Updated: Nov 9, 2019
Punjab and Maharashtra Cooperative Bank (PMC Bank) has been facing regulatory actions and investigation over alleged irregularities in certain loan accounts. Loans given to financially stressed real estate player Housing Development & Infrastructure (HDIL) are at the centre of the investigation.
The crisis at PMC Bank first came to light on September 24, 2019, the day the Reserve Bank of India (RBI) placed curbs on the activities of the Mumbai-based bank for six months. The central bank also limited the amount a customer could withdraw from their account during the next six months — to Rs 1,000 at first, and later to Rs 25,000.
What happened at PMC bank?
According to an FIR filed in the case, HDIL promoters allegedly colluded with the bank management to draw loans from the bank's Bhandup branch. The bank officials did not classify these loans as non-performing advances, despite non-payment. Reports estimate the bank’s overall exposure to the HDIL group at around Rs 6,500 crore or over 73 per cent of all of the bank’s advances — and all of this is not being serviced. The bank also allegedly created fictitious accounts of companies which borrowed small sums of money and created fake reports to hide from regulatory supervision.
In 2018-19, the bank had reported a net profit of Rs 99.69 crore in its annual report. The bank showed 3.76 per cent (or Rs 315 crore) of advances (Rs 8,383 crore) as gross non-performing assets (NPAs), which was good performance as compared to public-sector banks. However, it is now clear that the bank presented false financial reports to hide the bad loan mess and the alleged collusion with HDIL and other companies.
PMC’s results in FY19 show no issues with the bank, with net NPAs of 2.19% and capital adequacy ratio (CAR) of 12.62% — above the RBI’s 9% threshold. It was among the top five co-operative lenders in India, with a loan book of Rs 8,383 crore. However, this exposure excludes the bank’s Rs 6,500-crore hidden loans to HDIL as of March 2019, which is facing insolvency proceedings in the NCLT. In other words, PMC’s official exposure to HDIL constituted more than 75% of the bank’s total loans. The bank management replaced 44 loan accounts with 21,049 dummy accounts.
Fault in the financial system
1. Blindsided for a decade
The PMC issue came to light when a whistleblower from the bank wrote to the RBI on September 17 warning about the bank’s hidden exposure to the HDIL group. Subsequently, now suspended MD Joy Thomas and a few officials at the bank met RBI executive director Rabi Mishra to ask for some time to get their books in order. A central bank inspection of the books on September 20 led to Mint Road directions.
Data from the RBI annual report show that the aggregate position of co-operative banks has deteriorated over the past year. As of March 2019, there were 1,542 UCBs, down from 1,550 a year earlier. Last year, 39 of these banks had a negative net worth, which had increased to 46 in 2019. As of March 2019, 26 banks were under RBI directions, up from 20 last year.
2. Focusing on the details
The RBI’s Financial Stability Report, released in June 2019, said that at the system level, CAR of UCBs remained unchanged at 13.6% between September 2018 and March 2019. However, the CAR of four lenders was below the minimum required 9%. In a June 2018 guideline, RBI stipulated that UCBs have a professional board of management to oversee daily business operations. The central bank specified that this board should have well-qualified members who do not have any business relationship with the bank. For UCBs with a deposit base of over Rs 100 crore, such a board should come within a year. One is not sure whether such a board exists at PMC.
UCBs face growth constraints because of the high cost of capital. Unlike a commercial bank, UCBs have to raise capital from members on par and cannot charge a premium. Besides, the dividend is almost compulsory, making it like a quasi-debt instrument. To address this constraint, the RBI allowed UCBs voluntary conversion into small finance banks in September 2018. No UCBs have yet taken that offer.
3. Dotted line supervision
Although RBI regulates co-operative banks from the financial aspects, the management supervision is done by state and central governments. In other words, RBI can prescribe the best practices to run a bank but cannot make any changes in bank management unless in an emergency situation.
UCBs are primarily registered as cooperative societies under the provisions of either the State Cooperative Societies Act of the state concerned or the Multi-State Cooperative Societies Act, 2002. RBI prescribes prudential norms for capital adequacy, income recognition, asset classification and provisioning, loans and advances, investments and liquidity requirements. Further, guidelines have also been given to UCBs in respect of single/group exposure norms and sectoral exposures.
