Punjab and Maharashtra Bank Failure – Saving your savings

Last Updated at: December 16, 2019
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Punjab & Maharashtra Cooperative Bank Failure - Saving your savings

Since the beginning of this millennium, India has been a witness to the collapse of some of the biggest financial and business institutions – from the Unit Trust of India scam that wiped off people’s savings to the more recent Punjab National Bank collapse, IL&FS crisis and the Punjab and Maharashtra Co-operative Bank failure this year. What is strikingly common in all of these is the massive loss to savings of many small and medium level households that often put in a large chunk of their lifetime savings into these institutions. While UTI was a mutual fund backed by SEBI, the Punjab National Bank was a nationalised bank with government backing. IL&FS is a public-private partnership model and Punjab and Maharashtra Bank was a cooperative bank. This highlights that whatever be the structural nature of the institution, there is hardly any real insulation for the safety of deposits. In this post, we specifically focus on the Punjab and Maharashtra co-operative bank’s failure, while also highlighting risks, loopholes in the regulatory framework and steps that a consumer may possibly take to minimise the risk of losing their savings.

How did a cooperative bank with large deposits fail?

  • Founded in 1983, the Punjab and Maharashtra Bank has over 130 branches across India and reported a profit of almost 100 crores for the financial year 2019. How could then a bank with profits, market access and resources fail? The answer lies shrouded somewhere in a potpourri of blatant disregard of RBI guidelines, mismatched exposure to risk loans, political gains and deceitful ministerial motives.
  • The Punjab and Maharashtra bank violated the Reserve Bank of India (RBI) norms to lend heavily to one client, a real-estate firm Housing Development and Infrastructure Limited (HDIL), which itself is facing bankruptcy proceedings.
  • The bank’s financials for the year ended March 2019 did not provide any indication of financial stress, with its capital ratios well within the profitable range.
  • With RBI focusing more on private and public sector banks, the cooperative banks escape vigil mechanisms.
  • Banking Regulation Act, 1949 though applies to cooperative banks, but implements many modifications, such as RBI not having control over the appointment of directors in cooperative banks
  • Exposure to loan to a single entity was camouflaged under many dummy accounts, making detection difficult – thereby underreporting of risk exposure.
  • The total failure of internal controls – one of the directors of the Punjab and Maharashtra Bank had a stake in HDIL (the bankrupt company to which loans were granted)
  • Another deeper regulatory issue is the dual control over cooperative banks by the RBI and the RCS – the Registrar for Cooperative Societies.

How urban cooperative banks affect people and the economy?

There exist more than 1400 urban cooperative banks, rural banks and agricultural credit societies in India. While rural cooperative banks were set up largely to extend credit for agricultural, farm and animal husbandry related work, the urban cooperative banks play a significant role in helping a large section of the unbanked population to get access to credit and financial inclusion. Thus, providing last-mile access to small businesses, when large banks are focused on bigger businesses.

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Role of Deposit Insurance and Credit Guarantee Corporation – Importance for consumers

  • The RBI has placed a restriction limit of only ₹10,000 per account, leading to several hundreds of depositors facing the risk of losing their entire savings. In this context, the Deposit Insurance and Credit Guarantee Corporation comes into play. It is a wholly-owned subsidiary of RBI, which was established under the Deposit Insurance and Credit Guarantee Corporation Act, 1961 for the purpose of providing insurance of deposits and guaranteeing of credit facilities.
  • The maximum amount insured however is only 1 lac rupees and a premium is paid by banks at 0.1% of deposits.
  • The deposit insurance scheme is mandatory for all banks and no bank can voluntarily withdraw from it.
  • While the government is considering a revision to 15 lacs, which would cover 90% of accounts, it is important to know that if a person keeps different accounts, the current amount of insurance of 1 lac is available in aggregate.
  • In case of joint accounts, the order of the names of persons is the determining factor. If the order is the same in all branches – it is treated as one account.

Need of the hour – Synthesising governance norms with economics

Better supervision of the RBI – which must play a greater role of a scrutiniser, and supervisor instead of being a post-event entity. In line with the R Gandhi committee recommendation, the RBI has floated the idea of voluntary conversion of some cooperative banks into small finance banks – albeit with little success. Just like the IL&FS crisis, in the Punjab and Maharashtra Bank case too, there appears to be culpability on the part of the management and the board of the bank. The Malegaon Committee has recommended a “board of fit or proper persons” as opposed to a “board of management” where financially unaware people may take decisions without assessing long and short term repercussions.

Way forward – understanding and minimising risks

In a country with varied businesses, segments and financial needs, there is no denying that we need small finance banks, cooperative societies, payment banks and NBFCs. However, while legislative changes and accountancy mechanisms are carved out, it is important for individual investors to understand the risk profiles of their investments. While it may be tempting to invest in a new government-backed scheme promising high returns, one must assess their own “risk appetite” and balance it with gains. It is also a good idea to follow past records of the company, their financial documents, antecedents available while also following up their ratings and predictions on investment websites. It is worthwhile to always remember to diversify one’s resources, and not put all eggs in one basket.

