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Inaugural Address at the 26th Biennial Conference of The Bank of Maharashtra Officers' Association, January 26th 2013 ...

Inaugural Address at the 26th Biennial Conference of The Bank of Maharashtra Officers' Association, January 26th 2013

From the paradox of sustainable growth, structure of global growth the talk examines the design of fragile financial systems. It makes a plea for the design of responsible banking systems.

Global pressures for growth have concentrated global ownership of growth in a few nodes. Failure of one node quickly brings the global economy crashing down. The UID with its concentrating and connecting the financial network across the Indian economy promises high likelihood of destroying the resilience of the Indian financial system.

Responsible banking systems will focus on the borrower and lender relationships and ways to sustain it rather than ways in which this relationship will vanish and destroy banking.

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  • 1. The role of banks in building resilient economies Page 1 The  role  of  banks  in  building  resilient  economies   Inaugural  Address  at  the  26th  Biennial  Conference  of  The  Bank  of  Maharashtra  Officers'   Association,  January  26th  2013   Anupam  Saraph1,  Ph.D.,     The  paradox  of  sustainable  growth   I  am  not  a  banker.  I  was  therefore  more  than  a  little  surprised  and  skeptical  about  speaking  to   bankers.  Then  I  remembered  that  way  back  in  the  nineties  my  colleague  Prof.  Malcolm  Slesser   and  I  had  made  a  model  of  the  Scottish  Economy  for  the  Royal  Bank  of  Scotland.  Using  our   model  we  had  explored  many  scenarios  including  one  where  credit  would  be  advanced   liberally  to  the  population.  Our  model  had  suggested  that  a  liberal  credit  policy  would  be   deeply  unsustainable  by  2010-­‐2012.  If  Prof.  Slesser  were  alive  today  he  would  have  felt   vindicated!       In  the  mid  eighties  I  worked  for  the  Systems  Research  Institute  where  we  coordinated  a   network  of  over  1000  policy-­‐makers,  researchers  and  businesses  to  spread  the  idea  of   sustainable  development.  I  suppose  we  were  way  ahead  of  the  times.  Even  the  Brundtland's   World  Commission  on  Economic  Development  came  up  with  the  declaration  of  sustainability   in  1987!  Among  the  most  influential  ideas  since  those  years  was  the  work  of  the  MIT  team   lead  by  Jay  Forrester,  Dennis  and  Donella  Meadows  for  the  Club  of  Rome.  The  team's  research   suggested,  for  the  first  time,  that  there  was  a  limit  to  growth.  Sustainable  growth  was  an   oxymoron.  While  the  notion  has  since  become  axiomatic,  many  still  continue  to  swear  by   growth.  Year  on  year  every  business  and  every  financier  wants  more  and  more  growth.     The  structure  of  global  growth   A  world  growing  under  the  pressure  of  growth  has  driven  itself  to  a  concentration  of  wealth   and  power.  Research  by  scientists  from  the  Swiss  Federal  Research  Institute  found  that  from   the  43,060  trans-­‐national  companies  (TNC's)  sharing  ownerships  that  they  pulled  out  from  a   2007  Orbis  database  containing  37  million  companies,  1318  connected  to  an  average  of  20   other  companies.  These  1318  companies  represented  20  percent  of  the  global  operating   revenues.  Collectively  they  owned  most  blue-­‐chip  and  manufacturing  companies  representing   a  further  60  percent  of  global  revenues.     When  the  team  further  untangled  the  web  of  ownership,  they  found  147  more  tightly  knit   companies,  mainly  banks  and  other  financial  institutions,  whose  ownership  was  held  within   other  members  of  this  "super-­‐entity"  and  together  controlled  about  40  percent  of  the  total   wealth  in  the  network.     The  failure  of  one  node  within  these  147  causes  similar  failures  in  linked  nodes  to  propagate   causing  large-­‐scale  collective  failures.  It  is  no  secret  that  the  global  banking  network's   activities  are  directly  responsible  for  the  majority  of  the  financial  woes  that  have  befallen  the   global  community,  especially  since  the  2008  events  that  have  put  the  financial  system  into   meltdown  mode.  In  the  UK,  whose  GDP  is  2,470  billion  USD  and  annual  spending  1,019  billion   USD,  more  than  1,102  billion  USD  was  spent  on  Bank  bailouts.  In  the  US  over  700  billion  USD   was  spent  on  bank  bailouts.     When  the  global  GDP  stands  at  63  trillion  USD  off-­‐exchange  trading  of  financial  derivatives   stood  at  601  trillion  USD  in  2010.  At  the  same  time  the  total  volume  of  foreign  currency   1 Anupam Saraph is a Future Designer. He works with works with businesses and governments to build capacity and design better systems.
