Eroding Faith and Failed Regulation – The Saga of Urban Coop Banks
Financial institutions are in disarray due to a serial fraud perpetration, whether commercial banks or cooperative banks. Serious fraud investigations have invariably taken such long time that makes the system forget about the result and consequence of investigation with impunity. Thanks to Moneylife this time, the Punjab & Maharashtra Co-operative Bank (PMC Bank) fraud is exposed in public with a view to bring relief to the otherwise hapless numerous depositors and other stakeholders. 
 
Urban cooperative banks (UCBs) are just primary credit societies (PCS) in the lexicon of cooperatives. These PCS get converted to ‘banks under certain conditions and the Reserve Bank of India (RBI) provides them license. The joke of whole regulation commences from the stipulation that it is enough to have just a lakh of rupees to get such license!! The rule remains unchanged for decades. How can one expect stability of an institution termed as bank with such ridiculous level of capital? 
 
Several of these societies, when converted, work like community banks or family-controlled and family owned banking institutions with an apology of governance and with least regulatory interference. It has become fashionable for both the state government and RBI similar ‘to pot calling the kettle black’ when anything untoward happens with these institutions. Finally, both of them get away putting the depositors to untold suffering. 
 
UCBs have come to occupy a firm place in the financial system holding nearly 10 crore deposit accounts of which around 18 lakhs are no-frill accounts and nearly 3 crore loan accounts just in urban and metro areas. They lend for all the activities that the commercial banks do with low penetration in foreign exchange and exotic financial products like the derivatives. 
 
“It is, therefore, necessary that the UCBs emerge as a sound and healthy network of jointly owned, democratically controlled, and ethically managed banking institutions providing need-based quality banking services, essentially to the middle and lower middle classes and marginalized sections of the society.” (RBI Vision Document, 2005) 
 
Their heterogeneity in terms of geographical spread, restricted operational area, size or performance has potential for systemic risks that need to be insulated without sacrificing the cooperative character. 
 
There are strong Banks with good leadership following cooperative principles in letter and spirit like Visakha Cooperative Bank that has become multi-state after the Andhra Predesh state bifurcation with 38 branches and Gayatri Coop Bank, Jagtial that recently took into its fold a weak Samatha Mahila Bank at Dilshuknagar in Hyderabad. There could be a few more in other states. These few demonstrate that UCBs have a purpose to stay with confidence and inspiration for a good future. 
 
This is the right time to clean up the system. What needs to be done has to be done quickly. Regulatory intransigence has to be tackled firmly. 
 
Threshold Remains Same for Decades
 
Marathe Committee and Madhavarao Committee set up by the RBI have mentioned the need for raising the ridiculously low level of capital required for such UCB. But why did not the RBI raise the threshold for decades is a matter for introspection. No wonder year after year, state after state, are throwing up frauds with the PMC Bank joining the fray, a couple of months ago. 
 
Andhra Pradesh, Maharashtra, and Gujarat yester years and Punjab the latest are top of the five states of UCB concentration in throwing up fraudulent UCBs. Telangana has to its share 52 UCBs of which 40 are in twin cities alone. There are still primary societies that hold unsustainable deposits of over Rs1,500 crore and yet not converted into banks! 
 
This should happen despite a regular call to the registrar of cooperative societies (RCS) from RBI calling for particulars of societies that hold deposits of that size!! 
 
 
A look at the Trend and progress of Banking (RBI) December 2019 reveals the dubious strength of the UCBs, particularly after consolidation efforts.
 
Liquidation proceedings of the closed banks is left to the Registrar of Cooperative Societies (RCS). A person of the cadre of Dy. Registrar or Joint Registrar is appointed by the RCS and the cost of this officer – all salaries and perks – is debited to such Bank. If the liquidation proceedings are finalized, a post is abolished and therefore, the official keeps on postponing selling off the assets and making over the proceeds to the clearance of all dues to the depositors. 
 
From the day liquidation proceedings are issued, RBI washes off its hands. Krushi UCB, Charminar UCB, A.P. Prudential UCB, Tandur Mahila UCB, Vasavi, Gokul in Telangana from 2001 to now are those where the assets are yet to be disposed of. They have own premises in prime localities in twin societies that fetch a fortune to settle majority of the dues. This does not just happen because of the eagle eye of either a politician or RCS himself for some period to grab it for a song!! The song failed to reach the ears for years. 
 
