Concern over India’s co-operative banks

Paul Gosling looks at the crisis that has hit the sector in recent months

India’s central bank, the Reserve Bank of India (RBI), has taken control of Punjab and Maharashtra Co-operative Bank, one of the country’s largest
co-op banks. 

Under the direction of the Reserve Bank, depositors were initially restricted to withdrawals of no more than 1,000 rupees (about £11) from any account – a sum subsequently increased. The PMC Bank was also prevented from issuing new loans, though it is able to continue with conducting other business. 

An administrator and committee of advisors have been appointed to oversee the running of the bank. “The Reserve Bank is monitoring the position of the bank and will continue to take necessary steps in the interest of depositors,” the central bank said in a public statement.

The Reserve Bank took over the 36-year-old PMC Bank after concerns arose about the accuracy of its financial statements. Mumbai police are investigating allegations of fraud and have established a special investigations unit to investigate the PMC Bank. Its former managing director, Joy Thomas, and chair, Waryam Singh, have both been arrested.

Allegations against the PMC Bank centre on its relationship with property company Housing Development and Infrastructure Ltd, HDIL, which reportedly obtained 44 separate loans from PMC Bank. It is alleged that PMC Bank failed to properly report in its financial statements that these loans were non-performing and that it greatly exceeded the bank’s permitted exposure to any borrower. HDIL reportedly accounted for three quarters of PMC Bank’s total 89bn rupee (£992m) loan book.  

Mumbai police have also arrested senior directors of HDIL. A government valuer has been appointed to determine the market value of HDIL’s assets – though the company’s shares continued to be traded on the National Stock Exchange of India at the time of going to press. In a public statement, the Stock Exchange said: “The Exchange has sought clarification from Housing Development and Infrastructure Limited with respect to recent news item captioned PMC bank issue fallout: HDIL promoters arrested after dubious loans discovered. The response from the company is awaited.”

The problems of PMC Bank are part of a pattern afflicting India’s co-operative banking sector. More than 20 co-op banks are now under RBI’s administration, though PMC Bank is the largest so far to be taken under protection and direction.  PMC is one of India’s five largest co-op banks with more than 900,000 depositors and 137 branches, including in the Maharashtra, Karnataka, Goa, Delhi and Gujarat states. The bank has been particularly favoured for deposits by Sikh gurdwaras (temples, which provide social services).

According to the Financial Times, there are almost 100,000 rural co-operative banks in India, as well as more than 1,500 urban co-op banks.  While most of the co-op banks are small, taken together the sector is systemically very important – accounting for 11% of total bank deposits – and there is only so much failure that an already weak Indian economy can cope with. Given that typically the small rural co-op banks and societies hold deposits in the larger urban co-ops, failure of a large urban co-op bank could have a terrible domino effect.

Until now, the biggest crisis for India’s co-operative banking sector was in 2001, when the Madhavpura Mercantile Co-operative Bank was found to be insolvent. It had loaned money to stockbrokers to finance high risk investments – and one of the brokers built up substantial debts that he was unable to repay. Although the bank was rescued by RBI, its failure led to systemic concerns about the co-operative banking sector and the governance of the individual banks. Those anxieties have now resurfaced.

The Reserve Bank has responded to these latest concerns by issuing a public statement at the beginning of October in an attempt to reassure depositors and the wider financial market. Chief general manager Yogesh Dayal stated: “There are rumours in some locations about certain banks including co-operative banks, resulting in anxiety among the depositors. RBI would like to assure the general public that the Indian banking system is safe and stable and there is no need to panic on the basis of such rumours.”

This message followed a statement from RBI governor Shaktikanta Das that “RBI won’t allow a co-operative bank to collapse.” But he added that RBI is in talks with the federal government to discuss a regulatory overhaul of co-operative banks. It need hardly be said that it is not usual for a central bank to openly admit there is speculation on the health of its banking sector. The Indian federal government has called for a study to determine if other co-op banks have similar problems to those of PMC Bank.

The RBI’s comments are in the context of growing calls in the Indian media for action to strengthen governance of co-operative banks, with some discussion about privatisation and forced mergers. However, there is also political support for co-operative banks, with a widespread recognition of their role in addressing financial inclusion across India and for their support for rural co-operative societies, which have a crucial role in assisting small scale farming, purchases of fertilisers and the provision of rural credit. Rural co-operatives in India collectively have a vast number of members – estimated variously at between 120 million and 200 million individuals – and are said to represent around 67% of those living in villages.

In the southern state of Kerala a merger of 13 district co-operative banks is seen as an expression of strength, rather than weakness. This merger was an election promise of the Left Democratic Front, which won the state election in 2016. District co-op banks are being amalgamated with the Kerala State Co-operative Bank to form a new Kerala Bank, at the instigation of the state government. Under the terms of the proposed merger – approval for which had not been given by one of the affected banks at the time of publication – the state would need to bolster the capital of the new bank, in return for the adoption of a strong governance structure. The merger has been agreed by the Reserve Bank and will proceed, subject to legal challenges to be heard in court. The LDF is keen for the Kerala Bank to provide loans to support investment in agriculture schemes.

Yet, there are certainly no grounds for complacency either about the co-op bank sector, or the wider economy. The collapse last year of the listed infrastructure group IL&FS sent shock waves across the country. IL&FS controlled 24 companies and had interests in another 135 associated companies and six joint ventures. At the time of its collapse, the group owed 900bn rupees (£10bn), much of which it was unable to repay.  

A massive fraud at the Punjab National Bank – owned by the Punjab state – which also emerged last year has underlined the extent of the problems facing the country and the government. “Roughly a third of the financial system is on crutches or under suspicion,” said the Economist this month. Many other banks are now under pressure, some have declared themselves to be insolvent and other financial institutions are at risk of collapse. It is no wonder that many people in India believe they are beginning to experience their own version of Lehman Brothers. And we can all remember what happened after that failed in 2008.

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