The Hindu : Coop. Bank scams: Effective governance structure crucial

Online edition of India's National Newspaper
Monday, May 27, 2002

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Coop. Bank scams: Effective governance structure crucial

The new scam involving the co-operative sector points to a crying need to have a speedier and better co-ordinated process for dealing with financial frauds as well as an effective governance structure and settlement system for efficient functioning of financial institutions, says Oommen A. Ninan

WITH THE surfacing of the co-operative banks scam, once again the financial sector and its markets fell victim to the regulator's failure to check malpractices within the system. The new scam involving the co-operative sector points to a crying need to have a speedier and better co-ordinated process for dealing with financial frauds as well as an effective governance structure and settlement system for efficient functioning of financial institutions.

The present crisis is virtually a replica of the 1992-securities scam that involved Harshad Mehta. While Mehta used banker's receipts to have an easy access to huge funds, this time, Home Trade Ltd., a broking firm, used government securities (G-Secs) to avail itself of money. The Nagpur District Central Co-operative Bank gave Rs. 124 crores to Home Trade on the assurance that the broking firm would deliver G-Secs worth the same amount to the bank within 30 days. But these securities were never delivered. An analysis reveals that the scams more or less followed the same pattern — The Ketan Parekh — Madhavpura Mercantile Co-operative Bank (MMCB) scam occurred in 2001 and is also an instance of diversion of funds from the banking sector to the stock market, like the 1992 securities scam.

In 1994, close on the heels of the 1992-securities scam, the Reserve Bank of India put in place a delivery versus payment (DVP) system under the Public Debt Office (PDO) of the central bank. This is linked to Subsidiary General Ledger (SGL) accounts in banks. At the end of the day the buyer or seller will have to fill the SGL form and deliver it to the RBI. Now with the inception of Clearing Corporation of India Ltd. (CCIL), the SGL form filling procedure no longer exists.

However, co-operative banks are out of the purview of the DVP system. The RBI could have brought in co-operative banks under the ambit of DVP system when the MMCB scam broke-out. Last Monday all RBII-regulated entities have been asked to hold G-Sec in demat form. But the RBI waited for a scam to surface in order to initiated fire-fighting measures. Further, under no circumstances can the RBI allow a broker to act as a principal (a broker can only act as an intermediary between principals and cannot assume the role of a principal). In this case, Home Trade acted as a principal. Another issue is that many co-operative banks are not having Treasury divisions, which trade in securities. How the RBI allowed any bank without a Treasury division to operate in a debt market is a question that can be raised. In the case of co-operative banks, all the decisions of investment in securities are taken by the boards of directors which are elected rather than a full fledged Treasury that would otherwise be run by professionals.

The role of Primary Dealers (PDs) is also in focus at this point of time. PDs are interested only in large dealings rather than small deals of co-operatives. Moreover, PDs are interested in running a book to make proprietary trading profits rather than disseminating debt to and developing the non-wholesale debt market for which they were set up. A banking source told The Hindu, that a large co-operative body has already approached the RBI to act as a PD for the co-operative sector. This could help the co-operative sector get professional help in the dealing of securities in the debt market.

Violation of norms

The RBI found 25 urban co-operative banks — spread across Gujarat, Maharashtra and West Bengal — to be in violation of the RBI norms. Of these, eight co-operative banks have exposures to Home Trade. Among these, six banks are in Gujarat and the balance inMaharashtra. Four district central co-operative banks (rural) from Maharashtra also have exposure to Home Trade. In all, these 12 banks are suspected to have run up losses of around Rs. 500 crores. As more than one co-operative bank is involved, it is feared that this could be only the tip of the iceberg. In November 2001, the RBI found that these banks had flouted banking norms stipulated by it. However, action against these entities was initiated only in April. All boards of these cooperative banks were superseded by the RBI with the help of the Registrar of Co-operative Societies (RCS). The promoters of Home Trade — Ketan Sheth and Sanjay Agarwal — also duped the Seamen's Provident Fund to the tune of Rs. 94 crores. Investigations in this regard are proceeding separately.