  • 2. The role of banks in building resilient economies Page 2 transactions  stood  at  over  955  trillion  USD.  This  clearly  highlights  the  fragile  and   unsustainable  growth  that  threatens  to  sink  the  world  to  deep  crisis.     The  lessons  are  clear:  we  create  a  highly  fragile  system  if  we  connect  hundreds  of   unconnected  networks  to  allow  a  few  nodes  to  control  the  entire  network;  second  and  third   order  connections  result  in  auditors  nightmare;  frauds  get  amplified  not  contained  in  such   structures.     The  design  of  fragile  financial  systems   Closer  home  we  have  bigger  reasons  to  worry.  Ironically  it  is  the  Aadhar  initiative  that  will   connect  multiple  ID's  that  were  independent  of  each  other  and  facilitate  their  control  by  a   single  ID.  Further  in  this  web  of  intrigue  the  UID  is  generated  by  many  registrars,  sub-­‐ registrars  and  enrollment  agencies  with  no  accountability  or  legal  liability  resulting  in  an   auditors  nightmare.  Like  the  network  of  ownership  of  companies,  this  network  too  can   propagate  and  amplify  fraud  in  the  system.  There  is  no  audit  of  the  enrollment  of  persons  by   the  enrollment  agencies  beyond  a  "de-­‐duplication",  or  check  for  existence  of  the  same   individual  in  the  database  so  far.  The  de-­‐duplication  is  undertaken  by  three  non-­‐Indian   companies  on  the  basis  of  "biometric"match.  Biometric  is  not  a  foolproof  system  and  the   creation  of  fake  ID's  through  fraudulent  biometric  cannot  be  ruled  out.  Experts  estimate  that   there  may  be  over  30  million  fake  IDs  already.  Enrollment  agencies  are  private  parties  paid   per  record  they  add.  The  registrars  and  sub-­‐registrars  for  UID  are  the  very  governments  and   departments  whose  databases  of  beneficiaries  the  UIDAI  has  questioned.  Further  there  is  no   audit  of  the  records  generated  by  the  enrollment  agencies.     This  raises  many  questions  about  the  registration  process.  Who  certifies  each  UID:  the   enrollment  agency,  the  de-­‐duplication  company  or  the  UIDAI?  Who  certifies  the  KYC:  the   enrollment  agency,  sub-­‐registrar,  registrar,  UIDAI?  Who  audits  the  UID,  UIDA  enrollment   agencies  and  registrars?  Who  own  the  UID?  The  enrollment  agencies,  sub-­‐registrars  and   registrars  are  free  to  add  their  own  fields  in  the  form  and  deal  with  the  information  as  they   like.  Who  is  responsible  for  the  ownership,  privacy  and  security  of  this  information?  Who  has   the  legal  liability  for  correctness  and  protection  of  the  information?  Who  will  be  held   responsible  if  there  are  frauds,  thefts  or  other  crimes  based  on  the  UID?     According  to  the  UIDAI  an  instant  bank  account  can  be  activated  at  any  "manned  customer   service  point"  where  UIDAI  will  provide  instant  e-­‐KYC.  This  opens  up  possibilities  of  bulk   accounts  being  generated  through  UIDs  provided  by  KYC  service  agencies.  This  raises  several   questions:  Who  certifies  each  bank  AC:  the  “manned  service  point”,  the  bank,  the  KYC  service   provider,  UIDAI?  Who  audits  each  bank  AC?  Who  owns  the  bank  AC:  the  UID  number  or  a  real   person?  Who  has  the  legal  liability?  Who  is  responsible  for  the  fraudulent  accounts,  theft   through  such  accounts  or  any  other  crimes?     According  to  the  UIDAI  any  resident  can  automatically  receive  or  transfer  money  from  UID  to   UID.  If  there  is  no  bank  account  and  instant  account  can  be  created  using  the  UID.  The  UID  can   in  effect  replace  an  account  number  for  money  transfers.  This  raises  several  serious   questions:  Who  certifies  each  transfer:  the  UIDAI  or  the  bank?  Who  audits  each  transaction   for  being  to  a  real  person:  the  UIDAI  the  bank  or  the  banks  auditors?  Who  owns  the  money  in   the  account:  the  UID  number  or  a  real  individual?  Who  has  the  legal  liability:  the  bank  or  the   UIDAI?  Who  will  be  charged  for  frauds,  money  laundering,  theft  of  subsidies  and  other  money   using  shell  accounts  opened  instantaneously  with  UIDs?    
