Patterns behind the PMC Bank meltdown

As scores of depositors shared their stories of financial horror in the wake of RBI’s restrictions, Manjeet Singh Bhatti, president of the Guru Nanak Vidyak Society (GNVS) that is in charge of all Guru Nanak schools and colleges, tried to reassure the restive audience. “We will appeal in the Bombay high court together to get back our money," he said. His audience did not look convinced. Clearly, mere words were not enough to calm the panicky customers of the bank.

The reports of how depositors’ money was used to fund the lavish lifestyle of the father-son duo of Rakesh and Sarang Wadhawan—the promoters of real estate firm Housing Development and Infrastructure Ltd (HDIL) who had borrowed heavily from PMC Bank—seemed to have added fuel to the fire. There has been a well established precedence of companies using bank funds to shore up their equity. But the brazen manner in which the Wadhawans lived it up marks a turning point.

In the background lurk the usual villains: property developers who allegedly over-borrowed; complicit senior bank management, and, of course, politicians who wield considerable influence over co-operative banks. As Maharashtra goes to polls this month, PMC Bank is bound to become a political springboard, depositors be damned.

There have been four arrests since the irregularities at PMC Bank became public. Most recently, the Economic Offences Wing (EOW) of Mumbai Police arrested the bank’s former chairman, Waryam Singh. EOW has already arrested Joy Thomas, the former managing director of the bank, and the Wadhawans.

But depositors are far from being hopeful of a quick resolution in their favour. PMC Bank’s collapse and the subsequent revelations have laid bare the extent of misgovernance in co-operative banks. PMC Bank is yet another one in a long line of failed co-operative banks. And, yet, there’s no learning from past lessons.

“The sector has inherent structural weaknesses because of duality in supervision and other statutory provisions. That requires serious changes in the structure. Fundamental weakness relates to governance in co-operative banks," said R. Gandhi, former deputy governor, RBI.

Same old story

PMC Bank is the largest urban co-operative bank to be placed under RBI watch since the 2001 Madhavpura Mercantile Co-operative Bank crisis that was linked to Ketan Parekh’s stock market scam. While Madhavpura had a large exposure to a single stock broker, PMC Bank had given two-thirds of its loans to a single real estate developer—HDIL—whose creditworthiness was already under a cloud.

“Initially, when the news broke, I thought the scale of the crisis wouldn’t be that big. But after the managing director’s confession, this looks like it’s another fiasco that’s as big as the Madhavpura Co-operative Bank collapse. This is likely to end up in liquidation, and it will take at least 6-7 years to resolve this case," said Mukund Abhyankar, former chairman, National Federation of Urban Co-operative Banks and Credit Societies Ltd.

The crisis at PMC Bank is a symptom of a deeper malaise plaguing around 1,500 co-operative banks in the country. Typically, these banks are loosely monitored as they fall under the dual regulation of both the state government and RBI. While the central bank is responsible for supervision, other activities like bank management are monitored by the Registrar of Co-operative Societies.

The involvement of local politicians in the running of these institutions is another significant reason for the failure of these banks. The politicians hold sway over the boards of these banks and have a say in the appointment of management and board members. Under the Co-operative Societies Act, the board of directors in these banks is appointed through an election by the members. It’s not a professionally run board like in the case of scheduled commercial banks.

“One way of improving governance structure is to introduce board of management in between board of directors and line management. Board of management will be housed with professional, independent directors with due majority and who will be accountable to RBI. Operational decisions should be delegated to this board of management," Gandhi said.

The first signs

On 23 September, RBI curbed all activities of PMC Bank and appointed an administrator for the next six months. The regulator restricted withdrawal of money from customers’ accounts. Actually, large and frenetic withdrawals of deposits were noticed four days prior to the restrictions coming into force.

On 1 October, Mint had reported that nearly 5-10% of total deposits were withdrawn on a daily basis since 19 September. According to people aware of the matter, these withdrawals could be as high as 29% of total deposits. As on 31 March this year, the bank’s total deposits stood at ₹11,617 crore.

The massive fund withdrawals began after some of the large depositors reportedly got a whiff of a whistleblower’s complaint to the regulator. Typically, RBI slaps such massive restrictions if it finds withdrawals beyond a prescribed threshold in a given period. In PMC Bank’s case, more than 60% of its customers had small deposits of around ₹10,000 each in the bank. The whistleblower’s complaint had detailed the massive underreporting of the bad loans by the bank, and its exposure to troubled real estate companies like HDIL. Soon after, PMC Bank’s suspended managing director and chief executive officer Joy Thomas had in a “confession letter" to RBI admitted that the actual exposure to HDIL is over ₹6,500 crore—four times the regulatory cap or a whopping 73% of its entire assets of ₹8,800 crore.

