A sustained campaign by depositors of Punjab and Maharashtra Cooperative Bank (PMC Bank) against the massive fraud that gobbled up their savings has triggered a wider discussion on risks attached to cooperative banks and the need for better deposit insurance cover. Will the outcry and debate lead to reform?
If the past is an indicator, the answer is negative. Every major financial scandal has led to some palliative action by the Reserve Bank of India (RBI), often the setting up of a committee whose recommendations are largely ignored.
It is like a game of wits. Can depositors keep up the pressure of public meetings and legal action (which is expensive, uncertain and long drawn) to force a quick resolution and get their money back? Or will RBI win again by remaining silent and waiting for protests to lose momentum and when depositors back to repairing their broken lives and savings?
This may sound pessimistic, but notice that depositors of every massive Ponzi or collective investment scheme fraud have yet to get any significant refunds. Investors in Saradha (got a refund of only Rs10,000), IMA Gold, Pearl/PACL, QNet, Heera Gold or even all the art and plantation scams of the 1990s, haven’t received their money. For that matter, people who have lost money regularly in corporate fixed deposits have suffered the same fate.
The initial burst of actions, including arrests, investigation, attachment of property, etc, are all meant to appease depositors and cool public anger; but the money returned, if any, has been a pittance and that, too, after long time.
When it comes to cooperative banks, things are a lot worse. The banks are usually too small, and hapless depositors too dispersed, to put up a fight. Cooperative banks fail with shocking regularity—of over one a month; but it doesn’t even make news every time (see DICGC data below).
As a category, cooperative banks is the biggest (over 1949)—more than commercial banks (101), regional rural banks (56) and local area banks (3) put together. But they are under the dual regulation (by RBI and the registrar of cooperative societies) and their deposits are also insured to the extent of Rs1 lakh per person.
The effect of this is perverse. Deposit insurance is mainly collected from nationalised banks and large private banks but payouts are always to the depositors of failed cooperative banks.
The table below show the reality.
If RBI bails out PMC Bank with a forced merger, there will be several others, already under administration or in distress, wanting similar treatment. More importantly, it creates a moral hazard and lets off crooked bank management and failed supervision.
Zombie Cooperative Banks
In all these cases, RBI prefers to create zombie banks. It appoints an administrator and freezes all banking operations except recovery of dues. The banks, often, remain under administrators for years—as zombie banks—technically alive by using depositors’ funds to pay the staff, administrator and the branch expenses. RBI follows the same drill in each bank failure and it fails over and over again.
The bigger the bank, the more funds are sucked by them in the zombie state. In PMC Bank’s case, the depositors were told by the administrator that the cost of running the 137 branches across India and salaries will come at a cost of Rs1 crore a day (Rs27 crore a month or over Rs325 crore a year of deposits burnt up).
Inevitably, any recovery of outstanding loans goes into keeping the zombie alive leaving little for depositors. A swift resolution is imperative; however, until now, despite elections in Maharashtra, the government has apparently been under no pressure to find a solution. But what is the solution? So far, public discussion is focused largely on raising deposit insurance.
Is Deposit Insurance the Panacea?
There is a consensus among commentators that the extent of deposits insured must be raised; but the very basis of the discussion seems flawed. The extent of bank deposits insured per depositor shot up from Rs30,000 (since 1980) to Rs1 lakh (in 1993) after the securities scam took down two small banks and roiled the entire banking system and targeted RBI’s failed supervision.
The sum insured has remained static since then because there were no major failures; but that was not because banking supervision has improved. DICGC (Deposit Insurance and Credit Guarantee Corporation) cover doesn’t even take into account the real cost of keeping Indian banking safe. Let us examine why this is so.
Public Sector Banks (PSB): PSBs contribute the biggest chunk of the deposit insurance premium and also account for 70% of all bank deposits by value. Their depositors have never received a payout from DICGC which is why one committee set up by RBI has pushed for risk-based premium that would mainly affect cooperative banks.
However, the country, as a whole, pays a lot more for keeping PSBs alive. These account for the biggest chunk of India’s bad loans which are now over Rs10 lakh crore. In October 2017, Arun Jaitley, then finance minister, announced a massive Rs2.11 lakh crore for recapitalisation of PSBs over two years. This has been released in instalments, with finance minister (FM) Nirmala Sitharaman announcing an immediate release of Rs70,000 crore in August this year.
While depositors’ money is safest in PSBs, it allows bank managements to lend recklessly, while the entire country, including those who have no access to formal banking, pays the price. It is important to remember that only the richest Indians benefit from bad loans that are systematically written off by PSBs. But there is never a sustained public demand to fix this.
Private Banks: A major flashpoint that exposed poor supervision was in 2001, when a security scam led by Ketan Parekh scam took down Global Trust Bank (GTB) and Madhavpura Mercantile Cooperative Bank (MMCB). At one time, UTI Bank (now Axis Bank) was keen to acquire the failed GTB without adequate information about the losses. It was finally force-merged with Oriental Bank of Commerce which affected the latter’s finances for many years.