Memory may have faded for a few. During demonetization and post demonetization UCBs harboured many depositors, whose origin was suspect but went fully protected. Necessity of UCB like structures was felt more in situations of distress than when all things were right and this position was exploited by errant directors and unprofessional management. 
 
Fit and proper criteria in the appointment of both directors and chief executives (CEOs) was sacrificed. Who else but RBI were to take the blame?
 
Looking at the data of RBI 2018, UCBs in the aggregate have just Rs483 billion but a deposit base of Rs4,565 billion. Investments, loans and advances together constituted nearly Rs4,303 billion! RBI extols the balance sheet position of the UCBs! Who is at risk except the depositors who do not have voice in the credit committees, risk committees, and the board?
 
The UCBs have put the technology in place in good measure; going ahead fast in implementing core banking solutions; and building capacities to cope with the technology changes. But they are far inadequate in tackling the risks associated with such technological changes and about credit, market and operational risks.  
 
Professional competence is a casualty. They have been enjoined upon to become member of one or the other registered Credit Information Companies. Now they should assign 2.5% additional risk weight towards covering market risk. They should assign a risk weight of 100% against foreign exchange and gold and should build an investment fluctuation reserve up to a minimum of 5% of the investments held in held for trading and available for sale categories. These changes require continuing efforts in education, training, research and communication across and within the organizations. 
 
There were number of occasions when the regional office of RBI recommended deterrent action that was promptly rescinded by the central office that shows the power of the directors and interested politicians of the UCB on one side and the top regulatory official holding such position for decades!
 
Year after year, inspections by the RBI and audits by RCS and chartered accountants (CAs) winked at the misdemeanors and frauds of directors!! 
There are certain community-owned banks where the RBI inspection staff dare not enter. 
 
Net interest margins (NIMs) were always under pressure. The axe must surely fall on them from the origin of the fraud date if the system needs a remedy. If the fate of PMC Bank were not to be similar, the highest court should give a ruling fulling examining regulatory failures.
 
Several community savings banks in the US that are on par with our UCBs collapsed not because they did something wrong of the magnitude of the Wall Street Investment Banks, but because of their being part of the larger payment and settlement systems. 
 
In India, we could stall the size of damage because of the strong muscle of the regulator but could not escape the shadow. The reason is simple: Globalisation takes away as much benefit as it gives. 
 
UCBs that are growing in size due to mergers and acquisitions, and diversification of business in India, would be part of the overall financial system. The swings in the growth of UCBs have the potential of causing systemic risks. 
 
Pope Benedict XVI, in his June 2009 "Charity in Truth" encyclical, noted the misuse of financial methods that "wreaked such havoc on the real economy." 
 
He added, "Financiers must rediscover the genuinely ethical foundation of their activity, so as not to abuse the sophisticated instruments which can serve to betray the interests of savers." 
 
If there was a worry that conversation was not happening in regard to the disconnect between ethics, values and banking between the Wall Street and Main Street, the same worry would descend on us ere long.
 
The glue that holds markets together is a sense of trust and self-regulation among the participants, Lawrence Baxter, a former top executive at Wachovia said in a recent speech in Johannesburg, South Africa. "Mutual understanding endures only on the basis of a deep and widespread commitment to moral integrity within a market," he said. "So even though it has lately been unfashionable to focus on market morality and ethics, we ignore the moral dimensions at our own peril." 
 
Baxter points out that Adam Smith, the 18th-century economist, wrote an ethics book, "The Theory of Moral Sentiments," years before he wrote his famous free-market manifesto, "The Wealth of Nations." 
 
There is also a push for banking to become a smaller, simpler, less-profitable industry. Banking's original purpose was to take in deposits and make loans so that the rest of the economy could function, but it became an industry focused on making profits for itself through esoteric products with questionable usefulness. The future of UCBs is here.
 
The Committee on Financial Stability Assessment 2009 (p30) assessed Basel Core principles in respect of UCBs and the position has not changed substantially despite consolidation that followed:
 
 
The above analysis clearly indicates that the UCBs are mostly non-compliant on risk management. Fundamentals of risk management prescribe that a risk culture should spread in the entire organization and not limited just to either compliance or Board purview. 
 
The experiment of TAFCUB revealed that the over-debated issue of regulatory overlaps has been resolved to mutual satisfaction. Even Rating mechanisms have also undergone changes. The revised CAMELS rating will be applicable to UCBs with Rs100 corer deposits and above and a revised simplified rating version thereof would be applicable to UCBs with deposits of less than Rs100 crore. 
 
