in place preventive measures to preempt frauds. in case of banks, three potentially powerful mechanisms could induce discipline against frauds : 1. investigative / vigilance / legal deterrence : criminal investigation of frauds and attached penalties can serve as an effective deterrence if reporting and investigation are expedient and penalties are adequately severe relative to the gains from fraudulent activity. 2. market discipline : fraudulent activity can be a net loss to the bottom - line ; in this case, bank investors would impose deterrence, e. g., uninsured creditors might “ run ” on the bank inducing liquidity problems, or shareholders might “ exit ”, effectively raising the cost of capital and inducing solvency questions. in anticipation of such disruptive outcomes that might cause loss of control, management and board members may put in place governance mechanisms to prevent or reduce the incidence of fraud and / or hold larger buffers in the capital structure to bear losses when fraud materialises. 3. regulatory discipline : banks in most parts of the world, however, have a significant portion of deposit funding that is insured, and since banks serve critical payments and settlements function, they are often too big to fail or too many to fail. hence, a part of the market discipline is weakened as a tradeoff with financial stability and is substituted by delegation of supervisory and regulatory powers to a banking regulator. detection and punishment by the regulator then need to be effective to discipline fraud. how do these mechanisms work in case of private and public sector banks in india? investigative and formal enforcement process takes in our country, perhaps for the right reasons, a fair bit of time. indeed, rbi data on banking frauds suggests that only a handful of cases over the past five years have had closure, and cases of substantive economic significance remain open. as a result, the overall enforcement mechanism – at least until now – is not perceived to be a major deterrent to frauds relative to economic gains from fraud. it is fair to say that in case of private sector banks, the real deterrence arises from market and regulatory discipline, and their confluence. a private bank ceo ’ s primary concern is whether s / he will be able to raise capital when the need arises or even whether s / he will still be running the bank the next day. the point is that they could be readily cautioned through their boards and even replaced by the rbi in case of large or persistent irregularities. further, a private bank failing to meet bank

to divert cash and assets, often outside of our jurisdictional reach. the rbi has been clamping down on the failure to recognise asset quality as non - performing as per its norms by requiring that banks, whose “ divergence ” exceeds by 15 % of the true nonperforming assets as per the norms, disclose the divergence. this should restore some market discipline against such practices, especially in the case of private sector banks. however, ultimately there also needs to be a framework in place for time - bound resolution of the underlying stress in assets that limits the discretion of banks to delay the recognition of stress, ever - green “ zombie ” or living - dead borrowers, and poorly allocate credit. to this end, i wish to present and clarify the rationale behind rbi ’ s revised framework for prompt recognition and resolution of stressed assets. the framework that was released last month remains somewhat under - appreciated in terms of its importance. so let me lay it out. prompt recognition and resolution of stressed assets – revised framework 1. the banking regulation ( amendment ) act, 2017, and the subsequent authorisation given by the government of india therein, has empowered the reserve bank to issue directions to the banks for resolution of stressed assets, including referring assets to the insolvency and bankruptcy code 2016 ( ibc ). the reserve bank has taken steps over the last year in this direction, with a focus on reference to the ibc of certain large value stressed accounts, covering approximately 40 % of banking sector ’ s overall exposure to the stressed assets. 5 / 8 bis central bankers'speeches 2. the revised framework for resolution of stressed assets released by the reserve bank on february 12, 2018 is a step towards taking these initial steps to their natural conclusion and laying down a steady - state approach. the steady - state approach is aimed at ensuring early resolution of stressed assets in a transparent and time - bound manner so that maximum value could be realised by the lenders while also recognising the potential ongoing concern value of stressed assets. as explained below, this approach is a positive step towards strengthening the credit culture in the economy, at both borrowers and banks. 3. various special schemes for resolution, which were introduced by the rbi in the pre - ibc context, had made the resolution process driven by asset - classification consideration of lenders. in particular, the forbearance that was embedded in the schemes to make it easier for banks to resolve assets became an end