From credit risk to operations risk in banking: Lessons from the diamond heist : Economic Times 21st February 2018

The common angst among bank customers is that every time one wants to get work done through a call centre or net banking, there are a series of passwords and checks that have to be gone through before reaching the destination. There are OTPs which come on mail and phone that have to be entered and only then you can proceed with the transaction — which can be as innocuous as transferring money from your bank account to another bank account which is in your name. With such rigour that has to be adhered to at this rudimentary level, it does come as a surprise that when money instructions are transferred through the guarantee route (the now infamous LoU), things could go through seamlessly within the system without such checks. The recent issue concerning fraud in a PSB branch is significant for several reasons which go beyond the usual umbrage raised when it involves deposit money. This holds in fact for any banking misdemeanour but tends to get blown up when a fraud occurs. First, the incident highlights that systems are not foolproof. In fact, when use of technology was limited in banks, manual intervention ensured that all the requisite approvals were received. Now with operations being automated, systems are efficient, but if they can be hacked or tampered with, tracking is hard as there are a plethora of transactions taking place on a real-time basis. Second, the case is a manifestation of failure of the systems in all concerned banks and not restricted to where it was perpetrated. So, quite clearly, the cog is not just with one bank but with the entire system where such acts went undetected. While the problem was with the use of SWIFT, there could be several such instances of tampering which have not come to light because no one knows that  By Colombia Third, the next question which comes up relates to the audit process. As all banks are audited annually, it is curious that such a fraud could not be detected for almost 7 years. Hence, there is a challenge of strengthening these processes as there could be other areas where such frauds may be residing in the system. While it is easy to blame the auditors, the fact remains that no system is perfect and there would always be lacunae as 100% audit of all operations is not possible. The message here is that we need to move towards the ideal situation as fast as possible. Fourth, the banking system now seems to be enmeshed in a peculiar situation where the worry has gotten deflected from credit risk to operations risk. The NPA brouhaha was caused due to failure in assessing credit risk, which has now snowballed to this dimension where funds are not available to make the system resilient. Now, banks would need to focus simultaneously on risk from fraud. Fifth, given that public sector banks are involved in this episode, the responsibility of reinstalling faith falls on the government. Depending on what the final amount is, the banking system has to make such provisions from internal resources, if they exist. Several banks are already afflicted with falling net worth, which means that they may not have the wherewithal to pay for this loss. In this case, the government has to step in and provide the capital once again. This is becoming progressively more onerous for the government, which has already stretched the band artificially through the recap bonds. Sixth, the present episode quite definitely makes a mockery of the idea mooted earlier in the FRDI Bill. Any such move towards shifting the responsibility of bank performance to deposit holders is quite meaningless because of the asymmetric information between banks and deposit holders. The latter do not know how good  Service At present, the only assurance that deposit holders have is that the RBI has never let a bank fail in the private sector and it is implicitly assumed that all PSBs are as good as the government. Therefore, the resolution of the present crisis is a litmus test for the faith people have in the government support for these banks. As a corollary, it may be expected that the banks will not be allowed to go down under. A broader question worth pondering over is what happens when all PSBs are privatised and such a fraud occurs. Who bears the cost then?