How central banks Fail
From the Greek fiasco to India’s bank crises – it has been brought to light how freedom without sufficient accountability spawns the bedrock for tragedy.
Donald Trump is one of the most hated politicians in the world dominated by the liberals and commentariats. So, when he said during his presidential campaign that by keeping interest rates low the central banks had been "doing political things'' nobody paid much attention. Those who support the independence of central banks and believe that monetary policy decisions must be kept outside the purview of politicians and elected representatives, do not feel that the Trump's statement is worth mentioning, forget about even discussing. Also, little or no attention is paid to Yanis Varoufakis, the Greek economist who was appointed finance minister during the Greek debt crisis.
When Varoufakis went to negotiate with the European Union for a bailout package, he was rebuffed. Evidently, Germans believed that the Greek crisis was primarily caused by the previous Greek governments' corruption, irresponsible borrowing and inability or unwillingness to collect taxes. They were staunchly unwilling to allow debt restructuring to precede reforms. Austerity was shoved down the throat of the democratic government of Greece – the technocrats of Europe had no sympathy for the people of Greece or its government. Varoufakis failed to use his desired trigger – default to expose the German and French banks so that the technocrats of EU baulked. His government was more keen to stay put in the EU than risk the collective wrath of the rest of Europe. Greece is not the UK, nor could they have a referendum on leaving EU.
Failure of the elected government of Greece to negotiate their terms with the technocrats and the refusal of the EU to rectify its hidden malaise of failure to enforce even policies for all member nations remain unchecked. The only success has been that Greece has slipped out of the news headlines, as pointed out a recent Brookings paper. Greece is not the only country that lost out to the mandarins of the financial world. Nor will it be the last. The lesson from the Greek crisis is that, in "negotiation'' what the owner of the purse says matters. Monetary policies of countries in a globalised economy are based more on what is fashionable and most acceptable to the owner of the purse.
The rise of populism in many countries (including the USA and India) has led to the rise of a school of thought which recommends that politics should be brought back to monetary policy. It may sound inappropriate to the vast fraternity of freedom from populism but the question that cannot be winked at is that monetary policy impacts the lives of people and acts-interacts with the fiscal policy administered by the democratically elected governments. Why, therefore, in a democracy, would monetary policy decisions be left to a bunch of technocrats? The other issue that cannot be brushed aside, more so in the context of India, is what role is entrusted to the technocrats of the central bank (RBI in our case) and how have they been performing? Take, for instance, the role of a central bank as a regulator of the financial sector, banking to be more specific in this context.
The global financial crisis of 2008 had its genesis in unchecked growth of credit instruments arising out of deregulation. In scripting the liberal rule that allowed banks to engage in hedge fund trading with derivatives, there worked a strong lobby which was joined by the US Federal Reserve chairman Allan Greenspan. Thus, a monster was created which worked beyond the realms of banking supervision eventually hurting people across the globe. There had been many financial technocrats like Greenspan in the history of modern finance.
RBI governor Urjit Patel, an accomplished economist who is not known for jumping for media attention, had lamented recently on the lack of the RBI authority to govern the public sector banks. Expressing anger and frustration over the Nirav Modi fraud in Punjab National Bank, Patel claimed that RBI did not have adequate supervisory power over the state-owned banks. This was refuted by the chief economic adviser Arvind Subramanian who put emphasis on taking good decisions as a source of credibility, not legal authority alone. What both Patel and Subramanian missed is the fact that under the Banking Regulation Act read along with nationalisation of banks act, the RBI has enough supervisory authority over the sector – private or state-owned.
Take one example – that is, the use of SWIFT. The Society for Worldwide Interbank Financial Telecommunication (SWIFT) provides a network that enables financial institutions worldwide to send and receive information about financial transactions in a secure, standardised and reliable environment. The majority of international interbank messages use the SWIFT network. SWIFT sends payment orders, which must be settled by correspondent accounts that the institutions have with each other. Once sent through SWIFT, the correspondence bank does not need any other authentication to check the veracity of the message.
