MMCB vs PMC Bank

A COMPARISON OF TWO CO-OP. BANK FAILURES – MADHAVPURA BANK & PMC BANK
 
Since 23^rd Sept, 2019, there is lot of stress in the Co-op. Banking Sector in the Indian Economy. On 24^th September, the Reserve Bank of India, keeping aside the normal procedure of issuing a notice for irregularities to a Co-op Bank’s Board, following it with putting some restrictions on its’ operations and gradually increasing the restrictions if there is no improvement in the working of the Bank, suddenly stopped all the operations of the Punjab & Maharashtra Co-op. Bank Ltd., Mumbai which, till then, was one of the top ten co-op banks in the Country with Rs. 11,617 Crore in public deposits and about Rs. 8383 Crore in advances. A Multi-state Scheduled Bank, the Bank boasted of “A” grade in statutory audits consecutively for many years. It has 137 branches, spread over 6 states such as Maharashtra, Gujarat, Delhi, Karnataka, Goa, Andhra Pradesh and Madhya Pradesh.

• The Bank was conferred with Scheduled Status by the Reserve Bank of India in the year 2000. It is the Youngest Bank to achieve the ‘Scheduled Bank’ status.
• The Multi-State Status was conferred on the Bank by the Central Registrar in the year 2004.
• The Bank was given the Authorised Dealer Category I License by the Reserve Bank of India for Forex business in the year 2011.
• The Bank has been awarded with 'Best Bank award for the year 2018' in the category of Rs.2000 Crore & above deposits by the Brihan Mumbai Nagari Sahakari Banks Association Ltd. for consecutively 2 times.
• All India Bank Depositors’ Association, well known body of the bank depositors, felicitated the Bank in appreciation of “work ethics oriented to depositors’ service” in 1999.
• The Bank has been awarded with ‘Padmabhushan Vasantdada Patil Award’ as the ‘Best Urban Co-operative Bank’ by the Maharashtra State Co-op Banks’ Association Ltd. for nine times.
• The Bank received a ‘Special Jury Award’ from NPCI for the lowest dispute ratio in Co-operative Banking sector and also for the lowest unscheduled down time in 2012.
• It showed Gross NPA of 3.76%, Net NPA of 2.19% and Capital Adequacy Ratio of 12.62% as on 31/03/2019.

Question arises as to what went wrong so suddenly that RBI had to impose severe restrictions on the working of the Bank overnight and allow withdrawal from the Bank to the extent of only Rs. 1,000/- per person over a period of 6 months, which was revised to Rs. 25,000/- per person over next 6 months? There is no parallel in the Indian Banking History and more particularly in the Co-op. Banking History that RBI might have taken such an action before. What was the issue?

Some employees of the Bank, working in the Credit Dept. met the Executive Director of the RBI and cautioned him about the massive exposure the Bank had fraudulently taken by extending loans for more than Rs. 4500 Crores to the HDIL Group (Housing Development & Infrastructure Ltd.) which has been active in Slum Redevelopment and which has been facing insolvency proceedings for defaults in repayment of loans to Banks. This amount was routed through 21049 dummy loan accounts which were created so as not to be detected by the RBI Inspectors and the Statutory Auditors. The entire camouflaging has been done at the behest of the HDIL Group by the Chairman of the Bank, Mr Waryam Singh (who is closely associated with the HDIL Group and was on the Board of HDIL till 2015) and the Managing Director of the Bank, Mr. Joy Thomas. Question may arise, in the minds of general depositors, as to why the RBI Inspection as also the Statutory Auditors could not detect the blatant violation of RBI Directives while these violations were going on for several years, more particularly since 2008, as reported.

As per press reports, it appears that the Bank Management manipulated the system smartly and created small dummy loan accounts for transferring the funds to the HDIL Group. Since the amount of loans was small, the RBI Inspectors and Auditors did not get into details of such loans and the whole manipulation remained undetected for years. During this time, the Bank kept on booking income on dead advances which were not realisable and kept on showing substantial profit due to which it could create confidence amongst investing public and kept on attracting funds from them. Apart from individuals, HUFs, Trusts, etc, more than 130 non scheduled banks and about 15000 co-op societies (housing and other) have deposits of more than Rs. 2085 Crore kept with this Bank as on 31/03/2019. So much so that even RBI Officers’ Co-op. Credit Society is reported to have an exposure of nearly Rs. 105 Crore to this Bank. The exact modus operandi of the fraud is yet to be known but obviously, the seriousness of the issue prompted the RBI to take an unprecedented step of putting wholesome restrictions on the working of the Bank, dismiss its’ Board of Directors and appoint an Administrator to manage its’ affairs.

It is reported that RBI had taken objection to Mr. Waryam Singh continuing as Chairman of the Bank and had asked Central Registrar of Co-operatives to remove him since 2017. However, Press Reports suggest the CRCS did not act upon it. It is intriguing as to how RBI allowed the Bank to open 3 new branches during 2018-19 which went from 134 as on 31/03/2018 to 137 as on 31/03/2019. Normally, RBI does not allow expansion, opening ATMs, transfer of branches, etc. if its’ directives are not followed by any Bank. It appears that the Banks’ Management was able to hoodwink RBI also.

