Its not the politics – STUPID !!

Its not the politics – STUPID !!

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The PNB case could well have become an inspiration for the 1975 Arthur Hailey best seller “The Money Changers”…………

However, as it always happens, it has all been reduced into one big political bun fight; which I fear will take the focus away from serious independent investigations culminating into a plan for taking measures to ensure that, such frauds don’t recur.

Which is the reason I wont even go near the resignation of an independent director, the loss of tax payers money, the fiscal burden it will cause and the loss of stock market valuations.

Most disturbing to me is – I believe its really a major egg on face situation for the Country’s financial sector.

Why? Because it has shown the whole world the gaping holes in its internal controls and the ineffectiveness of our audit mechanisms. It has now given all of them a chance to ask – If the Country’s second largest bank is so unprotected, what would be the situation with the so called “weaker” banks?

SWIFTLY into disaster : The RBI seems to have done its job by passing a couple of “fatwas” but where was the follow up through inspections and audits?

The banks are almost constantly subjected to one audit or the other. Statutory, Internal, concurrent, RBI inspections, and so on.

How come no one has brought out these numerous reports to ascertain if there has (ever) been any comment made and if yes, was it resolved before the next audit cycle began?

If I still recall correctly, bank statutory audits were conducted ‘top down’ loosely called ‘balance sheet audits’ and what this meant was that, a huge amount of reliance was placed by the statutory auditors on the quality of the internal operational controls, internal audits and overall compliance mechanisms. .

Well, if this were so, there should have been strictures passed by the auditors every year when the Bank conducted business without SWIFT connectivity to its “Core banking” system. Especially considering the RBI has been giving directions on this.

The single biggest advantage of ‘core banking systems’ is their ability to centralize most communication gateways, codes / keys, checks, proofs, reconciliations and take them out of reach of the transacting offices and their staff.

The SWIFT messages get coded by the system, later the transaction gets independently verified again before being set loose. More importantly, the Bank’s SWIFT keys should be lodged in the head office – away from every one, in the personal custody of the highest possible level of executives (like the ‘nuclear button’) to ensure they are kept protected. Any change to SWIFT keys on the systems, has to be done only and personally by these senior people.

The remittance instructions generated by the core banking system, get reconciled with the outgoing SWIFT file by the system!!

Its ridiculous to see these banks conducting coding of transactions and also reconciling them manually on site branches, decentralized, in this day and age when most reputed banking software provides these software interfaces.

During the heady days just before the Harshad Mehta scam hit the fan, I vividly recall being jubilantly told by the treasury head of one of the banks (which eventually paid a heavy price for its weak internal controls) that, they had made “record all time high profits, after he had taken charge and he had elevated his entire team one grade up”. On being asked“what had changed so much since the last time we met less than a year ago?” He arrogantly retorted “Why worry when the income rises, I only look when costs go up”.

That’s the next big thing missed in this case too!

No one bothered to check where the “Fee Income” (was it Rs 200 crores over past 6 years from 1 client?) was coming from because, no one must have felt it necessary to “reconcile” the Fees with the Contingent Assets/Liability accounting entries!

If they had done it, the game would have been up long time ago.

In cases of these “LOU”s (Letters of Undertaking, which I was surprised are still being issued!) the lending bank is most likely to pay the borrower through the LOU issuing bank branch. In which case, PNB’s Nostro Account (its foreign currency account) would see a debit and a matching equivalent credit.

I can visualize this being treated as a “set-off” item in the reconciliation; which too could well have been conducted in that same branch (which issued the unauthorized and unaccounted LOU, sent out the SWIFT message confirming the LOU and also made the remittance of money from their Nostro to the borrower’s account). No red lights went off naturally because, there were no nostro reconciliation outstanding!

“Handing over end to end control over any transaction to a person or a group of persons in the same location” is possibly the greatest internal control sin one could commit as a banker.

And, this should have been thrown up in the internal controls / operations process review conducted by at least one, if not all the numerous auditors running a muck  around in that bank and that should have set off the fire alarms!

However, the real challenge at the root of all this is that, when most of these banks shifted to “core banking systems”, instead of re-engineering their organisation to take full advantage of this system’s capabilities; they ended up changing the system to replicate their manual processes. Basically, they merely reduced it into a higher version of their calculators!

I believe, the reason for not going in for “re-engineering” is the vested interests which benefit from the status quo.

The senior management is not up to speed with technology and wants to carry on its “fatwa management style”. (Its not rare to see senior executives handing over their system passwords to some “trusted” junior, who is expected to print out the emails for them and “system authorize” transactions based on “initialed emails”!).

Also “re-engineering” the organisation to centralize the access to SWIFT infrastructure; breaking the lending functions into “independent silos” for sales, credit policy formation & approval, credit operations and collections; will upset the “Regional – Zonal -City and branch managers” because they will be rendered “power less”.

It is the unbridled power to hand out loans which feeds their status!

Centralized and independent silos although highly effective in curtailing end to end control on the entire loan transaction – as one can imagine will make “flexibility” (read graft?) considerably more difficult and may therefore be opposed tooth and nail by all irrespective of their station.

Finally, it should be said that, nothing of which I have said above is really any genius rocket science – because, it was all functioning most effectively in the banks I worked in, well over a decade ago!

There are many in India’s private sector banks and IT companies who can be drawn in to assist those in the public sector banks to re-engineer themselves.

Of course that is, if we can all keep aside our biases and vested interests – as things stand today, that may well be the most utopian ask!!


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