PMC Bank Crisis -future of cooperative banks

Madhavpura Mercantile Cooperative Bank was a bank having good business with 50000 depositors in 1999-2000 based out of Gujarat. When the bank was doing well, the bank started lending huge sums to stock brokers which was not as per the guidelines issued by the RBI guidelines. The assets have become substandard but the real problem started when the bank issued pay orders worth Rs 1200 crores to Mr. Ketan Parekh which he in turn discounted with Bank of India. They also lend to another brokers lime Maniar Group. The RBI guide lines were not allowing banks to lend more than Rs 15 crore to stock brokers at that time. But the year 2001 was a disaster for stock brokers who had large outstanding positions as the dotcom bubble burst and the Sensex crashed by more than 3000 points. Brokers lost money including Ketan Parekh and Maniar, and repayment problem started. Parekh lost money so the bank, depositors started withdrawing, all should not get. Eventually 2002 RBI cancelled the licence and net result depositor’s hard-earned money gone. This was the largest urban cooperative bank in Gujarat.

Cooperative banks are made under Reserve Bank of India in 1966 for better control, but the real problem started there, the dual regulation. RBI is the regulator for cooperative banks under Banking Regulation Act, for granting licence, maintaining cash reserve, statutory liquidity ratios, capital adequacy ratios and also doing inspection. But the cooperative banks are registered with The Registrar of Cooperative Societies. The Registrar is in control of management of administrative issues, management elections and also auditing. So even if the cooperative banks are advertising that they are licenced with RBI, we may not be understanding the difference they have with private sector banks, which are fully controlled by RBI.

One of the major problems faced by cooperative banks are the political interference, shifting of focus, poor audit systems, not having proper internal audits, poor compliance system etc. After the Madhavpura episode the Reserve Bank tried to create a platform where the problems or loopholes in the working of cooperative banks can be discussed, as they themselves cannot take all action due to dual control. This was an eye opener for cooperative banking system and RBI in association with Registrar of Cooperative Societies constituted a Task Force for Urban Cooperative banks ( TAFCUB) . It was co-chaired by RCS and Regional Director of Reserve Bank and will take the case of each individual cooperative bank and give solutions. The Reserve Bank regulated new licences or branches motivated existing cooperative banks to take over weak cooperative banks. It looked like working, as many small banks were delicenced, merged or liquidated and created a group of banks wo are financially sound. Regular inspection and proper follow up reduced the number of banks who have capital adequacy ratio less than the prescribed limit. In fact, in 2017-18 there were only four urban cooperative banks with poor capital adequacy ratios.

But now in September last week 2019, the news broke out, PMC bank one of the largest urban cooperative banks, one of the largest urban cooperative lenders in the country, that they failed. The real question came in to the minds of every depositor or interested parties that even after these many regulations how can such big scams can happen? OR whether the system is at failure? Merely having systems doesn’t mean that there will not be any problem. We should see that it is implemented and it should be voluntarily abided by the parties. It is an inherent problem in every system that there will be entities who always try to make some business by doing something extra, which are not allowed under the regulations. In the case of Punjab and Maharashtra Cooperative bank case also we are witnessing a clear case of systemic failure from bank’s side rather than from regulators. As mentioned earlier there exists a common platform at state level for finding solutions and avoiding problems at every cooperative bank. Here what PMC has done is fraud, that hiding the details of transactions or exposure, the company is not legally can have from the regulators. It is a huge exposure which is more than four times than the legal limit to a single entity which was hidden from the regulators by creating 20000 plus fictitious accounts. The first and second reaction from the top management of the bank was a clear evidence of things happened with full understanding of the management.

There arises a question, what was the auditors were doing? Are they also taking part in the fraud? Arriving a final answer at this juncture is difficult, but without their knowledge things of this magnitude may not have happened. In the present case there are four problems, 1. Financial irregularity 2. Lack of internal control and systems 3. Under reporting of exposures to hide wrongdoing 4. Lack of compliance reporting. The real problem is the huge exposure the bank had with HDIL a real estate developer. The exposure of the bank was more than four times of the stipulated limit. This might have hidden with the knowledge of auditors, may not be possible to accept the white washing press meet by the now suspended MD. HDIL was a company of more than three decades of experience, developed successfully many properties. The company have helped the bank to come out of turbulent times safely. It created a situation of mutual help, and when the company was finding difficult to swim through troubled waters, the bank given a helping hand by violating statutory regulations.

When we go deep to the problem, this a clear example of misusing of dual regulation by the bank. As the bank is regulated by both RBI and RCS, each of the authorities will start presume things and facts. More over having state control on management of the cooperative banks creates a situation where the banks were managed by nominees of political parties or affiliates. As mentioned earlier the real problem is transparency, governance and compliance issue. There is a scheme announced by RBI for the voluntary conversion of cooperative banks into small finance banks which have a capital of more than 50 crores or capital adequacy of 15%. The central bank should provide some incentive in this entry criteria and make more small banks converted a small service bank. It doesn’t mean that only cooperative banks have problems like this, big corporates, public sector banks, private sector banks etc. also have problems of non-compliances. In the present case one of the solutions is to make the management of the bank capable of making prudent management decision in the interest of the bank, rather than fulfilling the wishes of the political masters. The system of supervision also should be capable of catching any situation which can put the entire customers of the bank at risk.

To conclude we can clearly say that, there should be a proper system of compliance audit rather than just financial audit by a qualified persons like Company Secretaries, in addition to overall improvement in supervision, internal controls and systems, best practices policies, professional management and ethics. Hard earned money of the small investor should not suffer, also the cooperative banks are one of the major places where the small entrepreneurs and common people will get support. They should not fail.