RBI rules on opening current accounts have operational and regulatory issues
Some bank borrowers went to court and demanded that it be canceled Reserve Bank of India (RBI) circular dated 6th August, 2020 Feather opening current accounts. RBI has since The date of compliance has been extended till October 31, 2021.
Diversion of funds for large non-performing assets (NPAs) is a major reason. The internal diversion is for non-priority purposes such as limousines, luxurious offices and vanity acquisitions of companies. Funds can also be diverted to other firms owned or controlled by the same group, friends or relatives. The first is the result of misguided strategies or confused priorities. The second is intended to defraud lenders, other creditors and non-controlling shareholders.
Current accounts of non-lending banks are an important channel for diversion. To prevent this, RBI mandates No Objection Certificate (NOC) from the lending banks before opening such accounts. Banks should verify with CRILC, RBI credit database and inform the lenders. Banks should also obtain a No Objection Certificate from the drawee bank for opening an account through cheque.
regulation
The intent of the impugned circular dated 6th August, 2020 is infallible. Widespread non-compliance of mandatory safeguards forced the RBI to bar non-lending banks from opening current accounts for large borrowers. Thus, if the borrowing is through cash credit or overdraft account, no bank can open a current account.
If a borrower does not have a cash credit or overdraft account, a current account can be opened subject to restrictions. If the bank’s exposure is less than 10% of the total borrowings, the account can be debited only for transfers to the accounts of a specified bank.
If the total borrowing is ₹50 crore or more, there should be an escrow mechanism managed by a bank that alone can open a current account. Other lending banks may open ‘collection accounts’ from which funds will be transferred to an escrow account from time to time.
Lending banks can open current accounts if the loan is between ₹5 crore to ₹50 crore. Non-lending banks can open collection accounts. Non-lending banks can also open current accounts if the borrowing is less than ₹5 crore. Working capital loans should be divided into loan and cash credit components at different bank levels.
operational issues
The rules cover a number of operational issues. First, if a borrower has an overdraft, how can one not have a current account? An overdraft is a right to overdraft in a current account up to a limit. Without a limit, a banker can allow a temporary overdraft.
The second issue is that circularity shuts down such operational flexibility.
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Third, why should a bank with less exposure transfer funds to another bank when it can use it to set off other dues?
Fourth, the share in borrowings is not fixed. Threshold crossing can often happen both ways. It can be seasonal or monthly with salary payment or collection of dues. Nor are they smooth curves. Huge lump sum payments or with large export proceeds.
Fifth, there is a mismatch between what the borrower needs and what the regulations allow. Support of non-lending banks through current accounts in other banks is essential for large accounts. The circular rules out this possibility. But such support is available when the exposure is less than ₹5 crore, when it is not required.
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Sixth, transactions in an active current account enable a bank to monitor the borrower’s account, no matter how small. The lack of such controls led to the creation of large NPAs by large development financial institutions.
Seventh, the regulation mandates the division of working capital into loan and cash credit components in all banks. Such one-size-fits-all regulation doesn’t factor into the purpose of the various facilities. A large company can avail loan in Mumbai, but needs to have current accounts with any other bank in Assam where it may have a factory. Procrustean controls add cost with no concomitant benefit.
There are other regulatory issues. First, regulation based more on principles that focus on outcomes than on the content of the rules is more effective than just compliance with the rules. The rules are not flexible, do not provide for unforeseen circumstances, and can be easily circumvented. Second, the regulation needs to use more general terms. Terms like working capital term loan can have different meanings in different banks. Third, should the regulation be designed to target exceptional events such as diversion of funds, and bear the cost to the entire system? Isn’t it better to leave the management of such extraordinary risks to the banks? Fourth, shouldn’t the costs of regulation be justified by the benefits? Finally, is more regulation the answer to non-compliance?
implications for compliance
There are also implications for compliance. When regulation ignores market practices, it lacks legitimacy, a construction from neo-institutionalist literature. When legitimacy is lacking, compliance suffers. Regulatory bodies will resort to what the literature calls cosmetic or constructive compliance.
Thus, a new banking practice of overdraft in fixed deposits has emerged. Another form of constructive compliance may involve approving unnecessary unfunded limits to artificially inflate risk. A bank can only overdraft by changing the name of current accounts, as there is no bar on maintaining credit balance in the overdraft account. All this will have the counter-intuitive effect of weakening rather than strengthening credit discipline.
Yes. Sreekumar is a former central banker
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