PMC Bank scam is indication of the systemic rot in India’s financial sector

The scam in PMC Bank is not the first and will definitely not be last, unless issues plaguing the banking sector are addressed. This article spells out dynamic prescriptions for safeguarding our banks’ resources and grievance redressal.

Background

PMC (Punjab and Maharashtra Co-operative Bank) was founded in 1984, and has grown into a multi-state bank with over 137 Branches and a deposit base of Rs 11,600 crores and reported advances of Rs 8,383 crores as on 31^st March 2019.

On the fateful morning of 23^rd September 2019, account holders of this mid-sized, Mumbai head-quartered Co-operative Bank –- which has no previous history of serious default, no strictures passed by RBI or Government -– hit the headlines for all wrong reasons. Newspapers reported on their front page that RBI had placed operating restrictions on PMC Bank for a period of six months, but allowed it to remain functional.  Payment transactions by account holders were restricted to a mere Rs 1,000, later enhanced to Rs 25,000 in a phased manner. Barring this concession, money of all depositors and account holders stand entirely inaccessible to them until further notice.

Needless to say, this has resulted in grave hardship to account holders. There was the usual public outrage, media coverage, even threats of suicide by grief-stricken individuals. As expected, electronic messages of assurance by PMC Bank officials that their money was safe was sent to all concerned, notably sent by its erstwhile Managing Director, Joy Thomas – a wily, reticent long timer with PMC.

The days that followed unravelled the grave crisis, initially brushed aside and played down by RBI as “nothing serious”. 

Positives of PMC: One of India’s top Urban Co-operative Bank

PMC Bank has been a compact, useful, service-minded institution, with a young and competent workforce, whose employment must be safeguarded at any cost. The Bank has moved with the times in terms of progressing towards electronic banking and value-added services, which match the best that PSU (Public Sector Undertaking) and large private banks provide. The staff are known to be efficient, friendly, helpful and service minded. 

There is always a functionally advantageous role for such co-operative banks pan-India, bridging as they do, the gap between shadow banking and the large PSU and private banks. The sad act of wrong-doing by a few dishonest people does not – and must not – undermine the valuable role of such banks in a progressive and growing economic environment.

Event and Scale of Damage in this scam

The direct loss resulting from the HDIL (Housing Development and Infrastructure Limited) linked fraud is presently placed at Rs 4,355 crores but it could be higher. The value of loss of PMC Bank’s reputation assiduously built over 35 years is hard to estimate and not easy to rebuild; the agony and inconvenience to customers whose money is blocked is incalculable. The uncertainty over their future employment looming large over the dedicated bank staff is bound to take its toll on them.

The Deeper Malaise

The simple prima facie diagnosis is that the top management of the PMC Bank discovered various systemic loopholes in the working of the bank and exploited them to the advantage of a select group of large and  unethical customers, and in turn, to their own.

The Board of any organisation is mandated to ensure that all major decisions concerning the conduct of business are taken collectively by the elected Directors with care and responsibility, thus precluding the likelihood of ad hoc decisions by those vested with operational powers to misuse them.  This role has, sadly, been compromised.