Role of the auditor

Yet, the financials of PMC Bank do not reveal any serious case of financial irregularity. The annual report audited by Lakdawala and Co. shows that PMC Bank had, as on March 2019, reported a net profit of ₹99.69 crore compared with ₹100.90 crore a year ago. Capital adequacy of the bank stood at 12.62% and net non-performing loans were at 2.19%. However, both the regulator and the bank’s auditors seemed to have no inkling of the fact that Wadhawan group’s exposure, which was around ₹500 crore till 2006-07, had grown to a whopping ₹6,500 crore.

In his letter, Thomas wrote that the statutory auditors were checking only incremental advances and not the entire operations in all accounts, due to time constraints. “They validated the incremental loans and advances, and scrutinized the accounts which were shown by us," he wrote.

RBI also missed these stressed legacy accounts during inspections as they were replaced with “dummy accounts to match the outstanding balances in the balance-sheet". In the RBI inspection in 2015, “officers checked mostly the top few borrower accounts reported by the bank branches. Therefore, these accounts did not come into the picture. It was around 2017 that RBI started asking for indent for the Advanced Master," Thomas wrote.

Even as late as August 2018, PMC Bank had given a loan of ₹96.5 crore to HDIL to settle its dues with Bank of India (to prevent the latter from initiating insolvency proceedings against the troubled real estate developer). Bank of India was among the lenders that initiated bankruptcy proceedings against HDIL before the Mumbai bench of the National Company Law Tribunal (NCLT) last year.

PMC Bank and HDIL

The relationship between PMC Bank and HDIL dates back to the mid-eighties. In 1986, just two years after it began operations, PMC Bank was on the verge of a financial collapse after its net worth eroded. The late Rajesh Kumar Wadhawan, erstwhile director of Land Development Corp. and many other companies run by the Dewan family (and subsequently promoter of HDIL), infused ₹13 lakh into the bank during 1986-87. The family also kept a “huge quantum of deposits for the revival of the bank", wrote Thomas in his letter.

The family supported the bank on many other occasions as well. Rakesh Kumar Wadhawan had deposited more than ₹100 crore on one such occasion to help the bank tide over a liquidity crunch. “Since the time Rakesh Kumar Wadhawan started banking with the bank, the performance of all his accounts were good. More than 60% transactions of the bank were from this group," said Thomas in his letter. “In this process, our bank used to charge 18% to 24% interest from their accounts and earned very good profits," he said.

However, things changed after the group started facing a liquidity crunch in 2012-13. One reason was the cancellation of HDIL’s slum rehabilitation project near the Mumbai airport. This led to the group defaulting on dues to all banks, which prohibited the Wadhawans from raising fresh capital or loans, resulting in their projects being stalled.

“The loans outstanding were huge and if these were classified as non-performing assets, it would have affected the profitability of the bank, and the bank would have faced regulatory action from RBI also. Further, this would have created a reputation risk for the bank. As the HDIL group had a good record of clearing their dues with certain delays, we continued to report all the accounts as standard accounts," wrote Thomas in his letter.

The board of the bank was not aware of this matter, confessed Thomas. “The concealment of information was done from the board due to fear of the reputation of the company as the cheques were of small amounts," he said. While Thomas has seemingly confessed, the people in the bank management told Mint that it was impossible that only Thomas took all the decisions, given that there was a loan committee, and that Thomas’ statements had to be reconciled with the books of the bank.

The road ahead

The bank’s depositors are now seeking direct government intervention. Reena Rishiraj, principal of Guru Nanak School, said the school and its teachers have savings accounts with PMC Bank. “We cannot pay our monthly salaries and other bills amounting to nearly ₹80,000 this month," she said.

“The government can easily infuse ₹2,000 crore of funds and restart the bank. It can seize the property of HDIL and help restart the bank. The bank has ₹11,000 crore worth of deposits, and it has lent only ₹4,000 crore to HDIL," said one of the depositors at the meeting.

Separately, representatives from GNVS, Guru Nanak Hospital and Navi Mumbai Gurudwara held a meeting with the bank’s administrator, J.B. Bhoria, last week. “Bhoria said the bank can be restarted only after the investigation and after assessing the losses. He also suggested that if all the major depositors give some assurance to the bank that they will not withdraw their money for 2-3 years, then they could be able to revive the bank," said Amardeep Tony Singh of Pritam Group of Hotels.

In such a charged environment, and just before state elections, such assurances can mean little. Until clarity emerges, the 1.6 million depositors of PMC Bank can only pray for divine intervention.