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Punjab and Maharashtra Bank Failure – Saving your savings

337

Since the beginning of this millennium, India has been a witness to the collapse of some of the biggest financial and business institutions – from the Unit Trust of India scam that wiped off people’s savings to the more recent Punjab National Bank collapse, IL&FS crisis and the Punjab and Maharashtra Co-operative Bank failure this year. What is strikingly common in all of these is the massive loss to savings of many small and medium level households that often put in a large chunk of their lifetime savings into these institutions. While UTI was a mutual fund backed by SEBI, the Punjab National Bank was a nationalised bank with government backing. IL&FS is a public-private partnership model and Punjab and Maharashtra Bank was a cooperative bank. This highlights that whatever be the structural nature of the institution, there is hardly any real insulation for the safety of deposits. In this post, we specifically focus on the Punjab and Maharashtra co-operative bank’s failure, while also highlighting risks, loopholes in the regulatory framework and steps that a consumer may possibly take to minimise the risk of losing their savings.

How did a cooperative bank with large deposits fail?

  • Founded in 1983, the Punjab and Maharashtra Bank has over 130 branches across India and reported a profit of almost 100 crores for the financial year 2019. How could then a bank with profits, market access and resources fail? The answer lies shrouded somewhere in a potpourri of blatant disregard of RBI guidelines, mismatched exposure to risk loans, political gains and deceitful ministerial motives.
  • The Punjab and Maharashtra bank violated the Reserve Bank of India (RBI) norms to lend heavily to one client, a real-estate firm Housing Development and Infrastructure Limited (HDIL), which itself is facing bankruptcy proceedings.
  • The bank’s financials for the year ended March 2019 did not provide any indication of financial stress, with its capital ratios well within the profitable range.
  • With RBI focusing more on private and public sector banks, the cooperative banks escape vigil mechanisms.
  • Banking Regulation Act, 1949 though applies to cooperative banks, but implements many modifications, such as RBI not having control over the appointment of directors in cooperative banks
  • Exposure to loan to a single entity was camouflaged under many dummy accounts, making detection difficult – thereby underreporting of risk exposure.
  • The total failure of internal controls – one of the directors of the Punjab and Maharashtra Bank had a stake in HDIL (the bankrupt company to which loans were granted)
  • Another deeper regulatory issue is the dual control over cooperative banks by the RBI and the RCS – the Registrar for Cooperative Societies.

How urban cooperative banks affect people and the economy?

There exist more than 1400 urban cooperative banks, rural banks and agricultural credit societies in India. While rural cooperative banks were set up largely to extend credit for agricultural, farm and animal husbandry related work, the urban cooperative banks play a significant role in helping a large section of the unbanked population to get access to credit and financial inclusion. Thus, providing last-mile access to small businesses, when large banks are focused on bigger businesses.

Get FREE legal advice now

Role of Deposit Insurance and Credit Guarantee Corporation – Importance for consumers

  • The RBI has placed a restriction limit of only ₹10,000 per account, leading to several hundreds of depositors facing the risk of losing their entire savings. In this context, the Deposit Insurance and Credit Guarantee Corporation comes into play. It is a wholly-owned subsidiary of RBI, which was established under the Deposit Insurance and Credit Guarantee Corporation Act, 1961 for the purpose of providing insurance of deposits and guaranteeing of credit facilities.
  • The maximum amount insured however is only 1 lac rupees and a premium is paid by banks at 0.1% of deposits.
  • The deposit insurance scheme is mandatory for all banks and no bank can voluntarily withdraw from it.
  • While the government is considering a revision to 15 lacs, which would cover 90% of accounts, it is important to know that if a person keeps different accounts, the current amount of insurance of 1 lac is available in aggregate.
  • In case of joint accounts, the order of the names of persons is the determining factor. If the order is the same in all branches – it is treated as one account.

Need of the hour – Synthesising governance norms with economics

Better supervision of the RBI – which must play a greater role of a scrutiniser, and supervisor instead of being a post-event entity. In line with the R Gandhi committee recommendation, the RBI has floated the idea of voluntary conversion of some cooperative banks into small finance banks – albeit with little success. Just like the IL&FS crisis, in the Punjab and Maharashtra Bank case too, there appears to be culpability on the part of the management and the board of the bank. The Malegaon Committee has recommended a “board of fit or proper persons” as opposed to a “board of management” where financially unaware people may take decisions without assessing long and short term repercussions.

Way forward – understanding and minimising risks

In a country with varied businesses, segments and financial needs, there is no denying that we need small finance banks, cooperative societies, payment banks and NBFCs. However, while legislative changes and accountancy mechanisms are carved out, it is important for individual investors to understand the risk profiles of their investments. While it may be tempting to invest in a new government-backed scheme promising high returns, one must assess their own “risk appetite” and balance it with gains. It is also a good idea to follow past records of the company, their financial documents, antecedents available while also following up their ratings and predictions on investment websites. It is worthwhile to always remember to diversify one’s resources, and not put all eggs in one basket.

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Avani Mishra is a graduate in law from the National Law Institute University, Bhopal. She qualified the Company Secretary course with an All India Rank 1 and is a recipient of the President’s Gold Medal for her academic distinctions. She also holds a B.Com degree with a specialization in Corporate Affairs and Administration.