India’s Finance Minister, on 2nd December, announced that 78% of PMC Bank depositors can withdraw their entire deposits. Though the annual withdrawal limit of Rs 50,000 imposed earlier still continues, most small depositors have been taken care of through this announcement.
This comes in the backdrop of yet another bank scam which was unearthed in September- the PMC Bank scam.
What is the PMC Bank scam? How was it discovered? What is the road ahead? These are some questions that will be dealt with in this article.
History of PMC Bank
The Punjab and Maharashtra Co-operative Bank was established in 1984 as a co-operative bank. It operated as a single branch bank in the beginning but expanded its operations gradually. In 2000, it was given the status of a scheduled commercial bank.
At the end of FY 2018-19, its balance sheet had declared certain numbers which would not normally seem suspicious to anyone. The bank’s total deposits stood at Rs 11,617 crores, and total loans advanced amounted to Rs. 8,383 crores. Its gross NPA stood at 3.76%, which is manageable, especially when the country is going through a huge NPA crisis.
However, beneath the numbers was a huge scam involving collusion between the bank’s top officials, and the Housing Development and Infrastructure Ltd. (HDIL).
The RBI got a whiff of the scam on 17th September when it received a letter from a whistle-blower. After this, it decided to clamp down upon the bank’s activities.
On September 24, restrictions were imposed upon the bank under Section 35A of the Banking Regulation Act 1949 to conduct normal business and a withdrawal limit of only Rs. 1000 was set for the depositors.
It was after this, that the scam was unearthed by the RBI. It discovered that about Rs.6500 crores worth of loan was advanced to 44 HDIL group entities (which is 73% of the bank’s total assets). Also, after RBI’s scrutiny, the percentage of gross NPA increased to 77% overnight, almost all of which belongs to HDIL.
The bank had grossly violated the RBI norms of exposure.
According to the RBI norms of exposure, a bank’s exposure to a group of connected companies is capped at 25% of its core capital, while it is capped at 15% for an individual company. In this case, the exposure was 73 %. (73 % of the total loans advanced were given to HDIL group.)
Everything was hunky-dory until HDIL started defaulting on its loans since 2011. The PMC bank did not classify these accounts as NPA and concealed it from the RBI. After the RBI’s scrutiny, the percentage of gross NPA increased from 3.76 % to 77 %.
Let us look at the scam in detail.
How did they do it?
The bank had created close to 21,000 dummy accounts, using which it advanced loans amounting to Rs. 6500 crores to 44 HDIL group entities.
To escape RBI scrutiny, the loans were channelized through these 21,000 accounts to the 44 accounts of HDIL group. And, they did not disclose the HDIL accounts to the RBI.
Whenever an RBI inspects or auditor looks at the books of the bank, they conduct a sample check of about 50-100 accounts only.
Obviously, the 50-100 accounts shown by the PMC bank officials did not contain the undisclosed HDIL accounts. Also, these accounts were reported as standard accounts (in which there are no defaults) and irregularities were not brought to the RBI’s notice.
Due to this ‘camouflaging’ of accounts, the scale of violation (not reporting defaults and classifying as NPA) based on available records (50-100 accounts) was very low. They were nevertheless flagged but since they did not affect the bank’s financial health, the bank continued its normal operations without raising eyebrows.
Most of the employees at the PMC Bank were oblivious to the fraud because they had limited access to the centralised software of the bank, known as the core banking solution. Changes were made to the rule engine of the CBS without the knowledge of the employees, and thus the scam remained covered up for more than half a decade.
Why did they do it?
In a letter addressed to the RBI, former MD of the PMC Bank, Joy Thomas admitted that the bank had concealed the fraud for many years.
The information was concealed because it would have led to a massive loss of reputation for both the bank and HDIL.
Also, declaring the loans as NPAs would have been undesirable for the bank. They would have had to stop showing interest earned (but not received) as revenue in their profit and loss account, and hence their profitability would have decreased. Also, according to the RBI mandate, they would have to maintain provisions for NPAs, leading to further losses- both financial and reputational.
[Read: What is NPA?]
This huge risk was taken by the bank as a sort of gratitude towards HDIL, with whom they have a long history.
PMC Bank was on the brink of closure in 1986-87 when HDIL infused funds into the bank and saved it. They helped the bank overcome a liquidity crunch in 2004. Most of PMC’s business was made out of HDIL’s transactions.
But HDIL started facing a liquidity crunch from 2011 and defaulted on its dues. It was from then that the bank came to its rescue, at the cost of its own depositors.
What now for the depositors?
The assurance given by the finance minister in the Parliament yesterday should come as a relief for the depositors, most of whom have been protesting since the scam was unearthed. About 78% of the depositors can withdraw their entire amount, although the annual cap of Rs. 50,000 remains. The minister said steps are being taken to seize properties of promoters of the PMC Bank, auction them and repay the depositors with the money obtained.
Meanwhile, the RBI will review the situation of the bank after 6 months, and if the discrepancies cannot be corrected, the bank will have to be shut down. In such a scenario, the bank’s agreement with the Deposit Insurance and Credit Guarantee Corporation will kick in, and the depositors will be allowed to withdraw only up to 1 lakh of their total deposits. The limit can be increased it the bank has the requisite assets in case it goes for liquidation.
Scams such as this increase insecurity among the citizens, who lose faith in the financial institutions. At this point, one can only hope that all the depositors get their deposits back soon.