Potential for systemic risk
 
UCBs have the potential for exposing Indian banking to systemic risk when they fully fall in line with the mainstream banking and open channel banking.  
 
McKinsey’s survey of wholesale banking in Asia observes that the wholesale banking space would be gobbled up by the commercial banks as they would found it to be within their technology reach and cost effective. 
Retail banking space would be available for the cooperatives of all hues, regional rural banks, micro credit institutions and non-banking finance companies (NBFCs). This space is not small and unprofitable but certainly not as comfortable and as cost-effective as the wholesale banking that would have global reach. 
 
Exploiting this space, however, requires that the risk capabilities of UCBs need to be professionalized and strengthened. Their products should be subject to stress testing and resilience. The boards of UCBs should devote adequate time on these issues at least on quarterly basis. 
 
Instead of crying over spilt milk, we need to see that the glass that holds the milk does not tilt. Technology is as much a facilitator as a contributor to risk. Technology risks arise from the life of technology – both hardware and software. The more one moves close to technology, the more the banks becomes vulnerable to new risks. There must be a professionally managed Risk Management Committee in the Board.
 
The UCBs during the past few years have put the technology in place and moved fast in implementing core banking solutions. Professional competence is a casualty. They have been enjoined upon to become member of one or the other registered Credit Information Companies. Now they should assign 2.5% additional risk weight towards covering market risk. They should assign a risk weight of 100% against foreign exchange and gold and should build an investment fluctuation reserve up to a minimum of 5% of the investments held in held for trading and available for sale categories. These changes require continuing efforts in education, training, research and communication across and within the organisations. 
 
The UCBs will drive the force of retail banking, in equal measure with that of commercial banks under the influence of globalization. 
 
National Federation of Urban Cooperative Banks and Credit Societies Ltd (NAFCUB) and the state federations need to brace up with emerging challenges and reformulate their skilling, re-skilling the staff at all levels, prescribe recruitment procedures (today, most banks have appointed relatives of directors or politicians surrounding them or the relatives of the cooperative department staff) and re-engineering the Banks to cope with technology risks also that are increasingly surfacing. 
 
With the repeat occurrences of the nature of PMC Bank frauds and overleverage deliberately passed off by the regulators, they are not far from being categorised as systemically important financial institutions as per the prescriptive norms of the Financial Stability Board: It is trust that matters and the growth driven UCBs have to preserve the trust carefully.  Ethics count. Each UCB shall have Ethics Committee and Whistle Blower Committee carved out of the huge mass of depositors and other stakeholders.
 
(The author is an economist and risk management specialist. He is co-author of ‘A Saint in the Board Room’. The views expressed are personal.
  • Like this story? Get our top stories by email.

    User

    COMMENTS

    Humayoun Mussawar

    4 weeks ago

    Building a home in today’s era can be very difficult due to the increasing cost of raw material and labor. Thankfully, some banks are providing home financing for Pakistani people.
    I have a List of Banks Providing Home Loans in Pakistan to know about these banks and their details read more on
    banks providing home loan

    New Test Rules for Independent Directors Are Hasty, Slipshod & Burdensome Without Corresponding Benefits
    New rules notified by the ministry of corporate affairs on 22 October 2019 require independent directors to pass test to demonstrate their knowledge and proficiency in certain areas for board level functioning in corporates. They need to score at least 60% marks in this test to qualify. They also need to enroll their name in a databank maintained for this purpose. The intention seems to be that companies should choose independent directors from this databank. These are the principal requirements notified by these new rules. 
     
    The new rules would come into force from 1 December 2019 and are spread over several notifications, one of which introduces a full set of rules, another modifies an existing one and yet another notifies the Institute that shall oversee all the teaching and test. A time of three months has been given to independent directors to enroll their name in the databank and a period of one year from date of such enrolment to pass the test. Companies are required to ensure compliance of this and an independent director is also required to confirm he is compliant in the filings he makes.
     
    It may be recollected that the Companies Act, 2013 requires listed companies and certain large sized public companies (in terms of specified net worth) to have at least one-third of board to constitute of independent directors on their board. market regulator Securities and Exchange Board of India (SEBI) has made similar requirements though with some differences. Their requirements apply to listed companies and provide for a higher proportion of independent directors on the board. 
     
    The qualities that make a person an “independent” director have been laid down in great detail in the law. However, these focus largely on how they are independent from the company and its promoters. No minimum knowledge, or educational qualifications have been specifically prescribed for them, except when they are part of the audit committee. 
     
