PMC Bank - RBI's Draconian Action to Freeze Customer Deposits

The Reserve Bank of India, under the powers vested with it under Section 35A of the Banking Regulation Act 1949, placed Punjab and Maharashtra Cooperative Bank (PMC Bank) under its directions for a period of six months from the close of business of the bank on 23^rd September 2019. Specifically, the following directions were issued to the Bank:

·    Depositors will be allowed to withdraw a sum not exceeding Rs. 1,000 ($14, yes you read that right!) of the total balance in every Current, Savings bank, Term or any other deposit account by whatever name called, subject to conditions stipulated in the RBI Directions.

·     the Bank will also not be able to grant or renew any loans and advances, etc without prior approval in writing from the Reserve Bank;

·    the Bank cannot open new accounts or accept new deposits 

With the above the directions, the Bank essentially ceases to be operational and has the effect of placing it under a run-off mode.

PMC Bank, established in 1984, is a multi-state scheduled urban co-operative bank with its area of operation in the States of Maharashtra, Delhi, Karnataka, Goa, Gujarat, Andhra Pradesh and Madhya Pradesh. PMC Bank has a network of 137 branches in six states and ranks among the top 10 cooperative banks in the country.

The announcement of the direction led to a panic amongst the depositors who rushed to the branch to lay their hands on their hard-earned savings only to return distraught and disappointed. Many of the customers had their life time savings with the Bank due to both proximity and good interest rates given by the bank. The fact that the entity is regulated by the RBI adds to the Trust amongst depositors.

Many have their primary account with the PMC Bank with standing instructions for Mortgage payments, Pension receipts, Salary account, Utility payments, school fees etc. By restraining the withdrawal to Rs 1,000 ($14) over the next six months, the RBI has played a cruel joke!

RBI’s Powers u/s Sec 35A

The directions were imposed in exercise of powers vested in the Reserve Bank under Sub-section (1) of Section 35A of the Banking Regulation Act, 1949 read with Section 56 of the said Act.

Section 35A in Banking Regulation Act,1949 empowers the Reserve Bank to give directions —

1       Where the Reserve Bank is satisfied that—

a)   in the public interest; or

aa) in the interest of banking policy; or

b)  to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or

c) to secure the proper management of any banking company gener­ally

it is necessary to issue directions to banking companies general­ly or to any banking company in particular, it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions.

2       The Reserve Bank may, on representation made to it or on its own motion, modify or cancel any direction issued under sub-section (1), and in so modifying or cancelling any direction may impose such conditions as it thinks fit, subject to which the modification or cancellation shall have effect.

The issue of the directions by the Reserve Bank should not, per se, be construed as cancellation of banking licence by the Reserve Bank. The Reserve Bank may consider modifications of these directions depending upon circumstances.

RBI’s regulatory oversight model

Co-operative Banks in India are registered under the Co-operative Societies Act. The cooperative bank is also regulated by the RBI. They are governed by the Banking Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1965.

Banking related functions are regulated by the RBI and management related functions are regulated by respective State Governments/Central Government. Powers have also been delegated to National Bank for Agricultural and Rural Development (NABARD) to conduct inspection of State and Central Cooperative Banks.

The co-operative banking structure in India is divided into following main 5 categories:

• Primary Urban Co-op Banks
• Primary Agricultural Credit Societies
• District Central Co-op Banks
• State Co-operative Banks
• Land Development Banks

Many of the regulatory norms applicable to a commercial bank also apply to cooperative banks, e.g. Capital, liquidity and other prudential limits.

In case of PMC Bank, while the capital ratio (12.6 per cent as of March 2019) was above the RBI’s requirement, despite a sharp increase in the gross non-performing assets to 3.8 per cent from 1.9 per cent in the previous year, which impacted its profits. Nevertheless, the bank had reported profit for the year.

So, what went wrong at PMC Bank?

Co-operative banks usually finance small borrowers in industrial and trade sectors, besides professional and salaried class. Also, the prudential lending norms would limit exposure to single obligor to 20% of the tier 1 capital and 25% for an obligor group.

However, the information in the media is that the Bank had a large exposure to a Real Estate Company, HDIL (Rs 2,500 crores - $350m) while its Tier 1 capital $140m. If this is true, this is a clear case of fraud by management and the Board. 

Several questions emerge from the above:

1. How could the Bank lend 250% of its capital to a Single Obligor against a prudential of 20%? Against a limit of Rs 200 crores (assuming it was legit customer), the Bank lent Rs 2,500 crores!
2. How could the company borrow from the cooperative bank when as per its charter it can only lend to its members? 
3. Why did the RBI not pick this up as part of its prudential supervision from a simple review of the Large Exposures report? 
4. What is the extent of oversight does RBI have on these entities?

These are some pertinent questions for which RBI owes an answer to the depositors of the Bank.  For its negligence in oversight, the RBI has put thousands of depositors into untold misery.  

What could the RBI have done?

The principal role of the Central Bank is to maintain financial stability and prevent risk of a contagion.  Unfortunately, RBIs action will create panic amongst customers and will potentially lead to a bank run on other cooperative banks. 

RBI cannot absolve of its responsibility to supervise these institutions properly.  If RBI is issuing banking licenses, then the onus is on it to regulate them properly.  The fact that RBI gives a banking licence to an institution, the depositors assume that these are regulated by the RBI and repose their Trust in these institutions.

