector banks," he said. Mr Patel said the government should make "banking regulatory powers neutral to bank ownership ... levelling the playing field" for public and private sector banks.
The government following the Nirav Modi allegations, had implied that the RBI was at fault, but it seems to have changed its tune towards the central bank.
Mr Goyal also said: "RBI is ensuring proper banking supervision, taking action against defaulters. The indiscriminate lending in the past has caused this distress but we are ensuring the orderly growth of the industry and accountability in the system."
But analysts warn it is important that the authorities do not become too overbearing when it comes to regulation of banks in India.
Manish Hingar, the chief executive of Financial Hospital, an investment advisory company headquartered in Mumbai, says that the RBI went too far when it decided to ban the issuance of letters of understanding by banks for trade credits for imports into India, in what he sees as a knee-jerk reaction to the PNB scam.
“That’s not the best solution at all,” says Mr Hingar. “They need to make their systems so robust and highly integrated that any transaction cannot bypass any approvals and any internal control system.”
He adds that there should also be greater controls and punishments for auditors to ensure “they perform their duties more professionally”.
But the industry has expressed concerns, as bankers have become more hesitant to lend after the regulator crack down following the alleged fraud. "Both the government and the central bank have taken a series of measures to tighten the regulatory and supervisory framework with regard to the banks," says Rashesh Shah, the president of the Federation of Indian Chambers of Commerce and Industry, a lobby group.
“Banks have also been directed to identify and deal firmly with wilful defaulters.”
He says he “welcomes and supports” these measures.
“However, at the same time, we are also seeing expression of concern from sections of industry, particularly micro, small and medium sized businesses, about limiting of credit facilities that could affect their business performance and increase costs,” he says.
Mr Shah “urges the government and the RBI that at the current stage of the economic cycle, when we are in a recovery mode, we should ensure that genuine businesses and entrepreneurs are not deprived of the needed liquidity and credit support”.
Just before the PNB scandal broke, the RBI issued new rules stating that if a firm’s debt is not serviced for 180 days, banks have to take action under the insolvency and bankruptcy code to force the company’s sale or liquidation.
Bad debts at India's banks amount to almost $150bn, according to unpublished RBI data reported by Reuters, with state-owned lenders being more affected than their private peers.
Some argue that there are more fundamental problems in the sector and that a far more dramatic overhaul of the banking industry in India needs to happen to reduce its problems. India has 21 public sector banks.
Privatisation and consolidation could be the answer, says Mr Sofat. Privatisation would bring more accountability, he says.
“I think we need to have fewer banks,” says Mr Sofat. “Why do I need to have so many nationalised banks? Why don’t I have just two or three banks as a government, if I want to fulfil the objectives of the country. This concept of having so many banks is one of the key reasons why there is so much mismanagement.”
If this fundamental structure of the entire banking system is not overhauled, he warns “the problems will continue to linger for more time.”