The last time Reserve Bank of India was forced to issue a statement on the robustness of India’s banking system was back in October 2008 in the wake of the global financial crisis. So, on October 4, after the implosion at the Punjab and Maharashtra Co-operative Bank, when the RBI reiterated that the banking system was “safe and sound”, quite a few eyebrows were raised.
Not just because this was seen as an over-reaction, disproportionate to the rumblings at a mid-sized, Maharashtra-based cooperative bank with a deposit base of just Rs 11,000 crore, but also because the RBI itself has a few questions to answer.
For, the PMC scam went undetected for around 11 years despite the RBI requiring all regulated entities — including cooperative banks — to submit details of transactions and accounts to it since February 2016.
The RBI clampdown on the bank, ironically, came 48 hours after PMC’s former Managing Director Joy Thomas apprised it of the fraud by way of a letter dated September 21. From a regulatory perspective, an even more worrying implication of the PMC implosion, experts said, is how it deepens lingering suspicion that banks and NBFCs could be hiding the full extent of their bad loans.
Preliminary investigations into the PMC Bank scam point to elaborate window-dressing by the bank’s top brass, primarily by way of floating fictitious accounts belonging to dead account holders to hide the loans awarded to the bank’s single biggest borrower, real estate firm HDIL.
“It was fraud involving the top management and the borrower. There was forgery, falsification of records and the bank was indulging in under-reporting. The RBI took action when it came to its notice. Only a forensic audit could have detected the problem,” said a top-level source close to the central bank aware of the development. The RBI did not respond to formal queries sent on the issue and the central bank has officially maintained that it responded “swiftly and promptly” after the PMC issue was brought to its notice and that only a forensic audit could have unearthed the fraud.
Indications of nervousness on Mint Street, though, are palpable.
In fact, sources confirmed, that with its back to the wall after the NBFC crisis and now with the PMC scam, the RBI is working on revamping its regulatory and supervisory structure by creating a specialised cadre of officers for supervision — a primary role of the central bank. Offsite supervision as well as analytical vertical are being strengthened, alongside a beefing-up of onsite supervision, market intelligence and statutory auditor roles for supervision, officials indicated.
The RBI has also proposed to create a mechanism for sharing of fraud-related information among urban cooperative banks (UCBs) on the lines of Credit Fraud Registry (CFR) that is in place for commercial banks which will enable sharing of information on fraud in a timely and uniform manner across the sector.
That Rs 6,226 crore, or almost 74 per cent of PMC Bank’s advances, went to just one group - Housing Development Infrastructure Ltd (HDIL), promoted by Rakesh Wadhawan — that has since become a non-performing asset precipitated the unfolding crisis.
This PMC-HDIL link went undetected for over a decade despite it violating the fundamental tenet of RBI norms — disallowing corporates from owning banks or dominating the transactions in a bank’s books. Moreover, on February 25, 2016, the RBI revised its “Master Direction” — communication to entities it regulates — that should have had an impact on PMC’s disclosures. For, it explicitly asked that all entities regulated by it, including cooperative banks, “are required to share/submit details of transaction/accounts”.
Two years later, around March 2018, the RBI started asking for indent for the “advance master” — list of accounts. It was here that the bank management, investigators said, replaced the stressed legacy accounts belonging to HDIL with dummy accounts to match the outstanding balances in the balance sheet.
All of this came to light after Thomas, who’s since been arrested, sent his letter.
“The bank management replaced around 44 stressed legacy accounts belonging to a borrower (HDIL) with dummy accounts to match the outstanding balances in the balance sheet. The bank management committed a fraud and hid it from the RBI. Finally they had to report it when it became clear it won’t be possible for them to manage the situation,” an official said.
In 2011, the HDIL group exposure was Rs 1,026 crore while total advances were Rs 2,000 crore. However, by September, the HDIL group exposure ballooned to Rs 6,226 crore while total advances were Rs 8,383 crore. As much as 74 per of the bank’s advances went to HDIL as against the RBI’s exposure norm of 15 per cent for a single group.
This failed to get red-flagged despite former PMC chairman S Waryam Singh having cross-linkages across both the Bank and HDIL, and having held 1.91 per cent stake in HDIL till 2017, two years into his tenure at the beleaguered lender.
“Some of the large accounts were not reported to the RBI from 2008 because of the fear of reputational risk,” PMC Bank’s Thomas said in the letter. Initial investigations by the Mumbai Police’s Economic Offences Wing seem to suggest that the fictitious accounts mentioned in the “master indent” submitted to the RBI in March 2018 included those belonging to a number of account holders who had passed away and some who had wound up their accounts with the bank.
The fictitious accounts were created outside of the bank’s Core Banking System and were simply entries in the indent submitted to the RBI. Audit firm Lakdawala & Co, which audited PMC Bank for FY18-19 and signed its report as recent as on September 7, 2019, maintained that books were in order and, in reference to the doubtful recovery of assets, said that against this, a provision of Rs 26.82 crore has been made by the bank.
A senior government official indicated that the cooperative banks sector, as in the case of the unregulated deposits sector, faces a problem of multiplicity of regulators and so the RBI is not entirely to blame.
But regulations prove otherwise. While the functioning of cooperative banks is guided by the Cooperative Societies Act of the respective states and at the state level, the Registrar of Cooperative Societies of the respective states exercises control over the cooperative banks, the banking functions of the Cooperative Banks are regulated by the RBI under the Banking Regulation Act, 1949 (as applicable to cooperatives).
RBI Governor Shaktikanta Das, in a subsequent statement, said the RBI acted very swiftly and promptly after it was brought to its notice. “The RBI will review all the regulations of cooperative banks and will discuss with the government if required,” he said on October 4.
Two days after Thomas’s letter, the RBI moved to slap curbs on PMC Bank, barring the bank from lending and accepting fresh deposits for the next six months apart from capping withdrawals first at Rs 1,000 per account which was later revised upwards to Rs 10,000 and then again to Rs 25,000.
RBI data shows that of the 1,542 urban co-operative banks operating in the country as of March 2019, only 46 UCBs had negative net worth and 26 UCBs were under directions — with curbs on their operations — of the central bank. But much of this is based on the banks’ books not undergoing a forensic examination.
During 2018-19, six proposals for mergers of UCBs were processed by the RBI. Of these, two merger proposals were approved and are awaiting final approval of the concerned Registrars of cooperative societies and one was rejected. The remaining three merger proposals are currently under process. The licenses of four weak UCBs were cancelled during the period of review, according to the RBI Annual Report.
(Tomorrow: Network of firms HDIL used to divert funds)