Out of control

Cooperative banks should be converted into small finance banks and brought under the supervision of the RBI

Even as the flow of credit to the economy is being eased, the pipeline is springing unexpected but not surprising leaks. The Rs 6500-crore gap in the books of Punjab and Maharashtra Cooperative Bank has overshadowed recent moves to nurse public sector banks to become fit to lend. The attraction of fewer strong institutions to meet the demands of a growing economy will be nullified if investors panic.  The latest cooperative bank to be in trouble created fictitious accounts to give nearly 73% of its lending surplus to a single borrower. Regulations are as good as their implementation. What the implosion underlines is that collusion between cunning customers and corrupt officials is not specific to any category. Broker Ketan Parekh triggered the collapse of the Madhavpura Mercantile Cooperative Bank and the new-age Global Trust Bank, later merged with Oriental Bank of Commerce, by using his access to their treasuries to manipulate stocks.  Punjab National Bank’s board was not aware of the misuse of letters of undertaking by Nirav Modi for overseas transfers from a single branch in Mumbai.  PMC Bank kept quiet despite HDIL not servicing the loans for many years. Auditors of these banks were either careless or collaborators. That these small but systemically important outfits have escaped from being taken over by the government even half a century after nationalization speaks of the powers that have come to control them. The Reserve Bank of India governor has said discussions are on with the Central government to reform the sector. The stage for cosmetic tinkering is over.

The cooperative movement started in the early 1950s, when banks were controlled by large industrial groups. The principle of each member being a stakeholder and a potential borrower was to ensure prudent practices and disciplined repayment. The 0.5% to 1% point higher interest offered by this category compared with government-owned banks, while not unusual in a competitive era after freeing of rates, should have resulted in a scrutiny of their practices. Excluding cooperative banks from exchanging high-value currency notes in November-December 2016 provides hints of the monetary authority’s unease. The PMC management admitted to siphoning of funds by the HDIL group after the board and auditor had approved the annual report and expressed satisfaction with the financial strength. Clearly, the dual-regulatory regime is not working. The RBI supervises their banking function. It does not have the power to constitute, supersede or liquidate the boards or remove directors. Registration, management and audit are by the registrar of cooperative societies.  A committee appointed by the central bank in 2015 had recommended converting multi-state urban cooperative banks with Rs 20000 crore of business into scheduled commercial banks. Even the very few that qualified did not show any enthusiasm. The recently issued norms for on-tap licensing of small finance banks should be modified to envelope these shaky edifices.  In the meantime, these entities should be barred from taking exposure to the corporate sector and instead limited to financing consumer goods, automobiles and gold. Treasury operations should be restricted to inter-bank transactions.  

A rapid crisis action team needs to be deployed to fire-fight a run on banks.  Clamp-down on withdrawals, though necessary to gauge the damage to the balance sheet, can prove counter-productive. Loss of confidence can set off a chain reaction of flight of deposits, undermining the foundation of even stable banks. The first step even before investigation starts into the causes and extend of rot is to ensure liquidity. A centralized contingency fund, with each bank contributing a percentage of its liabilities by subscribing to RBI's lending-rate-linked bonds issued by the task force, can provide support to troubled lenders. They can draw from the pool to return at least the principal if not the accumulated interest of worried savers. It will eliminate an important source of irritant: right now only up to Rs 1 lakh is insured and guaranteed by the deposit-taker. It is likely that housing societies, trusts and other non-profit organizations will be examining safer options. Most will opt for nationalized banks. Mutual funds should woo these risk-averse investors to money market schemes that invest in government securities. Redemption is assured. The entire subscription is available along with modest gains. The tax outgo, too, compares favorably with bank fixed deposits: as per the tax slab up to 36 months. The rate lowers to 20% with indexation benefit beyond that. There is no TDS applicable, unlike on bank fixed deposits if interest income crosses Rs 40000 in the year. Instead of trying to patch up the leakage after each eruption, the RBI’s focus should be on how to replace the pipeline to avoid any disruptions in future.

-Mohan Sule