In the mid-1990s, a set of new private banks got licences in a highly subjective and capricious process. Several of them stumbled and would have failed but were quickly taken over by larger banks, then on a rapid growth path. RBI’s extreme reluctance to issue new licences to private banks has also ensured that every private bank, even the small ones that flounder, find ready buyers.
This has allowed RBI to continue with non-transparent policies with regard to bank licensing, fit-and-proper criteria and level of promoter shareholding, in addition to very poor supervision. Consider how clueless RBI was about Rana Kapoor’s dubious dealings at Yes Bank which, until a few days ago, seemed on the brink of a collapse with no takers. Infrastructure Leasing & Financial Services and Dewan Housing and Finance Ltd, have exposed RBI’s poor supervision; but the cost is borne by depositors, investors and the financial system.
Cooperative Banks: DICGC’s annual report for 2017-18 mentions how it “had to settle claims for large amounts due to the failure of banks” with the result that it had to raise deposit insurance to 10 paise per Rs100 assessable deposits from 2005-06 to shore up the deposit insurance fund. This was in the aftermath of the Ketan Parekh scam of 2000-01 where the resolution process dragged on for years.
A massive Rs385 crore was paid only to MCCB depositors. Here is a list of claims settled by DICGC that year.
Following the debacle, RBI set up multiple committees to re-examine deposit insurance but has not bothered to implement their recommendations. Although rules for deposit-taking non-banking finance companies are repeatedly tightened and even collective investment schemes are better regulated, the cooperative banking sector remains a regulatory mess and continues to mislead people.
We even have a bunch of unlicensed cooperative banks operating as full-fledged banks! According to an RBI report, when “a primary credit society’s owned funds attain a level of Rs1 lakh, it automatically gets the status of a primary cooperative bank” and has to apply for a banking licence thereafter. Many don't bother to do it and continue to raise public deposits with a capital of just Rs1 lakh.
In November 2014, the National Democratic Alliance (NDA) government even bailed out 23 unlicensed district cooperative banks with a massive infusion of Rs2375.42 crore. In the circumstances, it is a little strange to hear FM Nirmala Sitharaman distance her ministry from the PMC Bank debacle.
Given the flawed structure of deposit insurance in India, successive RBI governors have followed a policy of ‘let sleeping dogs lie’. Moneylife too has been opposed to raising deposit insurance (as suggested by the Damodaran committee on customer services in 2011) without fixing structural and supervision issues in the banking system.
Interestingly enough, this flawed structure has allowed DICGC to collect premium every year as a mandatory fee, without the burden of having to make significant payments. In 2017-18, DICGC collected a massive Rs11,130 crore premium at 0.1% of insurable deposits from each bank; it paid hefty taxes, but did not need to shell out any money for settlements, because banks that collapsed had liquid funds available.
Its deposit insurance fund is a fat Rs81,400 crore due to accumulated premium, while it has paid out only Rs5,000 crore, cumulatively, to settle claims of 345 cooperative banks since inception. Last year, it did not need to shell out any money as settlement premium.
Ironically, DICGC ends up making some recovery after the long-drawn liquidation process. In fact, things move so slowly that many depositors don't even collect the money due to them because they are no longer traceable.
Clearly, the flawed system needs urgent fixing and there is nothing like a big financial scandal to get the regulator and government to work towards a better regulation, supervision and accountability.
RBI should force a conversion of cooperative banks into small finance banks or scheduled banks that are only under its supervision.
RBI inspectors and supervisors must be made accountable through a formal system of questioning their inspections. If independent directors of listed companies have onerous responsibilities, why shouldn’t RBI inspectors be subject to even more stringent rules, given that they doing a public duty?
Bank licensing and fit-and-proper rules should to be more transparent to allow easier acquisition of banks.
We need to put in place a time-bound financial resolution mechanism for the financial sector as a whole and for 1,900+ cooperative banks first.
The administrator appointed by Reserve Bank of India (RBI) on scam-hit Punjab & Maharashtra Cooperative (PMC) Bank has asked permission form economic offences wing (EOW) of Mumbai police to sell attached properties of Housing Development Infrastructure Ltd (HDIL) and the company promoters, says a report.
In thereport, the Economic Times says, the city police will soon seek court approval to hand over the assets to the RBI administrator. Confirming the developments, EOW chief Rajvardhan Sinha told the newspaper, "We have received a communique from the RBI asking us to de-attach the properties in the PMC case. We have given them an in-principle no-objection certificate."
HDIL promoters Rakesh and Sarang Wadhawan had given their consent to the auction, and the police will approach the competent court by the end of this week to release all provisionally attached movable and immovable property, estimated to be worth over Rs3,500 crore, the newspaper says.
The planned auction will be carried out under provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest (SARFAESI) Act, 2002, which allows banks and financial institutions to sell properties of defaulters to recover loans, the ET report says quoting two people with knowledge of the matter.
