The crisis at Punjab & Maharashtra Cooperative Bank Ltd (PMC) has once again raised basic questions over the Reserve Bank of India’s (RBI) role as a regulator and how well it has discharged its job as a guardian of financial stability.
Looking at past experience, one is compelled to be sceptical about the long-term measures the RBI may initiate to prevent recurrence of such a crisis.
But let’s start at the beginning. The PMC Bank was started in Mumbai in 1985 as a multi-state urban cooperative bank (UCB) and went on to open 137 branches across six states.
As of March 2019, its deposits and advances were Rs 11,617 crores and Rs 8,383 crores respectively. It had over 51,000 members and about 9,10,000 depositors. Its net profit was Rs 99.69 crore in March 2019, as against Rs 100.90 crore in March 2018. The bank’s gross non-performing assets (GNPA) were 3.76% and net NPAs were 2.19% of its advances.
It had a capital adequacy ratio (CAR) of 12.62%, much above the level of 9% prescribed by RBI. In addition to this, the PMC Bank was regularly audited by the statutory auditors and also by the RBI. It was among the top ten UCBs of the country.
On September 24, the RBI issued a notification under sections 35 (A) and 56 of the Banking Regulation Act restricting the amount that can be withdrawn by the depositors to Rs 1,000 for six months (now raised to Rs 10,000) and prohibiting PMC from granting any loans.
The board was superseded and the RBI appointed an administrator to run the day-to-day affairs of the bank. The extreme action has been taken by the regulator in public interest and the interest of the depositors.
What went wrong?
With a CAR above what was prescribed by the RBI, a relatively low share of NPAs and stable level of profits, what went wrong with the PMC? As of now, reports indicate that its excessive lending to Housing Development & Infrastructure Ltd (HDIL), which is now under liquidation, could have caused the sudden rethink on the part of the regulator to resort to the extreme measure.
A few media reports have also noted out of its advances of over Rs 8,300 crore, over Rs 2,500 crore, a disproportionately large share, has gone to HDIL. More recently, at least one report indicates that the HDIL exposure could even be over Rs 6,000 crore, a mind-boggling sum of money for a bank of PMC’s size.
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Although HDIL had defaulted in its repayment schedule, the PMC had not classified the loan as an NPA. With liquidation proceedings on, there is little hope of the cooperative lender expecting repayment; all that remains is the security, which may or may not cover the hole.
It appears likely that the HDIL loss, if accurately reported by the media, will be too much for the bank to withstand.
Customers stand outside a PMC Bank ATM. Photo: PTI
The importance of UCBs
Urban cooperative banks have specialised in catering to people of limited resources in urban areas. To quote from the RBI’s Report on the Trend and Progress of Banking in India for 2018, “Co-operative institutions play a significant role in credit delivery to unbanked segments of the population and financial inclusion within the multi-agency approach adopted in India.”
According to the same report, there were 1,551 UCBs at end-March 2018. To whom do they primarily lend? According to a study undertaken by the RBI-appointed Gandhi Committee on UCBs, small loans up to a limit of Rs 5 lakh accounted for over 53% of the total loan accounts of 50 scheduled UCBs and another 27% of the accounts comprised of loans between Rs 5 lakh and Rs 10 lakh. In contrast, the share of loan accounts of Rs 1 crore and above was less than 1%.
This is evidence enough to underline the reach of UCBs in the age of renewed stress on financial inclusion. This data also proves to be quite shocking when juxtaposed against PMC Bank’s exposure to HDIL.
Nevertheless, because of the general skew in loans given out by UCBs, advances given out to loan accounts greater than Rs 1 crore comprise nearly 60% of the total money that has been lent.
A glance at the RBI’s website helps us to understand the scope of the powers of its Department of Co-operative Bank Supervision (DCBS). Co-operative lenders are often seen as a state government’s responsibility because the Registrar of Cooperative Societies (RCS) of each state has a certain statutory role in relation to registration, administration, audit, supersession of the board and liquidation.
What measures has the central bank taken?
Nevertheless, the RBI’s DCBS has specific powers in the following areas:
- Laying down prudential norms on capital adequacy, accounting standards, classification of assets, provisioning etc.
- Fixing single/group exposure norms and sectoral exposures
- Conducting on-site and off-site supervision
- Calling for statutory/other returns
- Off-site monitoring of the financial position of banks.
