One year after PMC Bank scam: Are there any lessons learnt?

Financial MESS

The Indian financial system was in focus last year. Many have been worried about the stability of the financial system (both banks and non-banks). Before the Covid-19 moratorium set in, three financial institutions -- a bank, an urban co-operative bank, and a shadow bank -- either collapsed or were saved from the brink of collapse. Yet, it seems, hardly any lessons were learnt.

On the evening of September 23, 2019, the Reserve Bank of India (RBI) decided to crack down on one of the big-ticket co-operative banks in India -- Punjab and Maharashtra Co-operative Bank (PMC Bank).

The bank account holders were not allowed to withdraw more than Rs 1,000 from their accounts during this period of restrictions. It appointed an administrator and superseded its board of directors, sending shock waves among its depositors. However, giving in to the political pressure, on September 26, the restrictions were eased and the withdrawal limit was raised to Rs 10,000 for six months.

Panic-stricken customers rushed to the bank’s branches across the state. Their hard-earned money was milked by real estate players led by the now bankrupt HDIL with the connivance of some bank officials.

As RBI swung into action, the details of the scam came out. It was revealed that the bank had lent a whopping 75% of its Rs 8,383.33 crore loan book to just one entity — real-estate firm HDIL. On the deposit side, the scam-ridden bank had just 30% of its depositors controlling 92% of its deposits. The urban cooperative bank (UCB) had 70% of its accounts with a total balance below Rs 25,000. Of the Rs 11,617 crore deposits with the bank, only Rs 898 crore was owned by depositors with a balance of less than Rs 25,000.

One year on, the bank’s deposits continue to be under moratorium with the withdrawal limit of Rs 1 lakh (all inclusive). The moratorium has left many of the bank’s 9 lakh depositors in deep distress. Some, who has put all their life savings into the bank, say they are struggling to clear loans or pay their children’s school fees, while others say they depend on friends for their groceries.

As the issue dragged on, the depositors paid the price for idiosyncrasies of certain people. Who were they?

Firstly, owners of HDIL -- Rakesh Wadhawan and Sarang Wadhawan -- members of extended Wadhawan family. Wadhawans were known for their lavish lifestyle.

Secondly, PMC Bank Chairman Waryam Singh. In a conflict of interest, Singh also held a stake of 1.9% in HDIL till September 2017 and was the non-executive director of the real-estate company between 2005 and 2015. During this time, the bank was sanctioning loans to HDIL.

Consider the example of YES Bank

Earlier, on the morning of September 23, when RBI cracked down on PMC Bank, YES Bank, which has also fallen prey to the idiosyncrasies of yet another aggressive and flamboyant owner -- Rana Kapoor -- was batting on a sticky wicket.

YES Bank was trying to justify that it was well capitalised and was in no need of any funds.

The bank, which was India’s fifth largest before it crashed, had to be placed under moratorium and the management was superseded on March 5, 2020 -- less than six months after the action against PMC Bank.

According to the Enforcement Directorate, Kapoor and his family members got benefits worth Rs 4,300 crore through companies controlled by his family as kickbacks for sanctioning huge loans through YES Bank. He is also accused of receiving bribes for going easy on loans given to a few big corporate groups that had turned into non-performing assets.

In fact, under Rana Kapoor, YES Bank was being called ‘lender of last resort’, as the Bank used to say yes to financing each and every stressed entity that came its way, albeit with a high upfront payment of 10%, and in some cases, it went as high as 15%. To bolster investor mood, the bank used to evergreen the loans every now and then.

The ED has linked Yes Bank for various frauds and transactions amounting to Rs 3,700 crore as debentures in DHFL. The central bank appointed administrator at Dewan Housing Finance (DHFL) has ordered a transaction audit at the non-bank lender after allegations of money laundering surfaced in the aftermath of the regulatory action on YES Bank.

On November 20, 2019, under Section 45-IE (I) of the Reserve Bank of India Act, 1934, the central bank removed the board of directors of DHFL. The reasons cited by the banking regulator for the dismissal of the DHFL board of directors were: inadequate governance and the various defaults on its payment obligations.

Interestingly, DHFL is owned by sons of late Rajesh Wadhawan -- Kapil Wadhawan and Dheeraj Wadhawan -- first cousins of HDIL’s Wadhawans.

The eerie similarities don’t end here. In August 2019, offshore investor Ocean Deity Investment Holding, which owns a majority stake in the JV with HDIL -- Mack Star Marketing -- alleged that YES Bank gave unauthorised loans to the JV. The money, it was alleged, was not used by the JV but was moved to other HDIL group firms to repay loans taken by them from YES Bank. However, HDIL’s connection to the YES Bank scam has hardly been investigated, as DHFL took the centre stage.

In the case of YES Bank, despite the learnings from PMC Bank, the RBI acted very late, causing chaos in the financial system. The picture was clear by September 2019 itself -- write off of NPAs was waiting, depositors were ditching the bank, and capital had stopped coming. Yet RBI gave it a long rope -- which many governance experts questioned.

But the devil is in the detail. Section 36ACA of the Banking Regulation Act lays the ground for RBI seizing the control of the Bank. It states: “Where the Reserve Bank is satisfied, in consultation with the Central Government ....the Reserve Bank may, for reasons to be recorded in writing, by order, supersede the Board of Directors of such banking company for a period not exceeding six months as may be specified in the order.”

When RBI comes to decide that it needs to take such action is mostly dependent on the subjective assessment of the situation.

In case of prompt corrective active (PCA) -- that restricts the lending capabilities of the bank -- RBI has set trigger points on the basis of CRAR (a metric to measure balance sheet strength), NPA and ROA. But in case of superseding the board of the bank and placing it under the moratorium, it has been left to the judgment of central bankers.

With three big financial institutions failing in six months before Covid-19 moratorium sets in, it may well be the time for RBI to learn from the errors in the past and make much needed changes in the system.