The National Bank for Agriculture and Rural Development (NABARD) is the supervising body for all rural co-operative banks with the RBI as a regulator making the rules for these banks. However, the day-to-day administration of these banks are supervised by the RCS that come under State governments. Urban co-operative banks are monitored by the RBI and the RCS. The RBI-appointed Madhav Rao Committee on Urban Co-operative Banks, the Jagdish Capoor Report on Co-operative Credit and the Expert Committee on Legal aspects of Bank Frauds 2001 were unanimous on the need for a restructuring of co-operative banks and abolition of its dual management.

Dual management

Eventhough the RBI made its representation to the Government on dual management, the Union Government does not want to take a view on this. In the Credit and Monetary Policy 2002-03, the RBI noted, "The events in the last two years have made it abundantly clear that the present system of dual/triple regulatory and supervisory control (involving Centre, States and the RBI) is not conducive to efficient functioning of the co-operative banks in the interest of their depositors. Several committees in the past have also recommended elimination of multiple layers of supervision and regulation of this sector. In view of the local interest involved, it is also clear that there is no consensus at present in favour of removing supervisory and regulatory responsibilities at Central/State government levels and for entrusting it exclusively to the RBI. As a result, the 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. In view of this, it would be best, in the interest of the public depositors, if the situation is faced squarely and a separate supervisory authority is set up, with representatives of Centre, State and other interested elements. Such a body can then be exclusively made responsible for efficient functioning of the co-operative institutions and also take responsibility for ensuring the safety of public deposits.'' It is also interesting to note the inaugural address of the Reserve Bank Governor, Bimal Jalan, at the Natioal Institute for Bank Management (NIBM) annual day on "Corporate governance in banks and financial institutions'' in January. He stated, "By and large, the structure is weak in co-operatives and non-banking financial companies (NBFCs) for historical reasons, local practices, and multiplicity of regulators and laws. Old private sector banks also have poor auditing and accounting systems.

New private banks generally good on accounting but poor on accountability. More modern and computerised, but less risk-conscious. One thing that is common to all is that corporate governance is highly centralised with very little real check on the Chief Executive Officer (CEO), who is generally closely linked to the largest owner group. Boards or auditing systems are not very effective.''

Dual management itself is not an issue, if all agencies can get together and take a co-ordinated action against the erring entities. In the present case, all the agencies came together and superseded the boards of the co-operative banks and appointed administrators. Can anyone assure that this will happen every time. A recent development in Kerala points towards the irresponsible interference of politicians and bureaucrats in the co-operative sector.

A few months ago, the RCS of Kerala gave permission for many cooperative societies to use the word "bank'' with its names, without RBI's knowledge. According to the Banking Regulation Act nobody is permitted to use the word "bank'' or "banking'' without a licence from the RBI. When the RBI advertised — in the interest of depositors — against this in newspapers, the State Government made a hue and cry. In the same manner, when the RBI complained about MMCB, the Gujarat Government refused to take action against it. Political interference in commercial decision making brought down many premier institutions such as the Unit Trust of India.

Another regulator, the Securities and Exchange Board of India too looked the other way, instead of booking Home Trade — which is registered with SEBI as a broker — of its lapses in the markets.

The Listing Committee of the Bombay Stock Exchange (BSE) refused to give listing for Home Trade on charges that the company was involved in circular trading among its group companies. At that point, SEBI did not take interest in enquiring about it. The same was the case at the time of Ketan Parekh-related scam. Eventhough the RBI warned SEBI about the unusual price rise in Global Trust Bank, the capital market regulator chose to ignore it. No co-ordination among regulators and a delay in taking cases to their logical conclusion give scope for occurrence of such scams in the financial sector. It may be recalled that it took SEBI over six months to finalise its interim report on the Securities Scam of 2001. Co-operative banks or societies are meant for the people, of the people and run by the people. It is an excellent concept for a country like India, which is the largest democracy in the world. However, the boards of these cooperatives are more often than not filled with politicians and other unscrupulous elements as they are elected members.

The Government and the RBI have formulated rules and regulations for the governance of these organisations. In this case, the managements of co-operatives failed to adhere to the rules and regulations and the regulator failed in its role of supervisor.

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