Twenty years after he returned from “one of the highest parts of the Kaatskill mountains”, Rip van Winkle found that his entire village had changed. Most of the people he had known, including his hen-pecking wife, had died or gone away. The people dressed and behaved differently.
As Washington Irving wrote in his short story, “The very village was altered; it was larger and more populous.” The author gravely added, “His mind now misgave him; he began to doubt whether both he and the world around him were not bewitched.”
Almost five decades after Indira Gandhi nationalised 14 banks on July 19, 1969, the then van Winkles of the banking sector would feel the same if they were still alive. In many ways, the Indian financial institutions, including the state-owned ones, have transformed. Technology, including computerization, has magically, and bewitchingly, made them bigger, seemingly-better, and probably more efficient. They can possibly claim that they can compete with the best in the world. online banking, ATMs, plastic cards, digital payments, and cash-less transactions are the new buzzwords.
Yet in many ways, the fictional Rip found that life was still the same. The younger lazy Winkle, who had the “disposition to attend to anything else but his own business”, found that he could continue in the same way two decades later. “Having nothing to do at home, and being arrived at that happy age when a man can be idle with impunity, he took his place once more on the bench at the inn door, and was reverenced as one of the patriarchs of the village, and a chronicle of the old times ‘before the war’.” The 20year intoxicated sleep changed nothing.
So is the case with the Indian banking sector. The crony nexus between politicians and capitalists continues. Either under pressure, or for their own greed, bank officials grease the corporate machinery, and reward the rich with ill-gotten money in the form of loans that either remain unpaid, and turn bad, or are extended without adequate collateral and become non-performing assets. Technology, thanks to human intervention, can be manipulated as easily as typed and written files, ledgers, and notes. In fact, technology can ease the process.
The latest case of Nirav Modi, his successful scheme to scam Punjab National Bank of Rs 11,000 crore or Rs 22,000 crore, whatever the amount may turn out to be, and his arrogance to refuse to settle, are symptomatic of what happened to Rip van, Winkle. Five decades ago, banks were nationalised to save them; over 25 years ago, they were liberalised to save them. The result: Indian banks are as much under threat, pressure, and scandals as before. Maybe more so! Politicians, industrialists and corrupt bankers have treated them as their personal tizoris.
Greed is invariably good
In the seminal Michael Douglas starred Hollywood movie, Wall Street, the protagonist, Gordon Gekko, the corporate raider, announces, “The point is, ladies and gentlemen, that greed, for lack of a better word, is good. Greed is right. Greed works. Greek clarifies, cuts through, and captures the essence of the evolutionary spirit. Greed, in all its forms, greed for life, for money, for love, knowledge, has marked the upward surge in mankind and greed, you mark my words... (will save the) malfunctioning corporation called the USA.” For most sections in most societies, as also in India, greed has invaded the grey and black cells of its citizens in the most bizarre and corrupt ways. The individual changes – she may be rich, poor or middle class – but her desires and objectives are psychopathic and focussed. A Vijay Mallya may be replaced by a Nirav Modi. A midlevel banker, like Gokulnath Shetty, who retired from PNB and is claimed to be the mastermind of the latest scam, may emerge at regular intervals. But they are obsessed with a single-most overriding sin, greed. The case for modern greed, in its most logical and luscious sense, was made by economist Adam Smith just under 250 years ago. He wrote, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” Sadly, most of Smith’s followers misunderstood this concept of individual self-interest, i.e. the ability to work for and think of oneself, as greed, i.e. the brazen attempt to collect a material wealth of unlimited proportion and to show it in an opulent manner.
Instead, Smith’s supporters claim that the economist wasn’t a “laissez-faire, Darwinian capitalist”. What he said was an observation, a realistic assessment of human nature, and not an endorsement of it. It’s like if a human being is saddled and gravelled with the seven sins, it is the truth, and not an argument to pursue them without checks, balances and responsibilities. His ‘economic’ assessment needs to be married with his views on morality and ethics. His core message was, “Capitalism is dependent upon, and therefore nurtures, honesty and benevolence.” But, as is true with concepts, the ideas of morality were weaned away, and what remained was a blackened, barefaced, and audacious greed in its most devilish form. As they entered the gates of modern hell, quite like Dante’s one, people abandoned “hopes” of a better society, “suspicion” about what’s right and wrong, and “cowardice” about what others would say or feel. It was the new evolutionary Darwinian world, where survival of the fittest meant survival of the richest, wealthiest and most powerful. As Dante wrote, “We to the place have come, where I have told thee, Thou shalt behold the people dolorous, Who have foregone the good of intellect.”