In a tweet, Kirit Somaiya, former member of Parliament (MP) and vice president of Bharatiya Janata Party (BJP)'s Maharashtra unit, says the process to auction free properties of HDIL worth Rs4,000 crore under the SARFAESI Act, has started.
Meanwhile depositors are continuing to hold protests, trying to meet politicians and senior officials from the RBI. However, the RBI has refused to provide any answer so far, even while it has appointed Grant Thornton to conduct a forensic audit.
Earlier this month, the Enforcement Directorate (ED) had seized and identified movable and immovable assets worth more than Rs3,830 crores owned by HDIL, the company directors and promoters, as well as officials of PMC Bank and others related entities in the fraud case.
The Directors of the HDIL were arrested on 3 October 2019 by the Mumbai Police after they were found not cooperating with the sleuths.
It is alleged that HDIL, which is facing bankruptcy proceedings, and its group companies had taken huge loans from the PMC Bank. As many as 21,049 fictitious bank accounts were allegedly created to hide the loans, which were disbursed in violation of RBI norms.
It has also been alleged that HDIL accounted for nearly 73% of the bank's total loans. Out of the Rs4,355 crore loans under the scanner, around Rs2,146 crore were transferred to accounts held by the Wadhawans. An account belonging to the Wadhawans had a balance of Rs2,009 crore on 31 August 2019, according to the FIR.
During the probe by the Reserve Bank of India, it was found that directors of PMC Bank had replaced 44 suspicious loan accounts with 20,149 fictitious bank accounts with low individual balances by tampering with bank software. The PMC Bank's former Managing Director Joy Thomas was allegedly behind the masking of the borrowers' accounts.
On 24 September 2019, the RBI imposed strict restrictions on the Mumbai-based PMC Bank sending sent shock waves in Mumbai’s banking and business circles since the Bank used to be considered very ethical and was known for its high service quality.
Founded in 1984 by S Gurcharan Singh Kochhar, in a small room in Mumbai, it had now grown to a network of 137 branches in six states and ranks among the top 10 cooperative banks in the country.
The Odisha government on Monday had asked all departments, public sector units and state agencies to be careful while depositing money in any bank without proper enquiry. The government notification to this effect went viral on social media after it was reported by a news agency and caused panic among people, leading to a clarification of sorts.
In the clarification on Friday, the government said it does not have any view on the fiscal health of any particular bank and its circular was only meant to avoid opening of new accounts and shifting welfare and developmental funds of the government from one bank to other. Interestingly, the Odisha government had been warning all departments about 'unhealthy competition among banks' while soliciting deposits and dubious strategies. The two circulars only underline that there is something wrong with how government funds are being utilised by banks leading to official action.
On 21 October 2109, AKK Meena, principal secretary of the finance department in Odisha, in the notification, had asked all departments to utilise government funds directly from treasury through the integrated financial management system (IFMS) instead of parking the money in bank accounts.
"Further, it is reiterated that withdrawal of money from treasury without sufficient grounds such as immediate need for utilisation, matching share for CSS, and depositing the same in bank accounts shall be construed as financial irregularity," the notification warns.
It says, "...adverse reports are coming in the newspapers about the fiscal health of some of these banks and apprehensions are being raised in some quarters regarding safety of the deposits in some of these banks. It is to be mentioned in this context that each depositor in a bank is insured up to maximum of Rs1 lakh for both principal and interest amount held by him the same capacity and same right as in the date of liquidation or cancellation of bank's license or the date on which the scheme of amalgamation or merger or reconstruction comes into force under deposit insurance and credit guarantee corporation of India Ltd (DICGC), a subsidiary of Reserve Bank of India (RBI)."
"...the government departments, PSUs or agencies have to be very careful while keeping deposits in any bank and proper enquiry about the financial health of the concerned bank for making any deposit. It shall be the personal responsibility of the concerned authority for such deposit," the notification says.
However, on Friday, Mr Meena issued a clarification stating that there is no reason for anyone to get apprehensive about the financial health of banks in general. The notification says, "Finance department has empanelled certain banks for transactions based on bank's performance within the state for carrying out business with government agencies only. The circular dated 21 October 2019 was only meant to avoid opening of new accounts by DDOs and shifting government funds meant for welfare and developmental activities of government without any reason from one bank to another. Further, it may be noted that the drawal of government funds from state treasury and parking the same in banks for a long period without adequate justification causes loss to the state exchequer, which should be avoided.
The Odisha government has been talking about its funds unnecessarily being parked in banks or transferred from one bank to other. A notification issued by the same Mr Meena on 4 October 2019, talks about 'unhealthy competition among banks'. "...There has been an unhealthy competition among the banks to canvas and solicit government deposits from different departments and government entities and allegations and counter allegations are being received implicating government officers for acting in mala fide. This has resulted in a very ugly situation demanding urgent action to curb the tendency."
In July this year, Odisha government has emplaned 17 banks from the public sector, eight from the private sector, one small finance bank, two regional rural banks and one cooperative bank for handling business and deposits of state-run units and state level autonomous societies for FY2019-20.
Here are banks empanelled by Odisha government for FY2019-20...