Far and wide implications

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By: Ramesh Kanitkar

With the Reserve Bank of India (RBI) imposing restrictions on the withdrawal of deposits of Punjab and Maharashtra Co-operative Bank (PMC Bank), there are new questions being raised on whether the crisis in the public sector banks is spreading to the urban co-operative banks and if it would spread to the rural banks as well. While every slowdown in the economy affects the banking sector as a whole, we need to look at this crisis in isolation. Every time there is a slowdown, the firms that are having marginal profits feel stressed and that creates some sort of a liquidity crisis which permeates to the rest of the economy. The current crisis is said to be as a result of the failure of one large account of PMC Bank that seems to have been built up over a period of time and was undetected by audit and inspection. The RBI has taken the usual playbook steps in appointing an administrator and placing restrictions. Like in the past, it is hoped that the depositor interests will be taken care of, in the resolution process.

In general, RBI has been fairly good at managing depositor interests, but in case of the PMC Bank, the hole seems to be much larger and therefore will be a test case on how it finally gets resolved. While the intriguing nature of the current crisis seems to be the result of a curious build up of one account over years, we should take this opportunity to look at some larger implications. There are possibly four large implications. One, it pertains to how accounts are maintained, audited, supervised and inspected. The banks have completely computerised their operations. We have accounting standards and prudential norms on how to recognise bad loans and record them. Do we have similar standards for providers of banking software? Yes, there are large players who provide software, but is there some process of looking at the flexibilities in built in the software that makes it possible to classify and evergreen loans? There is of course no end to human ingenuity in committing fraud, but if there are adequate technological solutions, it should make it so much more difficult to cheat.

While the RBI has evolved great set of standards for the customer interface – for payment systems, internet transactions, card transactions and so on, we have not heard of stringent standards having evolved for banking software, with service providers empanelled. It is time that the software providers go through a due diligence process and we should have a version control to ensure that the essentials of banking software are not compromised. Two, the static nature of the deposit insurance which covers only Rs. 1,00,000 for deposits set in 1993.

While the Financial Resolution and Deposit Insurance Bill was sought to be introduced to look at the entire framework of crisis of a firm in the financial sector, it spooked the depositors by introducing a controversial “bail in” clause, which theoretically permitted the use of deposits as a resource in case of a stressed firm in its turnaround process. In the current context, the bail in looks dangerous but irrespective of the new reformist framework for deposit insurance, the amount of coverage at current levels needs a review. Three, the larger question of co-operative banks remains. A reading of the annual reports of PMC Bank clearly indicates that there is nothing “co-operative” about the bank. There is hardly a mention about the needs of the members, the products and services rendered to the members or the control systems exercised by the members. The report reads like that of a regular bank.

Here lies the problem of this category of institutions: Primary Urban Co-operative Banks. Co-operatives are expected to function on the larger principle of mutuality where people come together to meet each other’s needs. The moment an institution is a bank, it becomes open to public (and non-members). While RBI has not issued any new licenses for the urban co-operative banks since the failure of the Madhavpura Co-operative Bank, it has been making noises about issuing new licenses from time to time, the latest being when the Gandhi Committee submitted its report in 2015.

New licenses the committee had recommended norms for issuing new licenses. If the overall idea – as suggested by the committee is to consolidate and allow the banks to become commercial banks, there is no point in keeping the tap open for new co-operative banks that neither operates as good co-operatives nor as good banks. Four, the question of how to carry out decentralised and localised regulation of the financial sector to ensure that all regulation does not move towards a centralised regulator like the RBI which may not have the bandwidth to do look into micro aspects. Y. V. Reddy, former Governor of RBI, has been advocating the setting up of state level financial sector regulatory authorities to consolidate all the financial sector activities that come under the jurisdiction of the state governments. These include chit funds, self help groups, co-operative societies, state financial corporations and money lending activities. It is time that the government takes a comprehensive look about the regulatory architecture and re-engineer it to the contemporary times.

At this time, it is important that the RBI ensures that the negative reputational risk of the failure of PMC Bank does not affect the other co-operative banks and the crisis is contained and quickly resolved. Going forward, RBI needs to watch this space of co-operative banks very carefully. INAV

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