    They occupy a high position in a company and are expected to provide well-informed input on matters of governance, and strategy to the company and its management. They are also expected to keep a watchful eye on the finances, accounts and performance of the Company. They are expected to exercise skill and diligence. A failure on their part can be harmful to the company and to themselves since they may face liability and penal action in many forms. 
     
    Why New Rules?
     
    The new rules may be an attempt to provide a rudimentary level of financial and regulatory literacy. An institute has been notified (Indian Institute of Corporate Affairs-IICA) for this purpose. Such institute has to carry out several purposes. It has to release education material for independent directors that they can use for preparing for the exams. It is required to conduct online test for independent directors. The scope of the test covers areas such as company law, securities law and basic accountancy. Apart from this minimum qualifying exams, it is required to conduct an optional advanced test for those who wish to take it. 
     
    Enrollment and Daily Reporting by IICA
     
    The Institute is required to maintain a databank of independent directors that would contain detailed information of each such person. Companies seeking to appoint independent directors can access such information on payment of a fee to the Institute. Interestingly, the Institute is required to report daily to the government all additions, changes and removals in this databank. This makes one wonder why would the government want to monitor this databank so closely and so frequently. 
     
    Independent directors are required to enroll on such databank by providing required information and payment of a fee. Existing independent directors are required to do this within three months, or by 1 March 2020. A person seeking appointment as an independent director is required to enroll himself before being appointed. They are required to pass the prescribed test, with at least 60% marks, within one year of such enrolment. The enrolment can be for one year, five years or for lifetime. The test has to be passed only once in a lifetime. Directors, presumably, will update the knowledge of rapidly changing laws on their own.
     
    A person, who has acted as independent director or key managerial personnel for at least 10 years in a listed company or a public company with at least Rs10 crore of paid up capital is exempted from the requirement of passing such test. However, he would still have to enroll in the databank.
     
    Companies are required to ensure and report compliance with such requirements. 
     
    These new requirements will ensure that a person may be a top lawyer or chartered accountant (CA) with decades of experience, or a senior bureaucrat or a professor of a repute college and yet he will have to pass this test with at least 60% marks. Except for persons with 10-years’ experience as specified earlier, there is no exception provided.
     
    What Happens to Existing Independent Directors?
     
    The law has some gaps and is ambiguous at some places. It is not clear whether existing directors will vacate their office if they do not pass such test or if they do not enroll in such databank. Will the appointment of an independent director whose name does not appear in such register be invalid or will this be merely a violation of law? 
     
    Similar question can be raised for a person who has not passed the test with the minimum percentage of marks. The intention appears to be that such persons cannot be appointed and in respect of existing independent directors, they may vacate their office. However, this is not said in so many words expressly and clearly. 
     
    Similarly, the wording of the law is ambiguous on whether a company has to select an independent director from such databank only. The purpose of the database may get defeated if a company can appoint someone not enrolled in the databank, but yet, this is not specifically and clearly laid down.
     
    Pros & Cons of the New Rules
     
    The new requirements can be praised to some extent in the sense that independent directors will now be required to have such minimum relevant knowledge to do justice to their roles. 
     
    On other hand, it is also seen that, thanks to constant tweaking of requirements, the number of independent directors required are ever increasing. Their obligations and potential liabilities are also enormous and continue to increase. 
     
    Their remuneration, however, is not guaranteed and can be often very nominal with minimal sitting fees. The new requirements are not expected to be costly. 
     
    Even the fees payable to the Institute for the enrolment are required to be ‘reasonable’. It could be argued that the effort and costs would pay off in terms of knowledge. 
     
    Nevertheless, no attempt has been made to increase the powers of independent directors or ensure they have at least such minimum remuneration that makes doing their jobs worthwhile. 
     
    Independent Directors Have No Real Powers
     
    An independent director today individually or even collectively has very poor powers. He is often provided with some minimal information as statutorily required for board meetings. Some directors can of course attempt to use his personal and moral force to get his queries answered during board meetings and sometimes in between but success is occasional. If he is not happy, the eventual recourse he has is to resign. He may go public but he risks legal action since usually he may not have adequate information and documentation to back his claims. 
     
    There is no institutional or legal process he can take advantage of to express his views (preferably anonymously) and see that wrongs are corrected. Independent directors may also be often treated with contempt by management and as an unavoidable nuisance. 
     
    I would not be surprised if the allegations (as yet unsubstantiated) in Infosys case where two independent directors are said to have been referred as ‘Madrasis’ and a woman director referred to as ‘diva’. 
     