  • 3. The role of banks in building resilient economies Page 3 The  entire  processes  of  UIDAI  absurdly  do  not  have  UIDAI  certifying  anything.  The   registration  is  outsourced,  the  authentication  is  outsourced  and  even  the  storage  and   management  is  outsourced.  They  only  provide  a  number.     There  is  no  log  of  any  registration  or  authentication  undertaken  by  any  of  the  UIDAI's   "agents".  UIDAI's  agents  have  no  legal  liability  and  the  processes  and  contracts  do  not  fix   responsibility  for  frauds,  fake  ids  or  identity  theft.  The  UIDAI  only  issues  privacy  and  security   guidelines  to  its  agents.  There  is  no  audit,  certification  or  legal  responsibility  on  the  agents  to   deliver  privacy  or  security.     The  UID  is  based  on  the  assumption  that  each  UID  is  unique.  Private  parties  "verification"  and   “de-­‐duplication”  results  in  the  issue  of  a  UID.  Payments  to  these  private  parties  are  based  on   volume,  not  correctness.  In  fact  there  is  no  process  to  ensure  correctness.  This  process  cannot   guarantee  a  unique  UID.  There  is  little  reason  to  believe  that  residents  cannot  receive   duplicate  or  fake  UIDs.  Therefore  the  assumption  that  each  UID  corresponds  to  only  one  real   individual  fails.  UIDs  may  also  correspond  to  non-­‐existent  individuals.     There  is  no  process  for  any  verification  in  cash  transfers:  money  can  be  transferred  to  or  from   duplicate  or  fake  accounts  generated  by  UID.  There  will  be  no  reason  for  any  complaints  in  the   matter,  as  no  one  may  know  of  such  transfers  at  all.  These  accounts  can  become  unnoticeable   channels  for  routing  subsidies.       Today  there  are  only  18,950  rural  branches  to  service  593,731  villages.  This  means  there  are   31  villages  to  each  branch.  The  bank  infrastructure  cannot  cope  with  accounts  opened   without  verification  on  such  a  large  scale.  Even  in  urban  areas  there  are  over  7,500  persons   per  urban  branch  if  they  were  evenly  distributed.  If  the  9  trillion  (9  lakh  crore)  rupees  of   subsidies  were  passed  through  UID  accounts  every  year  it  would  be  impossible  to  track  and   prevent  theft.  Given  the  track  record  of  cooperative  and  private  banks  on  non-­‐performing   assets  this  is  a  huge  leap  of  faith  that  money  of  this  magnitude  could  pass  through  UID   channels.     Designing  responsible  banking  systems   Banks  do  not  stand  in  isolation.  They  are  part  of  a  system.  A  banking  system  has  borrowers   and  lenders.  It  is  the  relationship  between  these  key  actors  that  drives  the  banking  system.  If   this  relationship  gets  unfair  in  any  way  the  banking  system,  not  individual  banks,  becomes   unviable.  When  third  parties  like  regulators,  governments  or  foreign  banks  enter  the  system   they  alter  the  relationship  between  the  borrower  and  the  lender.  If  the  banking  system  has  to   endure  it  will  have  to  sustain  the  trust  between  the  constituents,  not  destroy  it.     The  way  ahead  is  clear:  schemes  like  the  Aadhar  card  that  make  the  stable  system  fragile  need   to  be  scrapped  before  they  bring  the  economy  crashing.  Accounts  must  be  opened  by  real   persons,  not  numbers.    Only  audit-­‐able,  transparent  systems  will  build  trust.  Banks  committed   to  local  self-­‐reliant  economies  will  endure,  not  ones  that  build  growth  on  distant  borrowing  or   lending.  Banks  will  have  to  pursue  missions  that  build  security  for  the  banking  systems  not   only  for  one  actor  –  banks  -­‐  within  the  system.