Not only has the RBI failed in supervising these institutions but has added to the misery by freezing deposits.  This is both negligent and inexcusable.

Instead of a freezing the operations of the Bank, the RBI should have taken several other measures like (not an exhaustive list):

1. Freeze new big ticket lending and renewals and let the Bank carry on with its transaction banking activities and small business loans (with a cap of say ~$0.5m per obligor) while conducting its investigation to establish facts on this exposure; 
2. Sought the Bank to sell part of its loan exposure to other banks to shore up its liquidity and funding;
3. ask the Bank to increase its capital contribution from members;
4. prosecute the errant officials and Board members for flouting the rules and perpetrating a fraud by granting the loan against the norms;
5. seek damages from auditors for their negligence and ban them from practice for failing to report irregularities in both lending norms and provisioning;
6. stitched up a takeover over the weekend for Re1 by writing off the entire capital like the take-over of Banca Popolare di Vicenza by Intesa Sanpaolo in Italy. Assuming even a write down of 40% on this large loan, it would support a take-over at Re1.

The RBI should have pursued some of the above actions before freezing the operations of the Bank which is essentially putting the Bank on a run-off mode. 

Deposit insurance
Many of the depositors with balances below Rs 1 lac would be able to recover their amounts under the Deposit Insurance and Credit Guarantee Corporation of India (DICGC) though this would only kick in if the Bank is liquidated.

Conclusion

The RBIs action to freeze the Banking operations of PMC Bank is draconian and for the customers of the Bank this is worse than the effect of Demonetisation. 

The RBI needs a lot of explaining to do for its failure of regulatory oversight and act with urgency to relieve the pain of the depositors.

The Great Indian Fiscal Give Away

In an effort to jump start the flagging economy, the FM announced, in a surprise move (or should I say knee jerk move?), a big fiscal give away by reducing the Corporate Tax rate to 22% (25% including surcharges and cess), giving up ~$20bn in tax receipts (Rs 1.4lakh crores).  Such a big shift in fiscal plan should be ideally be part of the budget and a matter for parliamentary discussion. This shows that the government has very poor strategic planning and is always on a tactical mode with piecemeal announcements that do not show the larger design of these actions.

Quite expectedly, the market received the news with cheer sending the equity indices up by ~6%. While this is positive, it remains to be seen whether it holds on to these gains or the benefit of the entire initiative is lost if economy continues to flag which could well result in markets giving up these gains.

The move has effectively resulted in frittering more than the special dividend received from the RBI’s (adjusting for the budget dividend assumption of ~Rs 85,000 crores).  This tax rate cut would push the fiscal deficit higher by ~50bps and take it closer to the 4% mark (after considering the RBI special dividend). 

While the Companies are looking for top line growth while the government has handed a bottom line relief.  This Corporate tax rate cut is a right move at the wrong time!

When Trump cut taxes for the Corporates, they did not rush out to invest it in more manufacturing or expanding their business.  They enhanced their earnings per share by either buying back stock or paying down the debt. Increase in corporate profits need not necessarily lead to higher investment unless the economic outlook improves.  Otherwise, it will most likely be used to pay down debt or buyback shares to boost Earnings per share for the shareholders.

And tax rates are not the only reason when investment decisions are made.  Several other factors like, ease of doing business, availability of skilled labour, state policies, land acquisition norms, law enforcement, social harmony, infrastructure etc. amongst other things.

While it is important to maintain the international competitiveness and keep the tax rates in line with regional manufacturing hubs, tax rate is not the only factor that drive investment decisions.  If that was the case, all the tax havens would have been manufacturing hubs.  Be that as it may, the urgent need in the current scenario is to drive demand higher and put more money into the hands of the people. 

Money going to people (instead of Corporates) will help drive consumption which will revive growth and nurse back the manufacturing sector and bring back jobs which will then lead to further earnings for people thereby creating a virtuous cycle.

What could the government have done instead?

This fiscal give away could have been directed better with greater (and perhaps a multiplier effect) on the economy:

·      Raise the minimum slab for income tax and deliver tax relief of Rs 50,000 crores;

·      Invest in market access of farm produce and raise MSP;

·      Reduce / Rationalise GST for specific sectors that are deeply hit to an appropriate level to drive up demand;
·      Cash for clunkers to drive auto demand;

Further actions are required besides the Tax rate cut for Auto like review of BS6 implementation timeline, review of insurance rates, reduction in road taxes etc. to improve automobile demand.

The proposal for real estate sector is unlikely to lead to a revival of the sector as the unfinished development and unsold inventories is not wholesome.

The above suggested actions would have more salutary effect than the headline grabbing Corporate Tax rate cut.

Sequencing of reforms is very important.  When Banks recapitalisation was required, the government gave Demonetisation shock further exacerbating the stress on Banks (as more assets went into NPA, Banks distracted with cash activity etc,). 

Before the economy could recover from that shock, it gave GST, without proper testing of the system and added to the stress on the economy.  Now when direct fiscal stimulus is required, it has come up with the Corporate tax cut that will do precious little to revive growth in the short term. And in the long term we are all dead!  This tax rate cut is a right move at the wrong time!

Unfortunately, this Government continues with its approach of headline management instead of well thought out actions to manage the economy!