Sucheta Dalal :Who Pays for RBI's Blunders?
Sucheta Dalal

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Who Pays for RBI's Blunders?  

August 31, 2004

In this article, Ila Patnaik argues that the latest move could make taxpayers pay more for failed banks and RBI’s failed supervision.

Who Pays for RBI’s Blunders?


By Ila Patnaik


The Reserve Bank of India (RBI) has reportedly approached the finance ministry, seeking an amendment to the Income Tax Act. The rule in question is Section 72-A, which deals with how losses may be set off against tax liabilities when a loss-making firm is taken over. RBI wants to make sure that the rules are changed so that public sector banks get these tax rebates.

If the amendment goes through, it will give one more channel for taxpayers to pay for failed banks. The amalgamation of Global Trust Bank (GTB) with Oriental Bank of Commerce (OBC) will then be one more case of taxpayers paying for RBI’s weak regulation.

A banking regulator is required to enforce sound standards for risk management. The best regulations will, however, not prevent some banks from going bust. Hence, the regulator’s second job is to force closure of a weak bank while it is still solvent. In this case, the only ones who get hurt are the shareholders of the weak bank.

Our banking regulator fails on both these requirements. RBI’s rules are riddled with analytical mistakes, where risk is not being measured and controlled correctly. In addition, RBI has always failed to detect and close down failed banks in time.

When the banking regulator fails, there is a choice in the allocation of pain, between depositors and taxpayers. Life is easy for a banking regulator in a country like India, where the government owns banks, since it becomes easy to inflict pain upon taxpayers.

The taxpayer is being asked to pay for GTB’s failure in two ways. First, under the amended rule, GTB’s net losses of Rs 812 crore in 2003-04 and Rs 273 crore in 2002-03 will be set-off on the OBC balance sheet. OBC will then pay less tax to the government. The government will get lower revenues from the banking sector as a result of the amalgamation. There will be no entry in the budget because no expenditure item will be shown. But it will still be a government subsidy.

Second, the government is taking a hit on its balance sheet. On 21st July 2004, five days before the amalgamation of GTB with OBC was announced, OBC’s market cap stood at Rs 5,008 crore. Four weeks later, that was down to Rs 4,481 crore. Thus, OBC’s shareholders took a hit of Rs 527 crore. The biggest shareholder in OBC is the Government of India.

As the owner of 66.5% of OBC, the government took a hit of Rs 350 crore. When we take into account the movement of Nifty over this same period, the more correct estimate of the loss of OBC shareholders works out to Rs 572 crore, of which GoI has borne Rs 380 crore. This hit is hidden from the taxpayer because, unlike in the case of a company, the government does not have a transparent balance sheet. Did the OBC board take into account the interests of its shareholders when it decided to merge with GTB?

Are more bailouts in the offing? Does the RBI want the IT Act amended merely to pay off OBC for taking on Rs 916 crore (as of 31 March 2003) of GTB’s NPAs? Or, is the stage being set for making the taxpayer pay more for future lapses in banking regulation?

A number of PSBs could be made victims of future forced mergers. For instance, the Indian Overseas Bank, Union Bank of India, Bank of Baroda or Allahabad Bank.

These banks could be ‘persuaded’ to take on failed banks with large NPAs because they will then be able to get tax rebates under Section 72, and therefore get the branch network and depositor base of the failed bank for free. Tax payers, who are paying the bill, will be no wiser. The RBI will look wise and noble, having engineered a costless merger and having “saved depositors from losses”.

The MoF should deny RBI’s request about amending the IT Act, even though it sounds like a normal tax treatment of losses. That would give RBI better incentives to do its job, and not dump the costs of its incompetence upon others. And, shareholders of “healthy” banks should worry about such acquisitions being pushed down their throats by RBI in the future.

The original article can be read at:



-- Sucheta Dalal