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Saturday, April 12, 2003

Series of scandals have engulfed the urban co-operative banks in the state. Thousands of small depositors, lured by the comparatively higher interest rates offered by some of these banks, lost their life savings and not know who to turn to.

Most of these urban cooperative banks were floated after deregulation of the banking sector in the 90’s. The intent behind creation of these banks is that they will raise and deploy resources locally and function as community banks. These banks were supposed to bridge the credit gap to small traders and small businesses that don’t have access to commercial capital. Even though there are many genuine banks offering valuable services to the public, there are also many fly by night operators who started these banks with intent to make a fast buck. It is widely known that many of these bankers offer loans to individuals/corporates by taking a 8-12 % commission bypassing all prudent credit norms!

Early last year, in the wake of the Krishi bank scandal, the state government appointed a committee to study the functioning of the urban co-op banks. The committee has done a detailed study and submitted its report to the government, recommending action against many banks. Under the current regulatory framework, the responsibility of overseeing the functioning of these banks lies with both the Reserve Bank of India and the state Registrar of Cooperatives (RCS). Sadly, in case of urban banks, both RBI and RCS have abdicated, each blaming the other.

All banking, like most human endeavours, is an attempt to reconcile greed and fear. When the management’s intentions are dishonourable, there is outright swindling of depositor’s money. But even where a bank does honest business, there are risks associated with banking. Banking, more than any other business, runs on trust, confidence and stability. No bank can have cash reserves to meet a run on deposits. Once confidence is shattered, depositors queue up for refunds. As the bank fails to repay, restive small depositors demand insurance refund (Deposit Insurance and Credit Guarantee Corporation). But our laws permit DICGC refund only after the bank is liquidated. Once there is talk of liquidation, the debtors deliberately default. Even the good loans turn bad. Crisis deepens, and liquidation becomes a self-fulfilling prophesy. Thanks to huge inter-bank transactions and general decline in confidence, failure of one bank usually has cascading effect. That is why wise governments take precautions to avert a crisis, and address a crisis swiftly to restore confidence.

So, what can be done to restore the depositors’ confidence, and safeguard the banks and the financial system? There are plenty of practical suggestions:

• strict monitoring to ensure that only persons with impeccable credentials promote banks;

• higher capital adequacy and liquidity norms;

• mandatory annual credit rating;

• making public the annual RBI inspection reports and

• strict and unambiguous regulatory supervision of RBI over banking. If a cooperative bank is faltering, it is better to allow it to convert into a society and permit acceptance of deposits only from members.

In the interim, we need to quickly restore depositors’ trust and prevent liquidation and defaults. If the state government and urban banks’ federation create a revolving fund to guarantee refunding of small deposits without having to resort to liquidation, banks will withstand short-term shocks. Then debtors will have to repay loans. Foreclosure of loans can be avoided. The vicious cycle of cascading collapse can be arrested. This doesn’t cost much money, and it will be only a revolving fund. Can the state government take such sensible initiatives instead of deepening the crisis by breast-beating and excessive publicity?

Finally future frauds can be prevented only by exemplary and swift punishment of the wrongdoers. Compare the various financial sector scandals in India with what happened in the US in the last two years. Within months of Enron and World Com scandals, the state and federal regulators have shut down their operations, issued indictments against key officers and Congress has passed new legislation to plug the loopholes. In India, we are yet to bring a finality to the investigation of the big bull Harshad Mehta, and the regulatory scenario continues to be lax. Ultimately there is no substitute to genuine regulation and rule of law. Only then will the confidence of investors and public be restored.