When banks use such a system, it does not need any lesson in rocket science to understand that it must ensure checks and balances while authorising its staff to use SWIFT. A primary one is linking every message sent through SWIFT with the bank's daily balance sheet (CBS – core banking system). RBI had dutifully issued guidance on the same to all banks. The fact that in the wake of the PNB scam, RBI had reiterated its instructions and asked banks to ensure the linking of SWIFT with its CBS, illustrates that the RBI did not follow-up with inspection if its earlier instruction was implemented or not. The omission is glaring, since as the central bank, the RBI must ensure the value of the Indian Rupee-exchange rate and, by dismissing SWIFT link with CBS, just as a circular issued without ensuring compliance, the RBI failed to discharge its assigned task. Subramanian is justified in pointing out, though not explicitly, that RBI had failed in using its authority when in 2016 it merely issued a circular on linking SWIFT with CBS but did not follow it up with an inspection. One must, however, appreciate Governor Patel that he did not pass on the blame to his predecessor Raghuram Rajan who should have followed up on the circular.
Those who join the cacophony of independence of the central bank, more so in India, are more interested in quizzing the top brass of RBI, on inflation targeting and how fiscal policy had been hurting the task. The dissenting voices asking for higher interest rates get undue limelight without link with the macroeconomic objective. Scribes, after all, are responsible for good copies which necessitate headlines against populism. The point missed in the process is that populism is nothing but the choice of the majority at that point in time. Technocrats in RBI too fall for this anti-populism trap.
Time and again, we have seen the deputy governor looking after the department of banking operations (DBOD), delivering sermons but not following it up with action on ground. For instance, the then deputy governor SS Mundra, in January 2017, had said, "There is an increasing trend in incidents pertaining to the theft of personal information, abuse of ATMs and Distributed Denial of Service (DDoS) attacks on various banks. We have already witnessed an attempt to defraud a bank by abusing the SWIFT messaging system, which thankfully could be salvaged post-event without any apparent monetary loss. We also continue to receive information on several other cyber incidents – be it ransomware attack, ATM/Debit card incident or unauthorised access to bank servers. Phishing/Vishing also continue to haunt bank customers with such attacks becoming more and more sophisticated.'' He had also mentioned the Bangladesh Bank Robbery of 2016.
A brief outline of the Bangladesh case will help us understand the gravity of SWIFT misuse. The incident, took place in February 2016, when instructions to fraudulently withdraw USD one billion from the account of Bangladesh Bank, the central bank of Bangladesh, at the Federal Reserve Bank of New York were issued via the SWIFT network. Five transactions issued by security hackers, worth USD 101 million and withdrawn from Bangladesh Bank's account at the Federal Reserve Bank of New York, succeeded. The Federal Reserve Bank of New York blocked the remaining thirty transactions, amounting to USD 850 million, at the request of Bangladesh Bank.
The very fact that Mundra mentioned this incident and was also well aware of the attempted forgery through SWIFT in January 2017, brings one to the sad state of banking supervision by RBI. Despite its knowledge, the central bank did not care to check if its instruction on SWIFT usage had been implemented in letter and spirit by banks in India. It may escape the attention of scribes reporting daily but it is disheartening that the commentariat too never cared to check the omission and point out the failure of RBI in banking supervision. Seen from this background, one cannot help but dismiss the comments of Urjit Patel on the lack of authority as a diversionary tactic to exonerate RBI of its errors and omissions.
The high-handedness of EU banks in dealing with the Greek crisis, the failure of RBI in performing its assigned task of supervising banks in India (accumulation of bad debt too is a result of same sloppy supervision – but that is another story) and the agility of the commentariat in defending technocrats with no accountability, all compels one to accept that central banks – in USA, EU or in India – act more for a rigid theory than for the people who get affected. The elected representatives take decisions which are subject to review by the electorate every few years, while the technocrats in central banks retire and enjoy their high-paying lecture circuits. A retired central bank technocrat will receive more headlines than an analyst pointing out the failure of RBI in discharging its duty on SWIFT. Facts can take a backseat in the days of headline hunting instant judgment days. The economist turned Greece Finance Minister Varoufakis will merely end up lamenting that, "The worst slavery is that of indoctrinated happy morons who adore their chains and cannot wait to thank their masters for the joy of their subservience.''
(Sugato Hazra is a senior PR professional)