Whenever there is a financial scandal, a number of foolish solutions emerge. They are often like Band-Aid for a festering wound. Ostensibly aimed at protecting us, these solutions can end up harming us even more. They can impose a crippling long-term cost on innocent depositors, while letting off policy-makers, regulators, auditors and rating agencies whose repeated failures have allowed innocent people to be defrauded.
The latest example is Punjab and Maharashtra Cooperative Bank (PMC Bank) which appears to have operated like a piggy bank for the highly controversial HDIL (Housing Development and Infrastructure Ltd). HDIL’s promoters, Rakesh and Sarang Wadhwan, were finally arrested on Thursday, under unrelenting public pressure. The fact that Maharashtra elections are less than two weeks away may have also helped.
The PMC managing director (MD), Joy Thomas, who has virtually confessed to a massive fraud going back a decade, is still at large. Is it because his letter exposes poor supervision, even when PMC Bank made little attempt to hide its relationship with the HDIL group? Or is it to hide the collusion?
The enormity of the PMC Bank fraud (where the Bank managed to show a healthy profit and dividend record right to the day its transactions were frozen) has triggered a rush to withdraw deposits from all cooperative banks and private banks, including profitable ones. This forced Reserve Bank of India (RBI) to take to social media to reassure people about the stability of the banking system.
Ironically, it is RBI and the finance minister (FM) who caused panic in the first place -- RBI, when it restricted withdrawals from PMC Bank to just Rs1,000 on 23rd September. Since then, it has been forced to enhance the limit to Rs10,000 and again to Rs25,000 (on 3rd October) without providing any details on the state of the Bank’s finances.
If PMC Bank has an exposure of Rs6,500 crore to HDIL and saw withdrawals of Rs3,363 crore in the three days before RBI’s clampdown, it would technically have only around Rs1,700 crore remaining, out of its deposits of Rs11,617 crore (March-end 2019 numbers). Is this enough to cover the withdrawal of Rs25,000 per depositor? Is anything recoverable from HDIL at all? Or is the Bank is getting a quiet bailout? We have no answers.
FM Nirmala Sitharman’s tweet on 30th September also triggered panic and outrage. Responding to an anguished investor, she appeared to shirk responsibility and claimed, “Multi-state cooperative institutions do not come under Ministry of Finance even if they are called banks.”
This strange little word play ended with her acceptance that RBI is the regulator and is taking action. She was also silent about dual regulation and political control of ‘cooperative institutions’ leading to repeated failures. The FM would have been more reassuring if she had pushed for a single regulators and better control over ‘cooperative institutions’.
After all, there are stringent rules in place for deposit-taking non-banking finance companies (NBFCs) precisely to safeguard depositors. Secondly, claims settled by the Deposit Insurance and Credit Guarantee Corporation (DICGC) reveal that almost all payments, over the years, are on account of politically manipulated cooperative banks. PMC Bank is, probably, among the first to be looted by a corporate group.
I appeal to you not to mention/speak/write of such extreme things. Multi state cooperative institutions do not come under Ministry of Finance, even if they are called banks. @RBI is their regulator and they are taking action.
Our bigger worry should be about knee-jerk regulations to resolve the problem. A bank union-leader-turned-depositor-activist claims that he will file a public interest litigation (PIL) to demand that 100% of bank deposits must be insured. On 2nd October, The Telegraph wrote that the contentious Financial Resolution and Deposit Insurance bill (FRDI Bill) is being ‘reframed’ and may be re-introduced.
Let’s examine both issues. The FRDI Bill was the result of an international commitment made without taking into account India’s banking structure, ownership and supervision. The Bill was withdrawn in August 2018, a year after it was introduced, because it sparked panic among bank depositors just ahead of the general elections. The National Democratic Alliance (NDA) also did not have the numbers in Rajya Sabha to push it through.
This time, things are different. The government has a better chance of pushing it through the Rajya Sabha. The government has also shrunk the number of public sector banks (PSBs) from 27 to a mere 12, in just five years. Once the new round of mergers is complete, the government could start pushing for privatisation of banks. This would eliminate its responsibility, as owners, to ‘bail out’ PSBs through frequent capital infusion, as was done by the United Progressive Alliance (UPA).
According to the news report, the reframed Bill may re-introduce the prickly ‘bail-in’ clause under another name. A ‘bail-in’ forces bank customers/depositors to bailout the bank by converting a part of their deposits into equity. If the bank turns around, they could potentially benefit from stock price appreciation.
The idea is that banks must be bailed out by their own depositors, instead of pushing the burden on the country at large, including the poorest people who don't even have access to banking facilities!
