Digging Deeper | The PMC Bank saga

Yes, we’ve more than had our fill of bank scams but, apparently, the rot in India’s banking system really does run deep.

What’s different this time? Well, PMC is a co-operative bank. In fact, according to the Economic Times, PMC is the largest cooperative bank to be put under scrutiny by the Reserve Bank since the 2001 Madhavpura Bank crisis that was linked to a stock market scam. The two scams share  similar stories of profligacy and risk exposure. At Madhavpura, the exposure was to a stock broker. At PMC, approx. two-thirds of the loans were allegedly given to a single -  now bankrupt- client in the realty sector.

In this episode of Digging Deeper, we’re taking a closer look at the PMC Bank scam.

Another month, another scam

The Economic Times carried an optimistic column on January 2 this year. The column hoped that the disaster for banking that was 2018 would be left behind and that 2019 might be a better year for the beleaguered sector. Looking back, it almost seems poignant. Madan Sabnavis, chief economist at Care Ratings, told ET, “2019 will be a turning point because we expect most issues to be sorted out giving banks more space for operations. We can expect only positive changes from hereon, which, however, will be gradual in nature.”

We’re well into October now, and one can safely say that the article’s optimism was a tad misplaced.

These last few weeks have uncovered another scam in Punjab and Maharashtra Cooperative Bank, or PMC Bank. This is the long and short of it:

On September 24 this year, customers of PMC Bank woke up to shocking news - a message  from the bank stated it had been put under directions by the RBI for a period of six months. What does that mean? According to an analysis in Moneycontrol, “When (the) RBI puts a bank under its directions, it is practically taking over the bank's operations. The...management is superseded and the board is dissolved. This happens when the regulator is not satisfied with the bank's functioning and takes the step to safeguard the interest of borrowers. In PMC Bank's case, it is said that the regulator found irregularities in lending. Under reporting of non-performing assets or higher than permitted exposure to same group accounts could have led RBI to take the step. An inspection is currently underway.”

Ah yes, the dreaded phrase non-performing assets. It’s like Indian banking’s equivalent of dengue fever.

Soon enough, angry customers demanded explanations from the bank and the police had to intervene to maintain order. In some PMC branches, officials were entirely absent, leading to some panic. ATMs were shut and security guards were seen putting up an apology from the bank’s MD. Customers were hit hard - they could withdraw only up to Rs 1,000 from the bank, irrespective of the type, total balance or the number of accounts. If your account was linked to monthly utility services, the payments wouldn’t  go through. There were restrictions on loan offsets and fixed deposits. It was a nightmare. The RBI increased that limit to Rs 10,000 some days later, and then to 25,000.

The sordid details, allegedly

Then the details emerged: a report in ET claimed, “the extent of irregularities came as a shock...as much as 73% of PMC’s 88 billion rupee loan book – or almost $920 million – was tied to just one borrower group: Housing Development and Infrastructure Ltd., a Mumbai-based shantytown developer that’s facing bankruptcy proceedings...(PTI)...cited a letter written by.. (PMC’s)... now-suspended managing director to the RBI. The executive had told BloombergQuint...that about a third of the bank's loans were given to HDIL.”

ET noted that “the size of the reported advance is far in excess of the bank’s capital. This goes beyond a failure of oversight, and would require top-level complicity. PMC’s annual report shows it to be a profitable lender with a capital adequacy ratio higher than the 12% minimum requirement and a bad-loan ratio of under 4% – almost respectable by the current standards of India’s banking industry. If the news reports are correct, the solidity portrayed by that document is a fiction.”

Pretty damning indictment there. How did PMC pull the wool over the regulator’s eyes? The Economic Offences Wing of Mumbai Police testified in court last week that PMC replaced 44 loan accounts of the HDIL group with over 21,000 fictitious loan accounts, thereby camouflaging defaults by the group.

Here’s what we need to know about HDIL, with regard to this case - HDIL is in bankruptcy court after failing to repay debt. The National Company Law Tribunal admitted insolvency proceedings against the Mumbai-based builder following a plea filed by Bank of India under Section 7 of the Insolvency and Bankruptcy Code.

The police claimed the loans from PMC Bank were not recorded in the core banking system. Instead, they were mere entries in the “master indent” (or the details of loan accounts) submitted to the RBI for inspection. The police officials also claimed the board of directors and executives, including MD Joy Thomas, had “full knowledge” of this. Thomas was arrested last Friday. The testimony also said the Wadhawans, who runs HDIL, played active roles in the fraud, and demanded custodial interrogation was in order to trace the “operations carried out with the funds borrowed from the bank.”

According to reports in BloombergQuint, the Enforcement Directorate is also conducting probing PMC under the Prevention of Money Laundering Act. This week, the Economic Offences Wing seized property worth 500 crores that belongs to certain entities involved in the alleged 4,355.43 crore PMC scam. A report in Mint claimed that, with this week’s move, the total amount of seizures is estimated at approx. Rs 4,000 crore. On 3 October, HDIL promoters Rakesh Wadhawan and his son Sarang Wadhawan were arrested on charges of alleged involvement in the fraud. It has also emerged that the bank did not report its exposure to HDIL for 6-7 years.

