CAG seeks auditing of regulators like RBI

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In a rare public appearance on Friday, the Comptroller and Auditor General of India (CAG) Shashi Kant Sharma added a new dimension to the ongoing debate on the Reserve Bank of India (RBI) and the banking system in general.

Delivering the keynote address at a conference on Financial and Corporate Frauds organised by industry body Assocham in New Delhi, Sharma said there was a need to consider CAG audit for financial regulators like the RBI. He also said that a significant portion of what is being recognised as bad loans may have been transferred abroad and may never get recovered.
Though a proposal on potential audit of RBI was floated in the past, CAG’s observations assume significance as they have come at a time when the banking sector is reeling under severe stress and the government is in the process of selecting a new RBI governor.

Sharma, who completed three years as the national auditor in May, referred to the way advanced markets such the US and the UK have dealt with the issue. “The examples (of US & UK) cite the moves being made to bring forth more accountability and transparency on the financial sector regulators. In India, the CAG doesn’t audit the RBI, whose auditors are appointed by the central government under the provisions of the RBI Act. In the light of the growing incidents of financial frauds, this is a thought for consideration. Our audits should look into the risks and vulnerabilities facing our financial sector as well as the ability and effectiveness of regulators to mitigate such risks,” he said.

The emerging international trend of oversight of the regulators, in order to provide a higher level of assurance, is an interesting development that must be watched to inform our own system of oversight and assurance, said Sharma.

Industry reacted cautiously to the idea. Devamalya Dey, group president – audit & management governance, Yes Bank, said, “It is a thought-provoking idea. It will be debated and discussed over a period of time, how we should go about it.”

The 12th CAG of the country explained how advanced financial systems such as the US and the UK are moving towards closer scrutiny of non-monetary policy functions of their central banks. “In the US the GAO (Government Accountability Office) (counterpart of CAG in India) didn’t audit the Fed till 1978; post-78 it was allowed to review the Fed’s regulatory duties in the payment system, but was still prohibited from reviewing the deliberations, decisions and actions on monetary policy. But soon after 2009, the year of the financial crisis, the US Congress allowed the GAO to audit loans made by the fed to individual companies,” the CAG said. After 2012, it was further allowed to review Fed’s internal controls, policy on collateral, use of contractors and other activities, whilst still keeping the monetary policy outside its ambit. Presently, he said, there was an ongoing debate of allowing the GAO to conduct a full-scale audit of the Fed’s activities and regulatory structure.

In the UK, the Bank of England has historically been outside the ambit of the auditing institution, the NAO (National Audit Office). However, a recent law mandates that the Bank of England should consult the Comptroller while appointing its auditors. This provides the Comptroller access to documents related to audit of the bank. The new law also authorises the comptroller and auditor general to carry out examinations into the economy, efficiency and effectiveness with which the bank has used its resources in discharging its functions.

Speaking about the stressed assets issue, the CAG said in recent times, a lot of attention has been given to frauds committed against banks, especially the public sector banks (PSBs) that are struggling with enormous non-performing assets or NPAs.

“There is a belief that a significant part of NPAs could be amounts fraudulently obtained as advances from the banking system. There is also a belief that a large part of these amounts may have been transferred abroad and may never get recovered,” said Sharma.

Sharma began his address with the recent incident of cyber crime in Bangladesh, which led to the resignation of its central bank governor Atiur Rahman. He spoke about the factors such as increasing technology use, faster communication and complexity of products aiding fraudsters.

“What should be the nature of oversight of the regulators who have such crucial role to play in protecting the financial sector and thereby the public sector from the ill effects of frauds?” he asked.

There should be a comprehensive strategy to deal with them in order to safeguard the integrity of the financial system as well as the enormous public interest, said Sharma.

In a country that is largely financially illiterate, the possibility of fraud is much higher. According to Sharma, promoting financial literacy is a long-term strategy for mitigating this risk. At the same time, the regulators have to work together to not only enhance their capacity to deal with financial frauds, but also to remove any regulatory arbitrage, Sharma said.