Kotak crackdown: The 'Regulatory Bank of India' is taking no chances

Stick to the regulatory lanes or suffer the punitive hammer. This is the message of the Reserve Bank of India (RBI) as it begins to take its regulatory role much more seriously. It has read the riot act to the banking industry with some of its recent actions, which many see as unduly harsh: The tough action by the RBI against Kotak Mahindra Bank shows the central bank is in no mood to be taken lightly.

For two consecutive years, the bank was assessed to be deficient in its IT risk and information security governance, the RBI said. During subsequent assessments, it was non-compliant with corrective action plans issued by the RBI in 2022 and 2023. The compliance statements submitted by the bank were inadequate, incorrect or not sustained. Consequently, the RBI barred Kotak Mahindra Bank from signing up new customers through its online and mobile banking channels, and issuing fresh credit cards, among the toughest curbs imposed on a scheduled bank.

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The RBI is taking its regulatory role seriously

The action against Kotak Mahindra Bank reminds of the recent crackdown on Paytm Payments Bank which too had been ignoring to comply with the RBI's norms for a long time. For quite some time now, the central bank is taking its regulatory role seriously. With a series of strict punitive actions, since 2020 when it struck at HDFC Bank, it has sent a loud message to banks and other regulated entities to not to trifle with its regulations.

Also Read: Kotak Mahindra Bank is the latest student in RBI's classroom

After the RBI was criticised for long for its soft approach, it decided to replace kid gloves with boxing gloves. In 2011, when scores of companies complained to the RBI that they lost hundreds of crores of rupees in currency derivatives manipulatively sold by banks, the central bank slapped the lenders with penalties in the range of just Rs 5-15 lakh. But last month, when the regulator found IIFL Finance Ltd in violation of its guidelines on gold loans, it ordered the company to shutter the business. “RBI’s penalties used to be in lakhs or a few crores of rupees,” R Gandhi, former deputy governor of the RBI, had told ET last month. “There was criticism that it was not pinching enough to make them take corrective actions. When transgressions are systemic than transactional, it’s not a few transactions that need correction rather a procedure itself. Now the principle seems to be substantive penalties which will bring desired behavioral change. The message is: until you correct, you can’t grow.”

The clear shift in the RBI's approach became visible in 2020 when it told HDFC Bank to temporarily stop all digital launches and sourcing of new credit card customers after the bank suffered its third big outage in the span of just two years. In October last year, the RBI banned Bank of Baroda from onboarding any new customers onto its ‘bob World’ mobile application after reports of the bank linking accounts to unregistered mobile numbers and signing up these numbers to the application. In November last year, the RBI directed Bajaj Finance Limited to stop the sanction and disbursal of loans under two of its lending products due to non-adherence to the digital lending guidelines. When Mastercard Inc did not comply with its guidelines on data protection, it banned the company from issuing cards in the country, its mainstay. In recent months, the RBI has taken a string of measures over the past six months to rein in some retail lending by banks and non-bank financial firms, and publicly warned them against "all forms of exuberance".

What's behind the RBI hammer blows?

The RBI's hardened approach to regulatory breaches in recent years comes in the wake of several cautionary cases. Infrastructure Leasing & Financial Services (IL&FS) went belly up in 2018 as the biggest bankruptcy in Indian history. Yes Bank had to be rescued by cobbling up an alliance of banks that invested thousands of crores in equity. Dewan Housing Finance Ltd, and PMC Bank crumbled due to corruption and slack regulatory monitoring.

All that hastened the way the regulator supervised, inspected and punished violators. To ensure a unified and systemic approach, a unified Department of Supervision was created, bringing all banks, NBFCs and co-operative banks under one umbrella. That reduced the supervisory arbitrage and information asymmetries and addressed the complexities from inter-connectedness, ET has written.

New trends in banking are also forcing the RBI to sharpen its scrutiny. Authorities today are as sensitive towards digital transactions as they were conscious about home loans 20 years ago, when, buoyed by low interest rates and banks' hunt for new business, home loans as a product took off in a big way.

The RBI's strong punitive actions are a departure from the historically nominal financial penalties imposed for breaches, S&P Global Ratings too has noted. The RBI is showing serious commitment to improving governance and transparency in the sector. "Governance and transparency are key weaknesses for the Indian financial sector and weigh on our analysis. The RBI's new measures are creating a more robust and transparent financial system," said S&P Global credit analyst Geeta Chugh.

The RBI is toughening its approach even at the possible risk of impeding growth and raising the cost of capital for financial institutions. "We do not wait for the house to catch fire and then act," RBI Governor Shaktikanta Das had said in December when asked about tougher rules the bank had announced for personal loans.

Kotak Mahindra Bank is known as one of the smarter banks when it comes to the use of technology, and the RBI's action against it for outages might seem disproportionately harsh. Many even suspect the RBI's recent stern actions could be due to some unseen risk building in India's banking sector. “The time to fix the roof is while the sun is shining,” deputy governor Rajeshwar Rao had told ET last month. “The banking sector in India at this juncture is sound, resilient, and financially healthy. So, the time is perhaps right to improve the plumbing by addressing the gaps.’’