Yet Another Collapse – The PMC Bank Saga

Hey readers! Its been a while. A lot of interesting stuff going on in the finance industry so far. Especially, the collapse of multiple NBFCs and Urban Cooperative Banks. In the recent past, the PMC Bank collapse has sought my interest in deciphering what went wrong. So here I am at 6.30 AM on a Saturday morning at Frankfurt Airport, Germany thinking “What must have gone with Punjab Maharashtra Co-Operative Bank? (PMC)”

Obviously with a view 🙂

The PMC saga brings a lot of questions to my mind:

1. Why does it always take years for the fraud to unfold despite the concurrent and regulatory audits? Should a forensic audit every year be mandated by the RBI?
2. How was this irregularity never highlighted in any of the audit reports over a period of 5-6 previous years? Are auditing firms equally irregular in reporting and being the gate keeper of the regulations?
3. Does the financial system learn nothing from the past instances? (Madhavpura Bank for instance!)
4. Does credit growth mean just numbers? Does the health of the credit system not matter?
5. Has RBI started considering financial stability more important than the depositor interests?
6. Is RBI being reactive than proactive? ´Is the Reserve Bank taking too much time to decide on liquidation or cancellation of the banking license in case of a severe financial irregularity?
7. And many more!

In a country so dangerous for banking as India, the practice of lending and borrowing must be conducted on the safest possible principles

John Maynard Keynes

Urban Cooperative Banks constitute 4% of Deposits and 3% of outstanding loans of the Indian banking system. Although, they have not been put in to the category of systemically important banks by RBI, the UCBs form an important part of the banking system. UCBs target markets are the un-banked areas of the country to contribute strongly to the financial inclusion initiative i.e the entire population under the banking umbrella. Without that, the economy will continue to go into the disrupts in the growth cycles.

Recently, RBI intervened and enforced a deposit withdrawal restriction of Rs.1000 per six month which was further revised to Rs. 10000 and consequently to Rs. 25000 providing some relief for the depositors. This affected to close to 9 lac depositors across the country. From an hawk eye view, the bank seemed to be excellent health. Below are the few facts!

Few things about PMC:

1. 5th largest UCB in the country
2. 9 lac account holders
3. Rs. 8383 crores of loan portfolio
4. Rs. 11600 crores of deposits
5. Capital Adequacy of 12.62% (well above the RBI mandate of 9%)
6. 137 branches
7. 7 states of operations
8. A decent growth rate over the years

From the above facts, looks like the bank is on track. However, the devil is in the details and those were exactly what was missed for an entire decade at the PMC bank. The PMC bank is a classic case of breach of credit exposure limits to a certain sector or a single borrower.

Let us take ourselves back to the year 2001. Do you remember a similar incidence and a similar bank going bust? Something related to the stock market exposure of a bank? The Madhavpura Mercantile Cooperative Bank case of 2001 where the bank’s exposure included an exposure to a stock market trader. On 13 March 2001 the RBI found out that the bank’s net worth was −₹1,147.13 crore (US$170 million), its deposit erosion was 90.9% and gross non-performing assets were 88.2% and ₹1,192.81 crore (US$170 million). The next day, the registrar superseded the board and appointed an administrator as the overseer of the bank. On 23 August a scheme for reconstruction of the bank was approved by the RBI for a period of 10 years. Further investigations revealed that after chairman Ramesh Chandra Parikh’s son Vinit had lost ₹50 crore (US$7.2 million) in the stock-market crash, his losses were paid for through the bank’s funds. The unfortunate aspect of the fraud was RBI took 11 years to cancel the banking license finally in 2012. Truly unfortunate!

In case of PMC, the bank has a loan portfolio of Rs. 8383 crores overall with 73% of the loans to a single borrower (HDIL – Housing Development & Infrastructure Ltd.). A clear breach of the credit exposure limits of the RBI regulations. The RBI mandates the exposure to be 20% of the core capital in case of a single borrower or 25% of capital funds in case of group borrowers. In this case, the exposure was at 73% of the overall loan portfolio.

How was this done?

Loans exposure of 44 risky accounts was replaced with 21049 dummy accounts of lower exposures (one of which was the exposure to HDIL). The exposure was taken off the books with safer exposures to be shown. Moreover, the HDIL exposure was untenable i.e non-enforceable. It indicates that in case HDIL defaults or diverts funds from the original funding intent, PMC will NOT have any action left to be taken and will convert into a bad loan.

Loop holes to be bridged in the financial system:

1. RBI needs a better supervision and forensic team to analyze such hidden aspects. The unsecured loans are off the record however must have left out some trail (emails, documentation, people, processing fees etc.)
2. External auditing firms have been under constant firing with all the frauds panning out. I would not agree more that this could have been avoided completely with better auditing standards. I believe PMC has given 9 years (9 regulatory audits) of chances to catch the activity before the depositor funds were in a dangerous situation.
3. Reporting and monitoring for credit exposures needs to be tightened further.
4. A forensic every year is a MUST to have in the financial system. Many banks going bust is not healthy for our growing economy
5. Tightening the licensing of the banks. Issuance of new licenses should be taken off the board by RBI until the existing players in the financial system stabilize
6. Last but not the least, a common link between all the crisis so far viz DHFL fall, IL&FS, Videocon, ICICI Bank etc, is a pure lack of integrity and honesty of the executives for the organization they are trying to build or running. Better recruitment/appointment of the executive and board members would add true value to the banks and their subsequent years of growth. I believe the executives are well off on their personal financial fronts and integrity for their work is the least we can ask for.

Be a smart investor:

1. Maintain deposits of not more than Rs. 1 lac in your savings or fixed deposits (Remember DICGC provides a insurance of Rs. 1 lac in case the bank goes bust so as a depositor you are secured)
2. Invest your savings into liquid mutual funds instead of FDs. The risk of markets fluctuating prevails but the liquid funds are debt oriented and do NOT fall in value as fast as the equities do. As an investor, you would get enough time to react. Also, liquid funds would provide money the very next day on selling off thus providing needed funds for the emergencies.
3. Be aware of the risk of depositing with various types of banks. A deposit with a nationalized bank is much more safer than the cooperative banks.

Thank you! Ending this with a nice saying I came across, “Run…Run behind everything. Just to find out that, the length is infinity and extreme points are only two. Both within you 🙂“