Explainer: Who is to blame for the mess at PMC bank (and will depositors get their money back)?

Imagine being told that you can only withdraw Rs 1,000 from your primary bank account for the next six months. This was the situation in which thousands of customers of the Punjab and Maharashtra Bank found themselves last week, after the Reserve Bank of India put restrictions on the bank’s operations after discovering “major irregularities”.

The RBI’s directions sent customers into a panic, since official figures had until then given no indication that the Punjab and Maharashtra Cooperative Bank – one of the 10 largest co-operative banks in the country – was in any trouble. Not long after, the RBI amended the rules to allow up to Rs 10,000 to be withdrawn from each account, providing some relief to many customers, even as rumours and reports about what had gone wrong at the bank continued to circulate.

Meanwhile, the actions at Punjab and Maharashtra Cooperative Bank sparked off a round of WhatsApp forwards about RBI preparing to shut other banks down, forcing the central bank to issue a clarification.

What is going on?

The Reserve Bank of India, on September 23, issued directions putting severe restrictions on the Punjab and Maharashtra Cooperative Bank, “in the interest of depositor protection”. The central bank said these decisions were “necessitated on account of major financial irregularities, failure of internal control and systems of the bank and wrong/under-reporting of its exposures under various Off-site Surveillance reports to RBI that came to the Reserve Bank’s notice recently.”

The new rules meant that the bank could not renew loans, accept fresh deposits or make any payments unless it has the permission of the RBI. The central bank also superseded the board of the Punjab and Maharashtra Cooperative Bank and put in place an administrator to manage it instead.

Most importantly for customers, the RBI restricted withdrawals to just Rs 1,000 per account for the next six months. On September 26, citing the “hardship of depositors”, this was relaxed to Rs 10,000 per account.

Why did it do this?

The official line, explaining that the RBI had found major irregularities and under-reporting of exposures, doesn’t provide much more information. On paper, the Punjab and Maharashtra Cooperative Bank was in excellent shape, earning a profit and declaring a dividend last year while mentioning that its Non-Performing Assets are just 2.19%, well below the figure in many other banks.

Yet it seems that those numbers were probably wrong.

Newspapers have drawn a connection between the bank and a realty firm called Housing Development Infrastructure Limited, or HDIL. The bank’s chairman was on the board of HDIL for nine years – a potentially significant conflict of interest – and also held a little under 2% of its shares. HDIL was one of the bank’s biggest customers.

Indeed, many are now drawing attention to the fact that the Punjab and Maharashtra Cooperative Bank gave a loan of Rs 96.5 crore to HDIL on August 30, after the latter company had already defaulted on its existing loans and had been taken to the National Company Law Tribunal by Bank of India. HDIL used that money to pay the Bank of India, but the loan now sits on PMC’s books. According to some reports, its exposure to HDIL might be as high as Rs 2,500 crore – a huge amount, considering its total loan book is around Rs 8,000 crore.

Who is to blame?

The brickbats will first have to go to the management of the bank. Former Managing Director Joy Thomas, who was sacked by the RBI, abruptly held a press conference on Friday in which he admitted that the bank did not properly label its loans to HDIL as non-performing assets, since it would have an effect on growth. “We did not classify the lending not because we were afraid that the borrower will default but because we wanted time to resolve this,” he said.

Though Thomas insisted that what had happened was not fraud, it seems likely that the RBI-appointed administrator to the bank will file a First Information Report against the sacked Managing Director. In his press conference, Thomas insisted that the Board of the bank was not aware of the HDIL loans, but this seems highly unlikely, considering the connection between the two companies. It seems possible that the attempt to shield the board might have something to do with its Bharatiya Janata Party connections, and the fact that state elections in Maharashtra are around the corner.

What about the regulator?

Indeed, it isn’t just the bank at fault. Thomas revealed that the RBI’s audit failed to detect the omission of the HDIL loans and they had to be voluntarily disclosed, reportedly after one bank manager turned rebellious.

For many years now, RBI’s handling of cooperative banks – different from public sector ones and private, commercial banks – has been woefully undercooked, in part because it shares responsibility with the Central Registrar of Cooperative Societies, which does nearly nothing.

Cooperative banks are infamous for being controlled by politicians or politically connected entities and are often used as an easy source of credit. The RBI is aware of this, but has done little about it.

But it isn’t just oversight that is lacking. Once it did realise that the bank is in bigger trouble than it seemed, the RBI quickly put in place those withdrawal limits that seem entirely arbitrary – and has never been done for a public or private commercial bank even if the alleged fraud within was much larger. This sort of approach causes panic because customers have no sense of how long the limits will be in place.

In the case of the much-smaller Rupee Cooperative Bank, for example, there have been withdrawal limits in place for more than six years now.

Is all the money gone?

Thomas, in his press conference, insisted that HDIL was not a non-paying customer, and that the bank just needed time to recoup money. A certain portion of the bank’s holdings, up to 20%, also includes government bonds, which are safe instruments. But the RBI’s panicked reaction, including withdrawal limits, suggests genuine fears about customers withdrawing all their money from a tottering institution that could easily collapse.

Bank customers in India all have access to deposit insurance guaranteed by the government. But there are two catches here.

One, you only get Rs 1 lakh per person. That means it doesn’t matter if you have Re 1 rupee or Rs 50 lakhs in one account or even Rs 10 lakh spread across 10 accounts, fixed deposits and other instruments. You are entitled to only Rs 1 lakh altogether.

Two, because RBI has not actually said this is a failed bank, customers don’t have access to this insurance money. So while they may know that they will at least get Rs 1 lakh in insurance, they have no immediate access to it or any idea when it will actually come.

Shouldn’t there be another way to do this?

Some argue that deposit insurance ought to be higher, since Rs 1 lakh is tiny compared to the equivalent in many other countries, with that amount having been decided on 26 years ago. But Sucheta Dalal of Moneylife argues that raising the amount alone is no solution, since it will only burden taxpayers while continuing to leave the regulators unaccountable.

“The story of cooperative banks is one of political capture and misuse compounded by Reserve Bank of India’s apathy and disinterest in supervising the sector,” Dalal writes.

CapitalMind’s Deepak Shenoy has argued that the insurance should be available immediately to depositors – if they cannot access it at a time of crisis, what is the point of insurance in the first place? In addition, the RBI needs to have a time-bound approach to handling such issues, which are bound to keep coming up for cooperative banks, if it does not want an erosion in trust in the banking system.

What does it mean for the rest of the banking system?

Though there have been troubles at other cooperative banks, an incident at this one is bound to have a bigger impact simply because of its size. Punjab and Maharashtra Cooperative Bank has nearly 140 branches over six states and public deposits of more than Rs 11,000 crore. That is not a small operation. Putting withdrawal limits, and the danger of collapse, for a bank that big undoubtedly will have repercussions across the industry.

Customers will be concerned about their money in other cooperative banks and, as mentioned above, there have been rumours about closures of even public sector banks. Many analysts have argued that individuals should spread their savings across several banks to avoid being exposed to just one, though few are likely to do this.

Instead, what seems more plausible is a genuine lack of trust in the banking system – not aided by events like demonetisation or the limited protections offered by the RBI here – which might prompt a search for other savings instruments, or even just hoarding cash.