Bank Failures: Knee-jerk Responses Can Hurt Depositors, Leaving the Regulator Unaccountable
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. 
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

Ranbir Lamba
4 years ago
Sq pegs in round holes. No accountability & no responsibility
Aditya G
4 years ago
What good is regulation when regulators are run by jokers? An airplane is only as good as its pilot -- no amount of safety standards can prevent a crash if the pilot doesn't know how to fly it let alone stick to the checklist. My biggest gripe with regulation is this country is not the laws per se (yes, they need fixing) but the quality & dearth of talent required to run these regulatory institutions. If you walk into any of the RBI or SEBI offices the lethargy is so evident. It's like a zombie house. Honestly though, I have no clue how these institutions are run. And it scares me. We have no idea how good (rather, how bad) our bureaucracy is. I know it's bad, but how bad? And how to "unscrew" it.
4 years ago
To be frank, if all depositors try to withdraw their deposits from the Bank at the same time, any Bank will go bellyup. In cases like these, it\'s better not put up a withdrawal limit that will only trigger panic amount depositors and lead to stampede.
Ranbir Lamba
Replied to AAR comment 4 years ago
Bank has no money to pay . Gone in drain
Nagaraju Bommanahalli
4 years ago
What RBI, central government telling is bogus,if they really interested they should arrest all board of directors, auditors, RBI officers , let central government should tell how much money refunded from scam banks from the last six years to invested, don't believe,all are looters
In India nobody knows how Indian companies are doing fraud from the beginning to last ,for example a big business men will start the company in India as below .His companies actual value is Rs2000crores but with the help of the auditors,Banks,and chartered accountants he made his company s values to RS 6000 crores by book adjustment with bribe and he call IPO that is in share market and collect Rs10000 crores in share market, first he pumped 60%of money to foreign country in the name of business and will deposit most of the money in his name next he will file bankruptcy due to losses and will write off all the loans this is the business doing in India ED is doing drama ICICI Bank chandakochar is well known to all she done huge fraud in ICICI Bank, this drama of enquire is doing from past one year, but still she is not arrested, reasons In this icici bank scam all SEBI auditors ED RBI central government rating agencies big leaders of all parties involved.central government making all efforts to avoid arrest these fellows,if arrested all all foreign country become knows most of the Indian companies running on bogus and take away all foreign investment,then India become bankruptcy.This is well known by central government hence avoiding all efforts to arrest directors of icici bank chandakochar DHFL jetairways Videocon kingfisher airline PNB bank head il@fs etc . wait in few months most of the common people investment in icici bank NBFC PSU banks equity NCD mutul funds become Zero
Rakesh Modi
4 years ago
What about Kapol Bank? I m still waiting since 3 years to get their directors arrested & refund of my money. All has become "cold" for that news now. As for PMC bank, even many has been cheated & their money stucked in Kapol Bank..& others..., RBI does not even responds to email let alone taking action. same with EOW..., i m really ashamed of my surname now......, He said correctly long back.....
Ranbir Lamba
Replied to Rakesh Modi comment 4 years ago
Lodge FIR against them
Rakesh Modi
Replied to Ranbir Lamba comment 4 years ago
4 years ago
shadi katyal
4 years ago
Thank you for such detailed article but RBI who should be responsible for such failures have lost its authority after it bent to Modi's wishes and gave crores of Rupees to center. One would have thought that after Punjab National bank Scam and others,strict rules will be enforced but re there any such rules? Are the looting of these banks in BJP duration more than UPA scams and yet everyone is silent. Why? Has any new laws been passed to save the depositors of their money or are we too busy to lynch and rape
Ranbir Lamba
4 years ago
Arrest & punish
Managers+Admin + board of directors+ auditor+Regulator+ ministry offical
Replied to Ranbir Lamba comment 4 years ago
Nothing much will happen...!
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