Who are to be held responsible and brought to Justice

Evidently, the scheming masterminds and abettors of the damage include–

• the active Board Members led by the now infamous Chairman and his complicit Directors for their direct role in scheming to defraud their own  PMC Bank and its depositors
•  the wily Managing Director for his skilful, clandestine criminal role to systematically defraud the PMC Bank wilfully over a prolonged period of 6-7 years as admitted by him in writing to the RBI
•  the senior executives of the PMC Bank for their support role to carry out and fulfil the unlawful directions of the above Directors
•  the management and senior staff of beneficiary organisations, most importantly HDIL (Housing Development and Infrastructure Ltd) — for their direct role in collaborating with the Directors of the PMC Bank to defraud PMC and its depositors
• The Inspectors and other concerned officials of RBI responsible for periodic audit and statutory reporting of the PMC Bank’s performance supported by key records, for their complicity and for not promptly alerting RBI of serious discrepancies noticed during their audit
• The statutory and concurrent Auditors of the PMC Bank — as well as of the HDIL — for their collusive role in certifying false annual accounts, consistently year after year
• The Independent Directors (if any) of the PMC Bank – as well as of the HDIL — for their apparent abetment and not discharging their duties as whistle-blowers
• The working level PMC Bank staff (to a lesser extent) who chose to remain silent and not discreetly report (to RBI) the fraud-in-progress perpetrated by the MD and other executives over a period of several years, and for their support role in opening and operationalising nearly 21,500 bogus accounts discarding all stipulated norms of KYC (Know Your Customer) etc.  How they managed to systematically generate, collate and aggregate the names, addresses, ID proof, address proof, phone numbers, PAN Cards, photographs, signatures, other supporting documents of such a staggering number of people and commercial entities -– followed by covert operation of such accounts and maintaining secrecy over long periods of time, maintaining a holy facade all along, beats one’s imagination. Their exemplary “team-work” in this devious achievement truly deserves “praise” and even a mention in the Guinness Book of Records (pun intended).

Urgent Corrective Measures and Future Safeguards Recommended for ALL Banks – Co-operative or otherwise

The recent statement issued soon after the event by Mr Shaktikanta Das, Governor, RBI on PMC Bank, in which he states with unwarranted bravado that “Banking System, including Co-operatives safe, sound” is indeed incorrect and unfortunate.  There is great and urgent need for improving governance systems of our banks and financial institutions which are undeniably vulnerable and constantly susceptible to fraud, as later sections of this article validate.  A report in The Economist points towards this malaise.

On the ground, the following series of important measures are therefore recommended for urgent and serious action by the Government and RBI, covering ALL Banks and FIs (Financial Institutions). These recommendations lay bare the extant faults, loopholes and weaknesses in our country’s financial systems and regulatory process, and provide the prescriptive ingredients to expeditiously develop a robust regulatory framework henceforth.

