Treat, not kill

PSU banks are too important for financial inclusion to allow them to fail

In the early 1990s, Harshad Mehta exploited the manual transactions undertaken by banks to get rich. Fake bankers’ receipts, not backed by underlying assets, were issued by two little known entities to secure funds. Some banks transferred money that was to be used to buy government securities into his personal account to play the market so that they could get better returns. Shares were held in physical form. Long positions could be carried forward from settlement to settlement after paying a nominal charge. Brokers undertook proprietary trades using clients’ money. The scam triggered the transition to automation in banks and the stock market. If modern trading practices have increased the size of the market, the downside is limitless damage. The rollover of letters of undertaking by some employees of Punjab National Bank did not leave a trail despite using the Swift network to direct money into its accounts in foreign branches of Indian lenders since 2011. The fraud, estimated to be more than Rs 11000 crore, was detected when there was a change in personnel mid 2017. In 1995, a two-centuries-old British bank vanished into thin air due to unauthorized trading by a 28-year-old derivatives trader in Singapore.

If an individual’s greed brought about a great institution’s demise, the meltdown of the global markets in September 2008 stemmed from the financial markets’ insatiable hunger for profit. To capitalize on the housing boom, there was a scramble to buy and sell mortgaged-backed securities comprising a cocktail of low- and high- rated paper. Eventually, prices of homes reached bubble territory. Buyers dried up, leading to loan defaults. Not only Wall Street firms but even those in remote places such as Iceland ended up holding worthless instruments. Finally, the US government forced many of the too-big-too-fail financial services providers to merge and allowed some to die. A few smaller economies in the euro region had to be bailed out by the rich nations.  The first conclusion is that money skimming schemes can occur with or without digitization. Second, internal controls and risk management are invariably lax. Third, greed at every level contributes to the blowout. Fourth, due to global linkages, the fallout is across partners within and outside the border. The PNB money-siphoning scandal has come at an inopportune time. Credit growth is reviving. The period for recognition of non-performing loans has been shortened. Time-consuming restructuring processes have been junked. Borrowers are being shepherded to insolvency. The headwinds of demonetization and roll-out of GST are fading. Yet, the demand for privatization of the ailing nationalized banks is growing louder. The rise and fall of Global Trust Bank, one of the earliest new-age private banks, should silence the vocal proponents of wholesale selloff of government-controlled peers. Goldman Sachs owned 4% and the International Finance Corporation 5% when GTB suffered in the market crash of 2001 due to exposure to Ketan Parekh-boosted stocks in 2001. It was acquired by Oriental Bank of Commerce in August 2004. Shareholders received nothing.

Nonetheless, the grouse against political interference, from appointing top managers to influencing to whom and where to lend, cannot be dismissed, going by the fate of UTI. Flagship US- 64 scheme bought KP stocks even as their market value was plunging mid 2000.  Getting a whiff of trouble, there was a run on the scheme mid 2001. Units of Rs 10 were redeemed at Rs 14.20 when the actual value was less than Rs 8. In July, purchase and sale of units was frozen for six months. A 10% dividend was declared. Repurchase was undertaken at face value. The then NDA government had to spend Rs 3500-crore on recapitalization. PSU banks need to thrive as they are important links in the last-mile connectivity of various financial inclusion schemes. The strategy to revive the PSU asset management company can be copied to clean up the banking system. In August 2002, UTI was split into two. Tax sops were extended to US-64 and assured returned schemes. These were handed over to the Specified Undertaking of UTI, managed by a government-appointed team. The shortfall in US-64 scheme was Rs 6000 crore and of ARS Rs 8561 crore. UTI Mutual Fund got other net asset value-based schemes. Shareholding was offered to some PSU banks. When the market recovered, Suuti returned all the support provided by the government and was wound up in 2012. In the same way, the top 10 banks’ assets can be divided into good and bad banks. Bad loans can be disposed of at a good price as economic recovery catches speed and the bad banks dissolved. The government should remain a strategic investor, instead of owner, in good banks.

Mohan Sule