by Sandhya Krishnan and Ritmbarah Arora
It looks like the woes of the financial sector aren’t about to end – be it mounting NPAs and defaults, considerable lending exposure to high risk sectors, higher provisioning, credit downgrades of borrowers and worst of all, the emergence of scams. The latest entrant in the troubled banks’ list is Punjab & Maharashtra Co-operative Bank (PMC), a Mumbai based cooperative bank, where a banking scam surfaced with possible ramifications to the tune of $1 billion.
Arrests of senior management suspected of fraud involvement have quickly happened. But the length of the scam raises concerns on regulatory oversight and the ignoring of early red flags.
Role of HDIL: Tip of the iceberg or a deeper rot?
People in the know have revealed that the fraud might have first begun way back in 2008, with bank officials allegedly creating accounts with fictitious names to fund sinking real estate company HDIL for over a decade. The involvement of the top management, including that of suspended MD has also come to light, where Rs 6,226 cr or the equivalent of 73% of PMC’s loan book was extended to HDIL. It is also alleged that in spite of the PMC bank Chairman being part of HDIL’s Board, the loans were not classified as a related party transaction.
These are gross violations of prudential banking norms. In fact, PMC lent Rs 98 cr to HDIL in Aug 2019 to fend off NCLT proceedings. HDIL filed for bankruptcy recently.
It is believed that RBI’s digitalization push has helped expose fraudulent practices. In fact, RBI red flagged the issue of Chairman’s interest in HDIL and recommended his removal to the central registrar, the body that oversees the functioning of multi-state cooperative banks. This request was not acted upon and the Chairman continued working until his recent removal by RBI.
Latest setbacks for PMC
There have been a large deposit withdrawals from the Punjab & Maharashtra Co-operative Bank (PMC Bank) in a span of a few days, as a result of which RBI placed a curb on the bank activities. The large withdrawals started on September 19, amounting to more than 5% of total deposits. These withdrawals and the attendant capital erosion forced RBI to place restrictions on withdrawals on September 23. The bank’s total deposit base was reported to be over Rs. 11,500 crore at the end of March 31.
Apart from the withdrawal of deposits, PMC Bank has also been active in the issuance of Letter of Credits (LCs). The total contingent liability of the bank was reportedly around Rs. 1,721 crores as on March 2019. About Rs 176 crore of LCs issued by the bank and discounted by other banks is expected to fall due shortly. PMC Bank will be required to repay these banks at the end of the tenure of LCs. The RBI has barred PMC Bank from carrying out regular banking activities in the meantime. The Mumbai Police has filed a case against the former bank management and HDIL, and said that a special investigation team will be scrutinizing the case.
RBI to the rescue
RBI swung into action and took a series of steps to address the situation. The Central Bank superseded the PMC Board and appointed Jai Bhagwan Bhoria to function as the bank administrator.
Prior to this, RBI had restricted the withdrawal limit of depositors to Rs 10,000 for the next 6 months, hiking it from the previous restriction of Rs 1,000 following a public outcry by bank customers. The new limit will allow 60% of the bank’s depositors to withdraw all of their money. The grounds cited by RBI were ‘’necessitated on account of major financial irregularities, failure of internal control and systems of the bank and wrong/under-reporting of its exposure.”
Commenting on how a scam of such a magnitude went undetected, MoS Finance, Anurag Thakur said “PMC is an eye-opener for the banking sector that such incidents should not take place at the outset. It also raises a question mark on the role of various people, including regulators, auditors and bank directors. Government will look into all areas as it impacts the common man.’’
Unanswered questions
Several questions remain unanswered in the scam involving the money of mainly small savers of a bank that boasts of operations spanning over 7 states. It raises skepticism of why the PMC Board, auditors and RBI were kept in the dark for such a prolonged span of time. The flagrant violation of lending to a single entity in excess of the regulatory cap is alarming. If one goes by the annual report numbers, it suggests a rather different story - one of healthy capital adequacy i.e. over the required 12% and NPA ratio of less than 4%. While, it is too early to comment on the validity of the fraud occurrence, one thing’s for sure, the end sufferers remain the depositors.
Time to weed out rotten apples in the financial sector
The financial sector is seeing its fair share of troubles, having witnessed ICICI Bank’s internal fraud perpetuated by the erstwhile CEO, IL&FS default, high profile borrowers who duped SBI and PNB, distressed condition of Reliance Capital, DHFL and and concerns over asset quality and capital adequacy in case of Yes Bank and Lakshmi Vilas Bank respectively. While the above episodes exposed the fault lines in the financial sector, it has also served as a wakeup call.
Perhaps to further strengthen the industry, it might be prudent to tighten disclosure and lending norms, and even merge or liquidate fragile players, who fall short of required capital or are unable to stay profitable in spite of a long tenure of operations, so as to avoid further pain or shocks in the system. The financial services sector, especially banking, which is the backbone of the economy has a crucial role to play in helping India achieve its goals of becoming a $5 trillion economy by 2024. The name of the game should be quality over quantity.