So, people madly ran after money, amassed them in quantities when numbers became mind-numbing and spent it in an unashamed manner. The same was true for a Modi, Mallya or Shetty. In recent times, the exposes under Panama Papers and Paradise Papers proved this unending, limitless and crazy love for money. They weren’t scared of the consequences for several reasons. one, they felt that in India they won’t get caught. Two, if they got caught they could bribe their way out, and escape the clutches of the law. Three, they could simply run away to another country. Four, it would take decades, if not centuries for the cases to come to fruition.
Tom Wolfe introduced characters dubbed ‘Masters of the universe’ in his book, The Bonfire of the vanities, who were essentially young, rich people on Wall Street. After the Financial crisis of 2008, he wrote, “Most of the young Masters already have their own personal nut free and clear. ‘Nut’ is the term for the amount of money you need salted away to live comfortably... in an enchanting European style... in a house... big enough to be called a manor. Every Master of the universe knows the number.” Even the Indians are well aware of it.
GULP THE WEALTH DOWN
Thousands of years ago, an Indian philosopher said that if someone put honey on the tongue of a person, the latter can only swallow it. It implied if easy opportunities existed to milk the system, line one’s pockets with cash, and fool the society, people will wantonly pursue them to the hilt. The quantum of money that’s amassed doesn’t matter; opportunities beget more efforts, which create more opportunities. And the cycle goes on! Like a successful Ponzi Scheme, there’s no end to it unless, of course, an insider pulls the plug, deliberately or inadvertently.
In the case of Nirav Modi, the chances to siphon off money, partly-legitimately, was ingrained in the technology and practice. The system was simple: businesspersons, especially global traders, required credit to make overseas payments. This was established through a fixed limit by the parent bank, which could issue bank guarantees of varying forms, including Letter of undertaking (Lou). The Lou allowed the business entity to borrow money from another bank abroad. It was obviously backed by collateral, mainly cash in the borrower’s account with the issuing bank.
However, in PNB’s system, the “sums transmitted via this mechanism” were not “matched routinely with the Core Banking System accounts”. In effect, “the two systems were running in parallel without anyone bothering to check if the numbers of one could be reconciled with the others”. In addition, the password to use the system for credit was shared with Nirav Modi’s employees. It was no easy to bypass the main system, and borrow money randomly and openly from the branches of other banks through PNB’s Lous without collateral. There was no limit to it. The scam was unearthed only when a banking insider bothered to check. PNB’s Brady House branch in Mumbai found that Nirav Modi’s companies had no sanctioned limit for the Lous and, hence, insisted on 100% cash margins. When confronted with the argument that this was done before without any margins, the bank found no records. It was out in the open. Decentralisation of the procedures and systems led to loose ends, which were swiftly clipped, and abused by fraudulent bankers and businesspersons to exploit the banking system.
It was the same with the bad loans and wilful defaulters in the recent past. The bankers, who sat on the boards of companies as directors, who routinely and carefully looked at the numbers, and knew what was in store in the future, willfully allowed a free hand to the defaulters. While it can be argued that some companies went kaput because of radical changes in the internal or external environment, say a huge fall in prices, the bankers were in a position to gauge the situation. Yet, they allowed the situations to linger, gave free ropes to the borrowers.
REGULATORS CAUGHT NAPPING
There are generally two types of regulators in any sector, especially finance. They come either in the form of foxes to stand guard against the chickens, or as chickens, dressed as oversized fowls, to guard the foxes. This was beautifully described in the 1990s book, Eagle on the Street, written by David vise and Steve Coll.