1. RBI should create a new, empowered Oversight Body to closely monitor the performance of all Co-operative Banks, NBFCs (Non-Banking Financial Company) etc. Ensure, Stringent Monitoring of Bank Operations by Independent Entities reporting to the above Body with Quarterly Audit of all Branches and pre-audit of all loans approvals exceeding a defined threshold.
2. Introduce new set of effective Oversight Systems and Controls. This could include a new cadre of empowered officials above RBI’s Inspectors to ensure the diligent performance of their enshrined duties.
3. New Corporate Governance Systems needs to be implemented with duly empowered trained, certified and licensed Nominee Directors placed by RBI on the Boards and Committees of Boards of ALL Banks, with annual rotation.
4. Develop a new system of handsomely rewarding diligent staff who spontaneously report incidents of real fraud-in-progress to RBI via new discreet, no-names basis  reporting mechanism via direct hotline to a designated senior watchdog official in RBI, upon veracity of report being ascertained.
5. Institute a new Mandatory Annual Asset Disclosure Procedure by all Directors and senior executives of Banks, in new format. All assets of those declared guilty to be appropriated, sold and proceeds applied to pay affected parties, pro rata, from a pool of such realisations.
6. RBI to utilise PMC Bank’s SRR (Statutory Reserve Requirement) funds to repay depositors and direct the Promoters and Directors of this Bank to recapitalise the Bank or face take-over following IBC (Insolvency and Bankruptcy Code) route.
7. Name and shame practice to be initiated, and permanently bar all such persons from accessing any Bank or other commercial credit facilities in future. Enhance punitive provisions for RBI officials and CA firms found guilty of collusion is bank frauds, following a fast-track process. RBI should compensate depositors for lapses in their regulatory role in not detecting and forestalling such loss in time by their Inspectors and other concerned officials for evidently side lining laid down Inspection and Reporting (I&R) practices set out in its Manuals.
8. Amend existing Deposit Insurance Schemes to effectively safeguard depositors with the assurance of expeditiously settlement of claims.  Present relief limit of Rs 1 lakh is insignificant.  The Insurance Premium in this behalf can also be paid in pre-approved proportion by RBI from source recommended at para 15 below.
9. Fix upper limits for single account / group exposures restricted to less than 3% of Bank’s total Deposit base or Rs 250 /500 crores (in the case of Urban Co-operative Banks), whichever is higher.
10. Fix well-defined sectoral lending caps, industry-wise, geography-wise, reviewed and reset annually. Curtail discretionary lending powers of Bank officials and Directors.Appoint one nominee Director from among the Bank’s large depositors on the Board to safeguard their interests.
11. Constant cross verification of all high value transactions, especially instruments of Documentary Credit which value-wise, do not correlate to the borrower’s reported income and GST and IT returns. Documentary credit are letters of credit and bank guarantees and letters of comfort, which have been brazenly misused by people like Nirav Modi and others. Random check of borrower’s books of account to understand end use progression and realisation of revenues resulting from such payments.
12. Improve loan evaluation process — including hiring outside domain experts to provide their expert professional inputs and unbiased views on each major loan proposal — and strengthen pre-release audit practices.
13. Enhance internal intelligence system of working of Bank branches and controlling offices to detect and preempt fraud-in-process within the organisation, on any scale. Strengthen Bank’s external intelligence network. Competitors, employees, ex-employees and vendors of borrowers are valuable sources of information concerning covert malpractices which are not available anywhere else.
14. RBI to prescribe Standard Operating Ratios, monitoring and reporting accuracy and quality  of which would strictly form part of the new role of its Inspectors on quarterly basis.
15. RBI to apply money held in its custody received by way of penalties collected from various errant Corporates,  Banks and Financial Intuitions each year, and provide a portion of it to aggrieved parties following a phased time-frame and priorities for those who are more troubled than others by the  misdeeds of those in charge. Future profits of the concerned Bank can also be similarly applied.

PMC is not the last Case

Judging by the numerous large-scale and widespread frauds detected in India’s banking and finance sector during the last several years resulting in massive write-offs, it is evident that the rot is very deep in India’s Financial System. Beyond doubt, replication of several PMC-type frauds are already in the making, perhaps on a larger scale.  Yes Bank is a classic example of misuse of bank resources, as their own records acknowledge.  Their shares have lost 96% of recent market value.

A recent report mentions a staggering loss of nearly Rs 32,000 crores in just one quarter of FY 2019-20 collectively in 18 PSU Banks. A total of 2,480 cases of fraud were detected.  Is this a small amount? Isn’t the latest claim by the RBI Governor that “all is well in our banking system” wholly falsified?

Political Parties not responsible for Bank Misconduct

It would be inane to connect the present bank fraud with any political party. Dishonesty, like its twin corruption, is a human weakness inbuilt in the psyche of the vast numbers of unethical people in positions of authority or financial power.  As stated above, frauds of varying magnitude in banks and financial institutions throughout the country have thrived and enlarged since Independence.  Unless prevented via a series of strong deterrent measures, they are very likely to recur.

State Machinery Adequate for Redressal

The State machinery ought to deliver justice within a maximum of six months, following a compressed timeframe using a specially designated fast track court, with day-to-day hearings. 

The State law enforcement and judicial authorities are certainly competent and well-equipped to deal with such relatively small scale and compacts of fraud.

End Note

Acts of unbridled greed are wont to turn aspirations of Joy to lives of unmitigated, enduring Sorrow, which, it is hoped, will be valuable lessons and deterrents for others perhaps busy sketching similar fraudulent actions in other parts of our great motherland.

Finally, PMC as an Institution and the employment of its loyal and trusting employees who helped built the Bank to its leading position it enjoyed must be saved.

The co-operative banking sector must be well supported by the Government, RBI and the public to grow and serve millions of small, micro and medium size customers.

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