What makes a person indulge in a corrupt practice? More particularly, what motivates a financial crime? It’s about morality, most would say.
The common strand of thought explaining dishonesty is that it is an innately ethical characteristic. Corruptibility, this line of argument goes, is a moral imperfection. ‘Criminal bent of mind’ is a familiar phrase that is often used to describe a person who suffers from moral vices and, therefore, has a higher propensity to flout rules.
The tricky aspect, however, is about financial offences. Last week, Reserve Bank of India (RBI) governor Urjit Patel raised a valid point when talking about bribery and rules transgressions in public sector institutions. The proclivity to break rules in such instances has, perhaps, got more to do with the trade-off between pecuniary inducements and punishments.
Patel’s speech, titled Preventive Vigilance – The Key Tool of Good Governance at Public Sector Institutions, delivered at the Central Vigilance Commission on September 20, referred to Nobel Prize-winning economist Gary Becker’s pioneering work in crime and punishment and its relationship with financial returns.
According to Becker, ‘a person commits an offence if the expected utility to him exceeds the utility he could get by using his time and other resources at other activities. Some persons become “criminals”, therefore, not because their basic motivation differs from that of other persons, but because their benefits and costs differ.’
Paraphrased this would mean the rewards or incentives for breaking rules far outweighs the risks of flouting laws and getting punished if spotted.
The RBI governor used Becker’s seminal analysis to call out the role of corrupt employees in public sector institutions, particularly banks. The role of employees in India’s recent headline-grabbing alleged bank frauds cannot be overemphasised.
Kingfisher Airlines (KFA) is a case in point.
In 2011, a year before the airline went belly up, a banks’ consortium, rather inexplicably, reworked KFA’s outstanding loans. The nature of the recast package allowed 13 banks to convert 30 percent of their outstanding loans to the beleaguered airline into preferential and equity capital.
Oddly, banks were given shares at Rs 64.48 apiece on March 31, 2011. This was nearly double the price at what KFA’s shares closed that day at the BSE. Even odder was that banks slashed KFA’s interest rates by three percentage points to 11 percent.
Many questions arise from this. Why did banks agree to convert a third of their loans to KFA into equity at double the prevailing share price? What was the logic that pressed these banks to cut lending rates for loans that had essentially turned bad by three percentage points? Most importantly, who were the bank employees that steered these decisions? What’s the status of these employees? Have they been penalised for this seemingly grave error of omission, if not commission?
Likewise, the letters of understanding (LoU) through which celebrity diamantaire Nirav Modi allegedly defrauded banks of more than Rs 11,000 crore could not have been possible without the active participation of bank employees. In this case, the investigating authorities have identified the employees involved in the alleged systematic swindle over several years.
The relatively low wages of public sector employees compared to their private sector peers makes it difficult to impose strict financial penalties on employees found to be breaking rules. Low wages limits the possibility of a salary cut as an effective punishment.
As Patel pointed out, “punitive vigilance” is difficult in a public sector institution because “the rewards are low to start with, thereby limiting the possibility of downward revisions. Given this constraint, disciplinary actions that limit the chances of career progression are often the preferred punishment”. It gets even more ineffective, when multiple layers are involved in the decision-making that led to the governance lapse.
“Preventive vigilance”, strict enforcement where the penalty far exceeds the incentives to be corrupt, can be the most effective governance mechanism at public sector institutions, particularly banks.
After all, as Patel says “governance lapses may be rational choices rather than mental illnesses or character flaws in transgressors.” Only enforcement, with clearly defined non-negotiable rules, can break the backbone of this white-collar crime industry that is purely driven by incentives, rather than any ethical deficiencies
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