Anyway, before we get into the details of what happened, we shall look into the two classic cases of large Co-op. Bank Failures, i.e. Madhavpura Mercantile Co-op. Bank Ltd., Ahmedabad and Punjab & Maharashtra Co-op. Bank Ltd., Mumbai.

The Scam raises important questions at to why this Scam happened? When the MMCB Scam happened in 2001, the RBI was monitoring the Commercial Banks closely so that there was no repetition of the Harshad Mehta kind of Scam in the Banking Sector. However, it appears they did not anticipate that the overzealous entrepreneurs would use the much smaller but easily manageable co-op banks. As such, the supervision of the co-op banks at that point of time was not so stringent. However, after the MMCB Scam, RBI became very strict with the Co-op Banks and various restrictions, such as restrictions on lending to share brokers and Directors & their relatives, etc. were imposed on them. But the RBI has always maintained that due to the Dual Regulatory Structure (banking business being monitored and supervised by RBI while the management and administration of the co-op banks being monitored and supervised by the State Co-operation Dept.), it was difficult for it to exercise full control over the co-op banks. To overcome the issues of co-ordination between Banks, RBI and the State Co-operation Dept, concept of TAFCUB (Task Force on Co-operative Urban Banks) was implemented.

The State Governments and the Reserve Bank of India signed a Memorandum of Understanding (MoU) with regard to Urban Co-operative Banks (UCBs) in the respective State. Consequent upon this, a State level Task Force for Urban Co-operative Banks (TAFCUB) has been constituted for each State. The TAFCUB is entrusted with the task of identifying the potentially viable UCBs and drawing up a time-bound action plan for their revival by setting specific monitorable milestones. The Regional Director for each State, Reserve Bank of India is the Chairman of the TAFCUB and Registrar of Co-operative Societies, State Government is its Co-Chairman. The other members of the TAFCUB include a representative each from the National Federation for Urban Co-op. Banks (NAFCUB) and the body representing the Urban Co-op Banks in the State, a nominee of State Government and a representative from the Department of Co-operative Bank Supervision, Reserve Bank of India, Central Office, Mumbai. 

The arrangement was working successfully and when the going appeared good, the PMC Bank Scam has broken out. It appears that the scamsters find out the loopholes in the system and they start using those loopholes to their advantage. When they are exposed, some people are penalized and those loopholes are plugged. But this arrangement works good for some time till when the new scam breaks out, using some other loophole in the system. And this keeps on happening with regularity. Unfortunately, the ultimate sufferers are the hapless depositors who have kept their hard-earned money in the failed institution which appeared infallible till not very long ago.

The moot question that may arise is why the Scam remained undetected for over a decade, even when regular RBI Inspections were being carried out every 2 years and Statutory Audit was being carried out every year and Concurrent/Internal Audits were being carried out every month/quarter? Reportedly, the Bank has Finacle CBS Banking Application Software installed. Finacle is one of the best Banking Softwares in the country today, having been developed by Infosys. RBI prescribes mandatory System Audit of all Banks every year. Obviously, even PMC Bank was getting its’ system audit done from qualified system auditors every year. How is it that even their scrutiny could not detect the fraud being committed?

Normally, when any such fraud takes place, it’s a fashion to blame the audit and inspection. Even in this case, questions are being raised as to whether there was some complacency amongst the Inspectors/Auditors, created due to the hype created by the Banks’ Management, of a Bank having extra ordinary track record of good governance? By nature, the statutory auditors undertake test check rather than detailed audit of the operations of the Bank. However, normally, RBI Inspection is quite detailed and they look into every aspect of the Bank’s working from regulatory point of view. Even then when the fraud remains undetected, it is obvious that the Management committed the fraud with lot of planning and shrewdness. Since it is too early to really comment since there are many aspects which are not yet known and clearer picture of what actually happened would emerge over a period of time.

However, few aspects have gone unnoticed which probably could have cautioned the authorities such as consistently falling Priority Sector Advances Ratio which was 41.61% in 2010-11 but fell to 15% during 2018-19 while Banks are mandatorily required to maintain the ratio at 40% of their Total Advances. It is further alleged that RBI was against the appointment of Mr. Waryam Singh as Chairman of the Bank due to his close linkage to HDIL Group and therefore, it had advised the Central Registrar to remove him but nothing further happened. However, these are all after thoughts. Who can really prevent a fraud from happening when the Top Management, which is the custodian of the public funds and of public trust, decides to commit fraud in utter disregard to the respect and confidence of lakhs of shareholders and depositors? It is also likely that the Inspectors and the auditors might have raised objections on certain aspects of the working of the Bank but their objections were either satisfactorily replied to or were ignored. One thing is certain. If the fraud had been unearthed earlier, it could have saved the plight of small depositors. It is to the credit of the Reserve Bank that they were able to move fast and allowed withdrawal of up to Rs. 25,000/- per depositor, easing the plight to some extent.