In reality, the manner in which the regulators and regulated are pictured depends on whose taking the photographs or describing them. The truth remains that in any period, the regulators need to figure out if they wish to act and behave as economists, as positivists, or as policemen, and negativists. Ever since the liberalisation days, the Reserve Bank of India (RBI) proved that it wasn’t capable of being either. In fact, the central bank vacillated as it ran around like a headless chicken to react to events.
on the Nirav Modi issue, the RBI claims that it issued several notifications and clarifications to the banks to act in the ‘right’ manner. The banks decided to shut their eyes and ears and, hence, the central bank could do nothing. This, in some ways, is an abdication of regulation. It’s akin to the police that issued warnings to people to keep their homes and offices protected and, hence, said that it wasn’t responsible for the robberies and burglaries. The central bank maintained that it had put in place policies and decisions to manage the situation. But this was after the horses had bolted the loan stables. A good central bank needs to be alert to situations that can go out of hand, and intervene at the ‘right’ moment. So is the case with banks and policymakers. All of them need to be active, rather than late-reactive.
As a review of the vise-Coll book rightly commented that “a heavier, more threatening hand (of the stock market regulator)... might have worked wonders in encouraging private sector self-restraint. Punishment and incarcerations are very effective deterrents among people in pinstripes.” But, as we have witnessed numerous times in this country, these are tools that are rarely, if ever, used against the errant individuals. In the end, greed turns out to be good.
WHAT NOW FROM HERE?
To tackle the Nirav Modi crisis, there is a Standard Operating Procedure (SOP), which is followed each time there is a financial scam. The most visible assets of the perpetrators, if there are any, are impounded and frozen. In this case, the investigators have taken over the dozens of vehicles, diamonds, and bank accounts of the various fraudulent entities. In most cases, such assets form a minuscule portion of the money that’s siphoned off; in some cases, the value is less than 1%. In due course, the bigger assets are pinpointed, and frozen. With new laws in place, they will be auctioned over the next few years, only if all goes well. at the same time, as the Modi-Mallya cases have proved, the scamsters run away to global havens, and it is a long drawn-out task for the government to extradite them. Lalit Modi of the BCCI fame has still not been returned, despite a decade. Mallya is fighting the case in Uk courts, and so will Nirav. In the meantime, the policymakers and regulators will wake up from their slumbers, and act as if they are the most vigilant. They will formulate new laws, rules and policies. They will then maintain that they have solved the problems, and future scandals of this nature will not happen. The operative part if of “this nature”; frauds of similar kinds, and other forms, will surface in the near future, as they normally do.
2008, AND THEREAFTER
Naked greed, in its purest fantastical form, was responsible for the Financial Crisis of 2008. It began with the mortgages in the housing sector in the US. Flushed with cash, the lenders decided to dole out money to borrowers, who were least likely to pay it back, in case of any crisis. The logic to do so was thought up by the mathematicians, some of them who were renowned and winners of the Noble Prize. They argued that if such so-called ‘sub-prime’ mortgages were unrelated to each other, they could be pooled together to reduce their risks considerably.
Theoretically, it was a near-perfect strategy. The housing markets within the US, in the various cities, were technically nonrelated. They would rise and fall independently of each other. There was little cause to worry that they would all fall, alarmingly and at the same rate, at the same time. Thus, these pools, if they included sufficiently large numbers of mortgages, would be safe – some of them would default, most would pay, and life would be normal. The problem arose when the entire country’s housing market collapsed in 2006, and continued to do so.experts feel that the contagion could be restricted. But the financiers had gone several steps further. To distribute risks among further entities, and globally, the pooled mortgages were used as back-ups and collaterals for even higher risk instruments called collateralized debt obligations (CDOs). The latter were sliced into ‘bits’ to reduce overall risks, backed by high credit rating, and farmed out to financial entities across the globe. The buyers gobbled them readily because of their safe nature, and high returns. Greed beget greed beget greed.
As the value of the pooled mortgages crashed, as the value of the slices of CDOs became completely uncertain, the owners of the latter looked for buyers, who were non-existent. They were forced to suddenly write down the values of the instruments, based on the expected market prices, which were way lower than what they had been. Global entities, from the largest and most powerful, to the smallest took the hits. In this case, the bigger ones, unlike conventional wisdom that they were too big to fail, were too big and certain to fail. They did, like nine pins, one by one
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