    Thus, neither from remuneration point of view, nor from personal satisfaction point of view, is the office of being an independent director so very worthwhile.
     
    Then there is the issue regarding the fast track implementation of these provisions. As of now, even the Institute and database or even the educational material or test system does not seem to be fully ready for the new requirements. 
     
    While some time has been given for the transition, this would still make it difficult for many to comply. If the rules are taken literally and narrowly, it is possible that many independent directors would become disqualified and some may vacate their office. 
     
    Clearly, some clarification and relaxation both in terms of time and requirements is needed. Generally, the office of independent directors also needs a holistic relook, lest most of the cream of the crop quietly leave the scene being underpaid, underpowered, under-respected and over-obligated. 
     
     
    (Jayant Thakur, a Chartered Accountant with an experience of over 25 years, is proprietor of Jayant M Thakur & Co. Mr Thakur also advises several listed and non-listed companies and intermediaries on SEBI laws.) 
     
  • Like this story? Get our top stories by email.

    User

    COMMENTS

    vswami

    3 weeks ago

    OFF hand > https://www.facebook.com/swaminathanv3/posts/2486794868063451
    courtesy

    US regulator probing whistleblower's charges: Infosys
    Global software major Infosys on Thursday said American capital markets regulator Securities and Exchange Commission has initiated a probe into the alleged unethical business practices of Chief Executive Salil Parekh and Chief Financial Officer Nilanjan Roy.
     
    "The Company has been in touch with the Securities and Exchange Commission regarding the anonymous whistleblower complaints and has learnt that the SEC has initiated an investigation into this matter," said Infosys in the statement.
     
    Infosys pledged to cooperate with SEC's investigation.
     
    SEC's mission is to protect investors, maintain fair, orderly and efficient markets and enable capital formation.
     
    Infosys shares are traded on American stock exchanges as American Depository Receits.
     
    A few anonymous employees Infosys have accused Parekh and Roy of unethical practices for many quarters, along with concerns on Parekh's travels to the US and Mumbai.
     
    "Parekh and Roy have been resorting to unethical practices for many quarters, as evident from their e-mails and voice recordings of their conversations," said the complainants, who called themselves 'ethical employees' in a 2-page letter to the city-based IT behemoth's board of directors on September 20, a copy of which has been accessed by IANS.
     
    According to the whistleblowers, Parekh directed the employees to cook account books to show favourable numbers and coerced staffers not to reveal crucial data to board members.
     
    Updating the bourses about the Indian capital markets regulator Securities and Exchange Board of India (SEBI), the Bengaluru-based company said the regulator demanded additional information about the anonymous complaints.
     
    Infosys said the additional information will be provided to SEBI.
     
    Infosys stated that it is aware of the class action lawsuit filed against it in a federal court in the US because of the many whistleblowing complaints.
     
    "The Company intends to defend itself vigorously in such a lawsuit," Infosys stated.
     
    At 10 a.m., Infosys shares were trading 1 per cent lower at Rs 644.25 on the BSE. 
     
    Disclaimer: Information, facts or opinions expressed in this news article are presented as sourced from IANS and do not reflect views of Moneylife and hence Moneylife is not responsible or liable for the same. As a source and news provider, IANS is responsible for accuracy, completeness, suitability and validity of any information in this article.
  • Like this story? Get our top stories by email.

    User

    COMMENTS

    Newme

    4 weeks ago

    Is the CEO Parekh a Gujarati?

    We are listening!

    Solve the equation and enter in the Captcha field.
      Loading...
    Close

    To continue


    Please
    Sign Up or Sign In
    with

    Email
    Close

    To continue


    Please
    Sign Up or Sign In
    with

    Email

    BUY NOW

    online financial advisory
    Pathbreakers
    Pathbreakers 1 & Pathbreakers 2 contain deep insights, unknown facts and captivating events in the life of 51 top achievers, in their own words.
    online financia advisory
    The Scam
    24 Year Of The Scam: The Perennial Bestseller, reads like a Thriller!
    Moneylife Online Magazine
    Fiercely independent and pro-consumer information on personal finance
    financial magazines online
    Stockletters in 3 Flavours
    Outstanding research that beats mutual funds year after year
    financial magazines in india
    MAS: Complete Online Financial Advisory
    (Includes Moneylife Online Magazine)
    FREE: Your Complete Family Record Book
    Keep all the Personal and Financial Details of You & Your Family. In One Place So That`s Its Easy for Anyone to Find Anytime
    We promise not to share your email id with anyone