The issues in co-operative banks span governance, technology, capital and skillsets. This is a 200-year-old sector in India and is, in a way, the genesis for banking in India, so there are legacy issues. Unfortunately, the RBI is not in full control; so, it is up to these banks whether they want to change their processes and systems or become extinct.
There is also the question of cross-holding of deposits within these banks, with ultimately the small saver holding the can. PMC, for example, had accounts of other cooperative banks, 1,754 co-operative credit societies, including ironically, the RBI employees’ credit society, and 15,000 other cooperative societies’ accounts that also include co-operative housing societies.
Do we need UCBs?
The universe of UCBs is not very big. Total deposits of UCBs at Rs 4,56,500 crore is just 3.87 per cent of the entire banking system. Similarly, advances of Rs 2,80,500 crore is about 3.20 per cent of commercial banking advances. These banks are also not serving any specific purpose or catering to any geography. Commercial banks have reached out to every corner of the country. In fact, the product profile of UCBs is similar to commercial banks in retail and business banking and MSMEs.
The problem is that UCBs are scattered all over. There are about 1,551 entities with only 54 under the scheduled bank category (following RBI guidelines) whereas 1,497 are unscheduled UCBs. The government has taken a good step of creating a few large PSBs for better serving the market and monitoring them. Like public sector banks, UCBs also mirror each other. Most have a poor governance structure, lack of professional management, weak risk management system, lax credit appraisal system etc. They are surviving primarily due to the blessing of political parties. The RBI has often faced issues in KYC violations, no proper fraud detection system, lack of anti-money laundering systems etc. In the case of Punjab & Maharashtra Cooperative Bank, there are reports of under-reporting of NPAs. Currently, the risk to the bank's portfolio comes from unsecured personal loans, business loans and MSMEs exposure. While RBI has allowed restructuring of MSME loans in the recent past, there are reports of stress in MSME loans.
The purpose of urban cooperative banks was to lend money to small companies and cooperative societies in urban areas with them providing attractive interest rates. With PMC is one of the five largest urban cooperative banks in India, it has given quite a big scare to the small businesses with these companies also complaining that their businesses have come to a halt because of the shock since RBI has directed banks to stop all investments, lending and business-based operations for six months. This has happened as a result of concentrated lending and undisclosed bad loans that have gone undetected by the regulators. With mainly UCBs being popular with retail savers and small companies, they have been facing a lot of trouble in the withdrawal of cash for their daily needs too. There are many housing societies all over India who have their savings with PMC. One of them being, Avillion Greenfields, a housing society in Mumbai have nearly 3.5 crores with the bank. They have nearly 200 people from their society with savings at the PMC.
Urban cooperative banks are divided into two tiers based on their area of operation. While only 31% of them are in the tier-2 category, they account for more than 85% of deposits and advances. This has caused distress in the States of Maharashtra, Karnataka, Goa, Gujarat etc. Gaining confidence with the depositors is necessary and has to be given importance going forward.
The way forward
After six months, RBI will take a call on whether to relax some restrictions or extend the period based on the bank's books. If the discrepancies found can be corrected over the course of time, by the sale of assets or other measures, the bank's functions will be reinstated. The RBI will try to clean up the bank's balance sheet and fix its asset-liability mismatch. However, if RBI believes that it is not in the interest of the bank's customers to keep it running, it may lead to complete closure of the bank. In such a scenario, the bank's arrangement with the Deposit Insurance and Credit Guarantee Corporation (DICGC) will kick in and customers will be eligible to claim up to Rs 1 lakh of their deposits with the bank. Until further orders from RBI, customers can only wait and watch whether they would receive their money or not.
Clearly, the RBI should force larger UCBs to convert into small finance banks. PMC, for instance, has a balance sheet of Rs 13,619 crore, which is quite big by UCB industry standards. A year ago, RBI allowed voluntary transition of UCBs into small finance banks. The objective was to allow them more opportunity as banks like the window to access the market through IPOs etc. But there was not much interest.
SFBs are the new banking models where RBI is open to giving licenses to NBFCs, MFIs and cooperative banks. In the first lot, RBI had doled out banking licenses to almost a dozen microfinance institutions (MFIs). SFB licenses are now available on tap. Now is the time to nudge urban cooperative banking.