Many Indian Banks Faced Penalties In Recent Times, Is This RBI's Move To Avoid Western-Like Crisis?

From last month to the current, many renowned Indian banks have faced penalties from the Reserve Bank of India (RBI) for non-compliance of its directions. The penalties were in crores and for reasons related to lending, deposits and carrying out other businesses. Either be private, public sector or cooperative banks and even including NBFCs, many have been penalised for various reasons. It makes one wonder, could this be a move of RBI to tame bigger problems that could hinder the banking system on a wider scale? The wounds from western banks' failure in early 2023 is still fresh!

Since the start of October to date, some of the big penalties by RBI would be -- Rs 12.19 crore on ICICI Bank, Rs 3.95 crore on Kotak Mahindra Bank, Rs 2.5 crore on L&T Finance, and Rs 1 crore on Union Bank of India last month. Also, Bajaj Finance and RBL Bank have been penalised with Rs 8.50 lakh and Rs 64 lakh respectively. The latest to receive penalties in big banks were Federal Bank (Rs 30 lakh), Punjab National Bank (Rs 72 lakh), and Mercedes-Benz Financial Services (Rs 10 lakh) last week.

Just this week, RBI penalised a couple of co-operative banks as well such as The Limabasi Urban Co-operative Bank, Malpur Nagarik Sahakari Bank, Shree Lodra Nagarik Sahakari Bank, and The Jolarpet Co-operative Urban Bank on November 6th for violating certain RBI rules.

It needs to be noted that RBI's actions is based on deficiencies in regulatory compliance and are not intended to pronounce upon the validity of any transaction or agreement entered into by the companies with its customers. The monetary penalty usually follows after a statutory inspection by RBI, and also after replies to the notice the central bank sends asking for valid reasons for irregularities from these banks and NBFCs.

RBI has the power to penalise banks and NBFCs if it finds non-compliance. However, in recent times, this action has increased drastically.

Shreyansh Shah Research Analyst told GoodReturns that recent penalties by the RBI on banks such as ICICI Bank Kotak Bank and NBFCs like Bajaj Finance are based on deficiencies in regulatory compliance. They are not intended to pronounce upon the validity of any transaction or agreement entered into by the banks with their customers.

However, Shah also pointed out that "We believe after the Western bank crisis, we saw at the start of the calendar year. The Indian central bank wants to ensure that the overall banking sector needs to be prudent in following the compliances set by the regulatory body."

At the start of March, while the world was grappling with higher interest rate cycles and inflationary pressures, the US banking system was in for the greatest crisis since the Great Depression of the 1930s. It started with Silicon Valley Bank in early March this year, and in a matter of the same week, another lender Signature Bank followed suit. Silicon and Signature had assets worth $209 billion and $110.36 billion, and their failure not only sent shockwaves to the financial markets globally but also jeopardized billions of worth depositors' accounts. The uninsured depositors faced a huge blow to their hard-earned savings.

In 2023 alone so far, five banks have failed. Two of them being Silicon and Signature in March between a gap of 2 days on March 10th and March 12th respectively. This was followed by yet another major lender First Republic Bank in May 2023, which surpassed Silicon in becoming the second largest bank failure in American history with a total assets of $232.9 billion. Now, First Republic holds the title of second largest bank failure in the US, followed by Silicon Valley and Signature Bank.

Apart from these major lenders, Heartland Tri-State Bank collapsed in July, and the latest to fail would be Citizens Bank on November 3, 2023.

In the United States, the failure of banks has totalled 5 year-to-date, which comes a zero banking failure for two consecutive years 2021 and 2022 respectively.

It wasn't just the US that was hit, even Switzerland-based global investment bank and financial services firm, Credit Suisse collapsed in March 2023.

The reason behind the failures of these major banks was that many of their reserves including US treasury securities at low interest rates for many years. However, when the US Federal Reserve started to aggressively hike interest rates to tame multi-decadal high inflation between 2022-to-early 2023, this led to a huge decline in bond prices and hence further pulled down the value of these banks reserves, causing the majority of them to incur losses in their books and face illiquidity.

In the latest monetary policy, on November 1, 2023, FOMC led by chair Jerome Powell said, "The U.S. banking system is sound and resilient. Tighter financial and credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks."

Fed kept key rates unchanged for the second time in a row at 5-1/4 to 5-1/2 per cent to achieve inflation at the rate of 2 per cent over the longer run. Fed rates are at a 22-year high.

Just like the Fed, RBI has also increased the key repo rate aggressively between May 2022 to February 2023 by 250 basis points. Last month, RBI decided to hit a pause in the key policy repo rate at 6.5% for the fourth time in a row. RBI aims to achieve inflation at 4% with lower and upper tolerance limits at 2% and 6%. In October policy, RBI was seen on a wait-and-watch mode to gauge the impact of rate hikes on the Indian businesses.

Lastly, Shah added, "Although these penalties are marginal regarding the bank's profitability, we believe that such compliance irregularities by the bank will not be taken as good corporate governance by the market participants. With NIM compressions taking a toll on the industry and intense completion for new deposit acquisition, we believe these may negatively impact the medium term."

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