Rajvardhan Sinha, joint commissioner of police, told the media, “We have discovered more bank accounts linked to the case. We will not be naming whose bank account and how much money at the moment.”

Cooking the books?

Following the arrests, PMC Bank appointed Grant Thornton, as suggested by the police, to conduct a forensic investigation into the allegations made by ex-MD Thomas. What’s causing worry is the magnitude of the fraud -  Thomas confessed to the Reserve Bank that PMC’s exposure to the bankrupt HDIL goes past  6,500 crore rupees  - four times the regulatory cap, or 73% of its entire assets of 8,880 crores!

Before we proceed, let’s look briefly at cooperative banks. According to an analysis in Mint, “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.”

It gets worse. Media reports indicated that 5-10% of total deposits were withdrawn on a daily basis since 19 September. Such withdrawals could, by some estimates, be as high as 29% of total deposits. As on 31 March, the bank’s total deposits stood at 11,617 crore rupees. More than 60% of the cooperative bank’s customers had small deposits of around Rs 10,000 each in the bank.

The large withdrawals were noticed after some of the large depositors reportedly got a whiff of a whistleblower’s complaint to the regulator. Not too long after, the bank’s suspended MD and CEO Joy Thomas wrote a “confession letter" to RBI admitting that the actual exposure to HDIL was over Rs 6,500 crore.

And yet, the annual report audited by Lakdawala and Co. shows that the Bank had reported a net profit of 99.69 crore compared to 100.90 crores a year ago. Capital adequacy of the bank stood at 12.62% and net non-performing loans were at 2.19%. Despite this, the regulator and the bank’s auditors seemed to have no inkling of the fact that the Wadhawan group’s exposure, which stood at approx. 500 crore till 2006-07, had ballooned to 6,500 crores. In fact, as recently as August 2018, PMC Bank had disbursed a loan of 96.5 crores to HDIL - to settle its dues with Bank of India  and thereby prevent it from initiating insolvency proceedings!

And now, following the investigations by the ED and Mumbai Police, the Institute of Chartered Accountants of India has decided to probe Lakdawala & Co.

It also emerged that there are old links between PMC Bank and the Wadhwans. That relationship goes back to the mid-1980s. In 1986, just two years after it began operations, PMC Bank was on the verge of financial collapse. Rajesh Kumar Wadhawan, a former director of Land Development Corp and many other companies run by the Dewan family (who would become a promoter of HDIL), put Rs 13 lakh into the bank that fiscal. Mint reported that the family also kept a “huge quantum of deposits for the revival of the bank." At another time, he infused as much as 100 crores to help the bank tide over a liquidity crunch.

The change started when the group started facing a liquidity crunch in 2012-13. One of the reasons was the cancellation of HDIL’s slum rehabilitation project near Mumbai airport. The cancelation led to the group defaulting on dues to all banks, which prohibited the Wadhawans from raising fresh capital or loans, and, consequently, their projects were stalled.

Thomas’s letter to the RBI stated, “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...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.”

What next?

Many investors are seeking government intervention. For instance, The Eden Garden Cooperative Housing Society in Mumbai’s Oshiwara, which is home to 29 families, cannot access the Rs 24 lakh it has in PMC Bank. They told Bloomberg, “Our entire amount has been locked up now. We have absolutely no money...We had kept fixed deposits, sinking fund, maintenance fees and other savings in PMC Bank...(we)have absolutely no idea how we are going to manage now...There’s no money to pay for the utilities like electricity bill, water bill, fees of the watchman, gardener and others.”

Or take the case of Guru Nanak School in Mumbai. Reena Rishiraj, principal of the school,told Mint the school and its teachers have savings accounts with PMC Bank. She said, “We cannot pay our monthly salaries and other bills amounting to nearly 80,000 rupees this month."

At a meeting of PMC Bank depositors, one person claimed, almost in desperation perhaps, “The government can easily infuse 2,000 crores...and restart the bank. It can seize the property of HDIL and help restart the bank. The bank has 11,000 crores worth of deposits, and...has lent only 4,000 crore to HDIL.”

However, Bombay High Court lawyer Vinod Sampat told Bloomberg that, legally speaking, there’s no way for the housing societies or the individual depositors to get back their money. He explained, “This is a systematic failure which occurred because of lack of due diligence on the part of government authorities like officials from RBI, PMC Bank, auditors, among others...For the housing societies and individual account holders, this is going to be only wait and watch situation. Chances of getting back their entire money are quite faint.”

But some statements from the Reserve Bank holds out hope for such depositors. Responding to questions regarding the PMC Bank scam, RBI Governor Shaktikanta Das said, “The Reserve Bank of India would not allow a cooperative bank to collapse.”