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S. D. Naik

WITH the unfolding of the Government securities scam involving the brokerage houses and co-operative banks in Maharashtra and Gujarat, the gross mismanagement of the sector in total disregard of sound banking principles and the Reserve Bank of India guidelines once again highlights the deep-rooted malaise afflicting this sector. It is now feared that more than 17 co-operative banks in Maharashtra and eight in Gujarat may have lost about Rs 400 crore in dealings with one brokerage firm — Home Trade alone. The other brokers implicated in the scam include Giltedge Management Services, Indramani Merchants, Century Dealers and Syndicate Management Services.

What is more shocking, the gilt scam has spread to even provident funds. For instance, about Rs 100 crore from the Seamen's Provident Fund was reportedly given to a broker for investing in government authorised securities, and who has disappeared without handing over the securities. The case is now being investigated by the Bank Securities and Fraud cell of the Central Bureau of Investigation (CBI). It has come to light that Rs 92.78 crore was invested out of Seamen's PF through four Kolkata-based companies, with whom Mr Sanjay Agarwal of Home Trade Securities and his associate Ketan Seth of Gilt Edge Securities operated. The four companies appear to be benami, since their offices could not be traced.

It has also come to light that Home Trade offered 2 per cent extra incentive to lure funds from co-operative banks. It issued contract notes to clients on trades that were never executed. The unsuspecting investors took them at face value and ended up losing huge sums of money. The contracts were issued without actually executing the deals. The investigators also suspect that some of the money lost by co-operative banks in the Home Trade deals may have entered the stock market. The RBI has so far asked the Registrar of Co-operative Societies to supersede the boards of five co-operative banks in Maharashtra. After the arrest of Mr Sunil Kedar, Chairman, Nagpur District Central Co-operative Bank, which lost Rs 150 crore in the gilt scam, the Maharashtra Government has ordered scrutiny of accounts of 658 UCBs and 30 rural banks in the State.

However, even as the investigations are in progress, everyday, new shocking stories relating to banker-broker nexus are coming to light. According to reports, the RBI discovered that an urban co-operative bank in Rajkot had not only given brokers power of attorney to participate in the bond market but also authorised them to raise deposits from the public. This is the most serious violation of prudential norms by a co-operative bank.

One is at a loss to understand the continuing laxity of the regulatory authorities in the inspection and audit of co-operative banks even after several co-operative banks went into liquidation. The weaknesses and instances of gross mismanagement of the co-operative banking sector were highlighted once again when the Ahmedabad-based Madhavpura Mercantile Co-operative Bank (MMCB), with deposits of Rs 1,200 crore, went under in March 2001 because loans worth Rs 977 crore were given to the stock broker, Ketan Parekh, without securing adequate collateral. The money found its way to the stock market and was never returned back to the bank.

The over-exposure of several other co-operative banks last year to the capital market was responsible for putting them in a spot. But, evidently, no lessons were learnt and this year the co-operative banks find themselves in a spot in gilt deals. Preliminary investigations indicate that while in some cases, it is a planned fraud, in others, the banks walked into the trap because of their greed to make a quick buck. In yet another incident of "closing the stable door after the horse has bolted'', the RBI has now banned all physical deliveries and disallowed co-operative banks from dealing directly with brokers. This should have been done soon after the Madhavpura incident. While even the small investors in the stock market were forced to go for compulsory demat, often at considerable hardship and inconvenience, it is surprising that trading in Government securities remains paper-based exposing it to all the attendant risks and scope for frauds. Surprisingly, the RBI has so far failed to use the debt trading system of the National Stock Exchange and introduce a nation-wide electronic fund transfer mechanism. It is time the RBI works out a system in collaboration with the Securities and Exchange Board of India (SEBI) to ensure the efficient functioning of its debt market.

For too long, the co-operative banks in the country have been ignoring the RBI guidelines with impunity. Majority of these banks are controlled by powerful politicians, whose main interest is in raising resources for the benefit of certain vested interested rather than making bank credit available to the weaker sections. They often offer high interest rates on deposits to lure the depositors and expose them to high risks in the process. Funds are diverted to unsound projects sponsored by political heavy weights. In majority of these banks, there is a total lack of corporate governance, the professional standards are poor and there is no transparency in operations. Not surprisingly, most co-operative banks in the country are in poor financial health today.

Recently, Nabard has labelled 130 district co-operative banks across the country as sick because their net worth has eroded. Besides, they have not complied with the statutory requirement of minimum share capital of Rs 1 lakh. Following the Madhavpura Mercantile Co-operative Bank scandal, the RBI had issued detailed guidelines to the co-operative banking sector, ordering them to have a capital adequacy ratio of eight per cent by March 2002 and achieving a net NPA ratio of 10 per cent by March 31, 2002. However, the co-operative banks have urged the Finance Minister, Mr. Yashwant Sinha, to allow them more time to fulfil the new prudential guidelines. They have sought four to five year time to fall in line with the norms relating to capital adequacy ratio and net non-performing assets. This indicates the prevailing weaknesses in the sector.

The extent of financial mess in the co-operative banking sector can be gauged from the fact that the Vikhe Patil Committee on co-operative banks has recommended a Rs 10,000-crore restructuring package for the sector with the cost to be shared in a 60:40 ratio between the Centre and the States. The assistance to individual co-operative banks is to be worked out on the basis of accumulated losses, interest overdue for more than three years, amount of non-performing accounts in the loss and doubtful category, amount debited to higher financial institutions such as Nabard and not accounted in the balance-sheets.

The money to be pumped into these banks is to be raised through a floatation of bonds by the Central and State Governments. These bonds will have a maturity period of 10 years; will be self-extinguishing in nature, which implies that the principal amount will not be redeemed. Hence, the interest structure of these bonds will have to be much more attractive with tax and other benefits. The question is: Why should tax-payers' money be wasted in bailing out these banks for their willful defaults and mismanagement?

It is time the Government tackles the deep-rooted malaise afflicting the co-operative banking sector through stringent licensing mechanism and by putting in place a foolproof regulatory mechanism.

The never-ending row over who is responsible for the co-operative banks — the RBI or the Registrar of Co-operative Societies — needs to be settled once for all. The RBI's Annual Policy Statement of April 2001 had announced a proposal to set up a new Apex Supervisory Body to take over the entire inspection/supervisory functions relating to scheduled and non-scheduled urban co-operative banks in consultation with the Central Government. The Monetary and Credit Policy 2002-03 says: "The events of the last two years have made it abundantly clear that the present system of dual/triple regulatory and supervisory control (involving Centre, States and RBI) is not conducive to efficient functioning of co-operative banks in the interest of their depositors.

Under the prevailing system, managements and boards of several co-operative institutions continue to reflect political interests rather than genuine co-operative spirit, and are not always amenable to normal banking discipline in their operations." The RBI has reiterated the desirability of setting up a separate regulatory authority for the urban co-operative banks.

Despite making all these recommendations, however, it cannot be denied that the RBI has been lax in its supervisory functions despite repeated instances of gross mismanagement in the co-operative banking sector. The central bank will have to strengthen its regulatory mechanism. The argument of dual control can hardly be an excuse for non-performance.

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