- Initiating supervisory actions against individual UCB to improve the financial position.
- Giving directions and operational instructions
- Imposition of penalty.
No matter how you look at it, as the final monetary authority, the RBI has powers to monitor the working of UCBs. This power has evolved over years of experience and based on reports of several expert committees.
Indeed, its supervision has been fine-tuned with the recommendations of successive study groups like the Malegam Committee (2011) and the R. Gandhi Committee (2015). Rigorous monitoring became imperative after the collapse of Madhavpura Mercantile Cooperative Bank, which was entangled with Ketan Parekh’s infamous pay order scams of 2001 and the findings of the Joint Parliamentary Committee on Stock Market Scam (2002).
In fact, as recently as June 2018, the RBI had announced a new slew of measures “with a view to strengthening governance” in UCBs by setting up a board of management (BoM) for each bank.
Also Read: How Much of a Monetary Boost Will We See from the RBI?
The BoM would be a professional team of management with autonomy on the functioning of the bank under the oversight of the board of directors. The RBI would have the power to remove the members of or supersede the BoM. The guidelines were to be made applicable to UCBs with Rs 100 crore of deposits within one year. These guidelines were framed in furtherance of the advice given by the Malegam Committee and reiterated by the Gandhi Committee.
At the time, it was reported that UCBs vehemently opposed the RBI’s proposal and it is unclear whether this system has been put in place widely.
In June 2018, the RBI announced a slew of measures “with a view to strengthening governance” in UCBs. Photo: Reuters/Altaf Hussain.
RBI’s concern on health of UCBs
The central bank has also been trying to evaluate the health of UCBs in terms of the now standardised CAMEL parameters.
It’s 2017-18 Report on Trend and Progress of Banking in India said this:
The financial robustness of UCBs is assessed through CAMELS (capital adequacy; asset quality; management; earnings; liquidity; and systems and control) ratings. (Chap 5, para V. 18)
The reality, however, was that these banks needed the expertise to run their affairs professionally.
As recently as June 2019, in his address at NIBM, Pune, RBI governor Shaktikanta Das acknowledged this weakness of UCBs:
Our experience suggests that the Board of Directors of UCBs require greater expertise and skill to conduct banking business professionally. The Reserve Bank is in the process of issuing guidelines on this issue.
At PMC Bank, the board of directors apparently were not even kept in the loop regarding the loans given to HDIL. Clearly, more work needs to be done.
Is there a regulatory failing?
The central bank, therefore, has been aware of the shortcomings of UCBs and the need to take corrective measures to put them on a sound footing. Through its multi-fold powers and its on-site and off-site monitoring of the PMC, the RBI should have picked up the warning signals. The PMC Bank’s very large exposure to a single client was not an overnight development. Evidently the exposure was swelling and the RBI had the means to know it.
It would be incredible that as a regulator, the RBI had no knowledge of the serious dangers the PMC was exposed to on account of its excessive lending to a single borrower and its associates. The notification restricting the withdrawals and granting of advances is tantamount to bolting the stable after the horse has fled.
In case of commercial banks, the losses could be covered under the carpet through mergers of loss-making banks with better-run banks, on the lines of the merger in 2004 of the Global Trust Bank with the Oriental Bank of Commerce. That measure protects the depositors’ money although the tax-payer loses in terms of provisioning for loan losses and capital infusion from the exchequer.
Also Read: PMC Bank Restrictions Leave Customers, Employees Feeling Worried
Even if it had no choice, the RBI’s actions over the last two weeks have hit the small depositors of the PMC hard. Reports have started appearing narrating the hardship of customers who put all their savings in the bank. While the underhand dealings at the PMC Bank will soon be exposed, the regulator’s failure has also contributed to the heavy price being paid by people who patronised a bank they had trusted.
Considering the fact that public memory is short and institutions do not generally learn the lessons from earlier mishaps, PMC may not be the last of the crisis faced by the Indian financial sector.
At the same time, the imbroglio underlines the urgency of long-term measures and effective regulatory oversight by the central bank as guardian of the financial system. If that is done, another PMC may not recur.
T.R. Bhat was joint general secretary of All India Bank Officers’ Confederation from 1995 to 2009.