It is quite likely that the System Parameters were manipulated so that the Exception Reports generated by the System would not reveal the true picture and would mislead the auditors. It is also likely that the scope of the System Audit being got done was such that the system auditors were not being allowed to check the system parameters and they were doing only the peripheral audit. Further, even if system audit was done meticulously, lot depends on how the system audit reports were dealt with by the statutory auditors and RBI Inspectors.

There are various rumours doing the rounds about the Statutory Audit Firm which was doing the audit of the Bank for past 2 years. First of all, not much is heard about this Firm, i.e. Lakdawala & Co. which has done the audit. As per Annual Report of the Bank, it is a Partnership Firm but the address of the Firm does not appear anywhere in the Annual Report or the Statutory Audit Report. From 1^st July, 2019, every CA has to generate UDIN, i.e. Unique Document Identification Number for any Report or Certificate he/she issues. However, no such number is appearing on the Statutory Audit Report of PMC Bank issued by the auditors.

If the Bank had been under the jurisdiction of the State Registrar, then the Firm must have been a partnership firm duly empanelled with the Registrar of the Co-operative Societies, Maharashtra. However, since it is Multi State Bank and the Central Registrar of Co-op Societies, New Delhi does not maintain a panel of CA Firms for doing audits of Co-op. Institutions under its’ jurisdiction, the status of the audit firm cannot be verified. It is interesting to note that the Bank was audited by M/s. Ashok Jayesh & Associates, a CA Firm from Bandra (E) having their Head Office in HDIL Towers in 4 out of 9 years since 2010-11, i.e. FY 2010-11, 2014-15, 2015-16 & 2016-17.

It is reported that the major chunk of advances given or funds diverted to the HDIL Group were in the Bandup Branch of the Bank. How such a large quantum of advances remained undetected/unverified by the Internal/Concurrent Auditors of the Branch? Is it possible that they did not come to know from the Branch staff as to what was happening in the Branch? Or they were silenced by the Bank Management due to which they could not make their observations known? Some media reports suggest that the Bank was maintaining 2 set of books of accounts by which they were manipulating the Advances Portfolio. If this is true, then it is an extreme kind of fraud which unsuspecting auditors would not be able to catch unless they are doing Forensic Audit.

Ironically, the paragraph on “AUDIT & INSPECTION” in the Annual Report for FY 2018-19 of the Bank makes some interesting reading :-

“AUDIT AND INSPECTION

 
The success of any institution is depending upon its governance. The Bank has formed an Audit Committee consisting of the directors who are experienced Banking Experts as per the requirement of the RBI. The said committee meets regularly and reviews the overall Audit and Compliance posture of the Bank. This has helped in ensuring transparency in financial statements and protecting shareholders interest.

 
Your Bank has put in place an effective and robust internal checks and control system, commensurate with its size, geographical presence, operational challenges and risk exposure.

 
All the Branches and Departments are covered under audit not only by external audit firms which are well experienced Chartered Accountant Firms but also by internal inspection team which consists of senior banking officials.

Also with the evolving banking technologies and thrust over Digital Banking, the need for ensuring information and cyber security is duly taken care of by your Bank. Your Bank has implemented a duly approved IS Audit process which covers security assessments of all critical IT infrastructure risks. For the purpose of System Audit your Bank had appointed CERT-IN empanelled IS Audit Firms who have submitted their System Audit reports well in time.
A risk based audit approach has been followed for managing the overall Bank’s governance aspect so as to monitor the performance of the overall internal controls implemented for current as well as upcoming risks of all nature.”

The fallout of the whole episode for the auditing community, the Co-op. Banks and the Depositors is likely to be severe. While most depositors, more particularly having deposit more than Rs. 1 Lac in the Bank, are likely to lose money, the going is likely to get tougher for the Co-op. Banks. The RBI is likely to press the Govt. for ending the dual regulatory structure for the Co-op. Banks. Or else, it may fiercely pursue the implementation of its’ Board of Management (BoM) Concept so as to segregate the day to day functioning of the Bank and the Board of Directors. (However, fact remains that even the in the Private Sector Banks, such misuse of funds has happened in the past, e.g. Global Trust Bank. However, RBI was able to merge that Bank with Oriental Bank of Commerce without much loss of time. The process is not so simple in case of Co-op. Banks as they can merge only with other co-op. banks and not with commercial banks.)

The regulation for the auditing professionals has already been made quite stringent after catastrophic rise in NPAs of Banks as a whole. There are likely to be more stringent measures implemented to monitor the working of the auditors and more stringent penalties for dereliction of duty.

Normally some smart people, in order to make quick money, use the loopholes in the system to their advantage and when such misadventure backfires, authorities take measures to plug such loopholes to make the system stronger. Let us hope that Indian Banking System will become so stronger that such frauds would not happen and if at all they happen, they would get detected at the initial stage so that the general depositors would not suffer for no fault of theirs’.

 
GOKUL B. RATHI
2, Madhav Apartments, Gupte Path,
Karve Road, Erandawane, Pune 411004
M – 9850041311
Mail – gokulrathi007@yahoo.co.in