Non-Compliance of RBI Guidelines

The need for a robust and effective monitoring regime

In the wake of Paytm Payment Bank failure towards noncompliance of RBI guidelines, yet another incident has been reported pertaining to RBI crack down on JM Financial Products from financing against shares and debentures including sanctioning and disbursing loans against initial public offerings (IPOs) of shares and subscriptions to debentures on account of serious concerns regarding compliance of regulatory authorities’ guidelines. In spite of penalties being imposed on banks and financial institutions regulated by RBI, noncompliance of RBI guidelinesis going on unabated. RBI has observed that regulated entities have not yet taken seriously to comply with RBI guidelines which forced RBI to observe and admit,“The compliance function in banks however, has not received the required attention by banks, as a number of instances of non-compliance and lack of proper interpretation of regulatory guidelines are being reported in successive RBI inspection reports. Further, in the absence of a comprehensive compliance structure, policy and manual for addressing compliance risk in most of the banks, compliance processes remain weak and the role of the Compliance Officer has not been an effective instrument for which it was created.”

Reserve Bank of India (RBI) has made certain observations with regard to the financial stress being built up in the financial system which may affect the growth adversely in the coming years.Increase in cost of funds, likelihood of deteriorating asset quality concerns particularly about unsecured retail loans and upward tends in the operational costs are anticipated in the coming years and RBI has advised the banks and financial institutions to take preventive measures to arrest any adverse impact on the growth of the financial sector. RBI has already instructed the financial institutions to increase the risk weights with respect to consumer credits exposure of commercial banks by 25% to 125% and asks the NBFCs and banks to strength internal surveillance mechanisms.Further, credit card receivables of scheduled commercial banks, which attract a risk weight of 125%, has been enhanced to 150% while NBFCs’ risk weights have been hiked by 25% to 125%. RBI has advised the regulated entities to take appropriate board-approved policies to put in place to prevent any adverse features in the future on account of the envisaged impact on the financial sector. The regulated entities who are expected to take such steps are warned to comply with the regulatory warning.

In this connection Goldman Sachs noted, “We believe the proverbial Goldilocks period-strong growth and strong / visible profitability – is over for the financial sector in the near term as headwinds are increasing.”

Two pertinent questions are to be answered of which one is how effective is the compliance of regulatory instructions given by RBI by the regulated entities and the other is what are the draw backs found in the implementation of supervisory functions carried out by the regulatory entities.  In either case, noncompliance of regulatory guidelines and instructions has far more ramifications on the financial sector and also economy and national security via money laundering, triggering concern about data privacy andsharing of data. Yet another very important grey area is in the matter of credit monitoring by the regulated entities. Compliance of regulatory instructions are an integral part of credit monitoring and not to be treated in an isolated activity. Credit monitoring is not a onetime affair but a continuous concerted commitment without complacency and neglect to prevent the account being declared as NPA. But the way RBI is penalising the regulated entities for non-compliance of RBI guidelines and notifications, it is obvious that they are becoming habitual offenders.

RBI issued comprehensive instructions from time to time to the regulated entities to effectively undertake compliance programming and about the consequences of noncompliance in detail including penalties to be imposed on account noncompliance. The reality is that in spite of being penalising heavily towards noncompliance of regulatory entities notifications, noncompliance galore unabated which means that imposing severe monetary punishment is not a deterrent solution to noncompliance. The reason for this state of affair is that the penalties imposed on the regulated entities are to be paid by them out of their public funds and the perpetrators are allowed to go with impunity. That raises a moral question whether is it justifiable as to public funds being paid towards the wrong doings by the wrong-doers?  Therefore, it is imperative that alternate deterrents are to be found out to arrest the existing trend. 

As per Banking Regulation Act the Reserve Bank of India has been empowered to inspect and supervise the regulated entities for which the following steps are to be undertaken.

1. On site inspection.
2. Off-site monitoring.
3. Corporate governance.

Besides, RBI has taken several other supervisory policy initiatives to commensurate with the banking sector reforms in India and “the global focus on internal control and supervisory mechanisms, the need for building a strong and efficient banking system comparable to international standards cannot be gainsaid.” In spite of taking all necessary steps to eliminate any shortfalls, grey areas are still existing denting the effectiveness of the RBI supervision of the regulated entities. Therefore, further studies are to be initiated to undertake course corrections for plugging the loopholes found in the system for effective compliance functions of the regulated entities. Unless stringent preventive   measures are taken, the efficacy of the preventive measures could not be ensured.

The regulated entities are to be brought under strict and constant monitoring by their own audit departments and also independent outsourced auditors monitored by the respective departments duly reporting to the Board of the regulated entities. Therefore, audit department and the competent and trained auditors have a specific and important role to play under compliance portfolio of the regulated entities. In the ultimate analysis unless a robust and stringent auditing and monitoring system and procedures are put in place, the remedy to prevent such contraventions will continue unabated for which the Board of Directors of the regulated entities are also responsible.