With most key indicators showing a downward trend, the state of the Indian economy is causing concern in India and abroad, though some diehard optimists continue to clutch at straws to declare that the slowdown in the economy is not as bad as projected. NCLT and IBC are extra-busy handling failing corporates. The sums involved are astronomical, totalling to more than Rs 10 lakh crore. Banks are taking deep haircuts adding to the stress in the financial sector.

At the beginning of 2019, RBI put 11 Public Sector Banks (out of 21) under Prompt Corrective Action because of their burgeoning Non-Performing Assets (bad loans). The situation was papered over by initiating a series of mergers, which saw 12 Public Sector Banks merging to form 4 large banks. The failure of the Punjab Maharashtra Cooperative Bank (PMC) has brought home the adverse consequences of bank failures for depositors. PMC’s banking activities have been suspended for six months by the RBI, which has also put a cap on withdrawals by depositors.

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Initially, the cap was Rs 1,000 which has been increased, in stages, to Rs 25,000 but it is of little comfort to depositors, who were in no way involved in the scam and who had put in their life’s savings in the bank. A video purportedly showing some of PMC banks’ members running away from the back door with cash and jewellery is doing the rounds. PMC Bank was an Urban Multi-State Cooperative Bank subject to regulations by both the RBI and the Central Registrar of Cooperative Societies, yet neither of the two is willing to take the responsibility for their lax supervision.

Preliminary reports indicate that PMC Bank had advanced almost all loans to a single entity ~ a real estate company that had directors in common with PMC Bank. A number of bogus accounts were created to mask the bank’s exposure to the builder. A part of the defalcated money had been used to buy a private plane and a yacht. A similar modus operandi was noticed when the Nonbanking Financial Company (NBFC), IL&FS went under. Notably, rating agencies had given IL&FS the topmost rating which was amended to unsatisfactory only after IL&FS collapsed. Similarly, the 11 Public Sector Banks which had to be under Prompt Corrective Action, were being monitored by both the Finance Ministry and the RBI. In this case also, no one came forward to take responsibility.

Rather, the RBI hastily clarified that it did not have much control over the banks in question because the chief executives of Public Sector Banks were appointed by the Finance Ministry. After the PMC Bank crisis broke out, the Finance Minister and the RBI have made sympathetic noises but at the same time both have categorically stated that the resolution process would be as per law, which does not hold out much hope for the beleaguered depositors.

The constituents of CKP Cooperative Bank, a similar bank that failed five years ago, have only been paid Rs.15,000 so far. Politicians are commiserating with the depositors of PMC Bank only because Maharashtra is in the midst of an Assembly election. Presently, deposits in banks are insured upto Rs. 1 lakh by the Deposit Insurance and Credit Guarantee Corporation (DIGCC). So far, DICGC has paid Rs.4,822 crore in claims on the failure of 351 cooperative banks, which shows that keeping money in cooperative banks is a risky proposition.

One can lose one’s shirt because one will get only a maximum of Rs.1 lakh in case of bank failure, that too after donkey’s years, even if the amount deposited was higher. Statistically, only 7.8 per cent of the total bank deposit base is covered by insurance. Contrast this with the US Federal Deposit Insurance Corporation which guarantees bank deposits up to $2,50,000 and makes payments to depositors by the next business day. The Federal Deposit Insurance Corporation successfully handled 165 bank failures in 2008 and 2009 alone. Reforms are due in the banking sector but the Government is not willing to venture in troubled waters, after public opposition forced it to withdraw the Financial Resolution and Deposit Insurance (FRDI) Bill in 2017.

The contentious “bail-in” clause in the FRDI Bill, which was the crux of the dispute, provided power to the Resolution Corporation (a replacement of the Deposit Insurance and Credit Guarantee Corporation) to cancel the liabilities of a bank on its failure, which effectively meant that in case a bank failed, depositors would not get anything in excess of the insured part of their deposits (which was not specified). To their credit, the Government and RBI have not allowed any scheduled commercial bank to fail, mainly by prompting mergers of weak banks with strong banks and by recapitalising failing Public Sector Banks.

The future may not be as rosy because looking to the humongous amounts of accumulated NPAs with banks, the end of the road may have been reached. NPAs arise as a consequence of the lending of funds beyond the repaying capacity of the borrower. Most of such lending is motivated; the creditworthiness of the borrower is overestimated for extraneous considerations. In most cases, few non-performing loan accounts bring a bank to its knees. The risk for cooperative banks is more because they lend only to members, violating the basic banking principle that funds should not be lent to related parties.

A simple safeguard could be to ensure that an Urban Cooperative Bank does not lend more than Rs.10 crore to a single party while a Rural Cooperative Bank does not lend more than Rs.1 crore to a single party. This would spread the bank’s risk and ensure availability of credit for small borrowers. Similar limits should be imposed on scheduled and nationalised Banks for similar reasons. Corporates needing more funds should be asked to go in for a public offer of shares. The turmoil in the financial sector has placed ordinary citizens in an unenviable position.

With stressed banks and failing companies, the average person does not know where to put his hard-earned money. Even if he is extra-vigilant and goes through the accounts with a magnifying glass, he would never notice anything awry because delinquent entities put manipulated figures in their account books. For example, PMC Bank’s Annual Report dated 12 September 2019 did not give any indication that the bank was stressed and was about to fail within two weeks. Rather, the balance-sheet, as on 31 March 2019, audited by a reputed firm of chartered accountants, shows a net profit of close to Rs.100 crore and Gross NPAs of only 3.76 per cent.

Surprisingly, PMC’s fraudulent conduct was exposed not by auditors or regulators but by some public-spirited female employees of the bank. Probably, a depositor can sleep safely if he puts his money in the State Bank of India, which is in no way better than other banks, having Gross NPAs of Rs.1.68 lakh crore (7.53 per cent of advances) but which would not be allowed to fail because it is the Government’s banker. On the flip side, the interest offered by SBI on its Fixed Deposits would hardly beat inflation. Perhaps, we have reached the position envisioned by the Nobel Laureate Joseph E Stiglitz: “We have banks that are not only too big to fail, but too big to be held accountable.” It is time that we ensured that our banks operate for the public good, not for the benefit of vested interests.

(The writer is a retired Principal Chief Commissioner of Income-Tax)