In India, the ‘moral hazard’ that economists want to avert, will actually be enhanced if corrupt bankers, greedy politicians and unaccountable regulators know that they will never be held responsible for bank failures. Recent financial scandals have shown how greed, corruption and collusion ensure that all checks & balances (credit rating, disclosures and statutory audits) have failed to work.
The government reportedly plans to make ‘bail-in’ more acceptable by raising deposit insurance from the present Rs 1 lakh to cover a larger chunk of deposits. This would protect a large swathe of depositors and reduce objections to bail-in, but is it fair?
Fix This Regulatory Flaw
A former central banker points out, “Globally, all deposit-taking institutions are regulated and supervised under a single regulatory framework and same standard of regulation.” In India, cooperative banks come under dual regulation of RBI and the Registrar of Cooperative Societies, a sleeping organisation, controlled by political appointees who do not even respond to court orders.
It is, indeed, true that the Modi-government, in filing charges against two powerful politicians in the Maharashtra State Cooperative Bank (MSCB), has shown a willingness to address this issue. It still needs to establish that the action in backed by solid evidence and not a political witchhunt.
Notice how the government, which prides itself on taking tough decisions without hesitation, makes no mention about fixing the pernicious problem of dual regulation and political control over cooperative institutions.
The previous version of the FRDI Bill had kept cooperative banks out of its purview. The size of the MSCB scam, and the easy loot of PMC Bank by a corporate entity, indicates that keeping out cooperative banks won’t fly this time, especially if deposit insurance is planned to be raised.
Insurance costs are low today, only because PSBs and other commercial banks contribute to premiums but have received no settlement in decades. Insurance premium will zoom upwards even if a single PSB or a large private bank needs to be bailed out. There is also no clarity about how the failure of payment banks, NBFCs and micro-finance institutions will be dealt with. The failure of a massive IL&FS (Infrastructure Leasing and Financial Services) caused a major systemic problem; Dewan Housing and Finance Ltd is teetering and there is a sense of unease about at least two big players in this space.
The government cannot push the burden of ‘bail-ins’ on to depositors without fixing regulatory arbitrage or making regulators and intermediaries strictly accountable. Also, if PSBs are subject to bail-ins without better accountability, there is bound to be a flight of deposits. All this will also increase the overall volatility in the banking system which had led to bank nationalisations in the first place.
Instead of causing panic through hasty action and poor implementation, the government would do well to put out a new regulatory framework and rollout plan that is well thought out and open to public discussion.
Watch this video: Why Say No to Cooperative Bank for Saving or Investing in FDs for 1-2% More Interest by Sucheta Dalal
The Enforcement Directorate (ED) has filed a money laundering case in the Rs 4,355 crore Punjab and Maharashtra Cooperative (PMC) Bank fraud matter, sources in the agency said on Friday. The sleuths of the federal financial investigation agency, are also carrying out raids at six locations in Mumbai.
The ED has filed an enforcement case investigation report (ECIR), equivalent to FIR, against Housing Development and Infrastructure Ltd (HDIL) and its promoters under various sections of Prevention of Money Laundering Act (PMLA) and has started probe into the matter.
Rakesh Wadhawan, executive chairman of HDIL, and his son Sarang, vice-chairman and MD of the group, have been named in the case filed by ED.
The ED has started probed taking cognizance of Mumbai Police's economic offences wing (EOW) FIR into the matter.
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The Reserve Bank of India (RBI) has raised withdrawal limit for depositors of Punjab and Maharashtra Cooperative Bank Ltd (PMC Bank) to Rs25,000 from Rs10,000. RBI has also appointed a three member committee to assist the administrator of PMC Bank.
"The RBI again reviewed the bank's liquidity position and, with a view to reducing the hardship of the depositors, has decided to further enhance the limit for withdrawal to Rs25,000. With the above relaxation, more than 70% of the depositors of the bank will be able to withdraw their entire account balance. The Reserve Bank is monitoring the position of the bank and will continue to take necessary steps in the interest of depositors," the central bank said in a release.
The RBI has also decided to appoint a committee of three members in terms of section 36AAA(5)(a) read with Section 56 of the Banking Regulation Act 1949, to assist the Administrator of Punjab and Maharashtra Cooperative Bank Ltd.
Earlier on Thursday economic offences wing (EOW) of Mumbai police arrested two directors of the Housing Development Infrastructure Ltd (HDIL) in the PMC Bank scam.
Rakesh Wadhawan and his son Sarang Wadhawan, accused of loan default, have been arrested by the EOW.
Properties worth Rs3,500 crore of HDIL have also been frozen by the EOW, an official told IANS. "We arrested the two directors of HDIL after a detailed interrogation," the official added.
PMC Bank used more than 21,000 fictitious accounts to hide loans it made, according to a police complaint lodged by officials, in the latest banking fraud case to spook the country's depositors and investors.