With great power come greater scams. This is evidently a mantra for India. Politicians getting named in large scams and then using their power to sway the decisions of government bodies has become a typical sight in the country.

The Punjab and Maharashtra Co-operative (PMC) bank fiasco is not the first time a major scam has been unearthed which has left a financial institution and its depositors in complete shambles. Call it misgovernance or blindsight of the management - borrowing from one bank to repay another bank has become a common practice in India.

A fraud to the tune of ₹6,500 billion was found in the books of the PMC bank, all of which were loans extended to only a single borrower: Housing Development and Infrastructure Limited (HDIL). This amount was way beyond the statutory limit set by the Reserve Bank of India (RBI) for lending to a single entity. Yet the senior management kept quiet on the matter until they were thrown under the bus by the managing director in his confession letter.

Relations between the Wadhawan group and the PMC bank have prevailed since the 1980's, wherein the former had saved the latter from the brink of a financial collapse quite a few times by infusing capital and keeping a majority of their deposits with the establishment. Thus, aiding the PMC bank to maintain the liquidity. 

But every good story has an end.

As HDIL’s business started to grow, and their capital requirements grew multifold, the group started to transact with larger banks in order to meet their needs. This hindered the profitability of the cooperative bank as the majority of the institution’s revenue was attributed to transactions in the Wadhawan group’s accounts. Hence, upon request the group started banking with PMC again after a short span of time.

In 2018-19, the bank had reported a profit of ₹996.9 million in its annual report. The bank showed 3.76% of advances (₹8,3830 million) as gross non-performing assets (NPAs), which was fair as compared to public sector banks.

However, things started to go awry when a few projects undertaken by HDIL were shelved, and this resulted in a liquidity crunch. Consequently, the bank started defaulting on all the loans it had taken from other banks. 

Initially, due to the past repayment record of the group, the bank continued to treat the loan as a standard loan. But when the loan amount snowballed to more than 73% of the bank’s total exposure, the issue came into the limelight and a strict moratorium was put upon the bank by the RBI. Hence, it's clear that the bank gave false monetary reports to cover its dangerous loan mess and the alleged collusion with HDIL and other firms.

To prevent panic and loss of public confidence, all the depositors were barred from withdrawing more than ₹1,000, but later the withdrawal limit was capped at ₹100,000 per depositor until further notice. In addition to the complaint that was filed with the authorities, the board of directors were suspended and the Wadhawan family members were arrested. The Enforcement Directorate, India's economic offences investigator, even seized movable and immovable assets of approximately  ₹40 billion in connection with the case.  

This whole case was nothing but another instance of corporate misgovernance and partial treatment to a particular lender by the senior management of banks, just like in the case of the Punjab National Bank scam. 

This fiasco could have been prevented had the institution increased its collateral against the loans disbursed and classified the Wadhawan group’s account as a NPA at the right time. The central bank should have learned its lesson post the PNB scam, and could have increased its due diligence on public sector banks by placing stricter checks and reporting standards on these financial institutions. 

In July 2021, the RBI approved the bid of Centrum Financial Services (CFS) and BharatPe to jointly take over the crisis driven cooperative bank, thereby providing some respite to its depositors. The president of BharatPe group said, “One thing was clear in our discussion with RBI that the interest of depositors is supreme”, further emphasising on the management's future intent. 

The RBI was initially reluctant in giving an in-principle nod to the two institutions to set up a small finance bank (SFB), however, it has finally given the licence and has even gone on to provide a lot of other statutory reliefs to the new entity to be jointly formed. 

There are different points of view on the RBI's decision to pick Centrum-BharatPe for the takeover of one of the largest cooperative banks in India. A section of the bank’s depositors are unhappy with the decision, as they preferred an established commercial bank to take over the entity rather than a new licensee with no direct experience of running a regular bank. 

CFS and BharatPe are set to infuse ₹5 billion each into the new entity when starting over and will increase the capital up to ₹30 billion in due course. Additionally, they also have the option to restructure the liability and convert them into capital instruments, take support from the Depositor Insurance and Credit Guarantee Corporation (DICGC) for repayment of insured deposits up to ₹50,000, phase withdrawal plans for individuals with higher deposits or convert the same into tier 1 or tier 2 capital. 

The joint venture is likely to form a good synergy between BharatPe and Centrum Financial Services. While the former is an establishment specialising in fintech with a strong footprint in the digital lending and Unified Payment Interface (UPI) industry, the latter is a non-banking lender with strong holdings and a good history in providing credit to small-mid size firms. Together they can bring innovation and renewed vigour to a fallen institution. 

The new entity is to be operational in 120 days post the principal nod given by the central banking authority, and only post this, will the RBI draft a scheme on amalgamation of the two entities with PMC Bank. The plan will then be sent to the government for approval and official notification. Under Section 45 of the Banking Regulation Act, only a bank can be merged with another, therefore, the process of handover will start only once the SFB (Small Finance Bank) is created.

Apart from that, the subsidiaries of Centrum namely Centrum Housing Finance and Centrum Microcredit are in the same business as the small finance bank to be set up by them. Hence, this poses a hurdle for Centrum, as one cannot have separate entities doing the same business. Either it will have to sell its majority stake or merge the subsidiaries; or not enter the microcredit and home loan business from the SFB set up, which would mean giving up a major business opportunity for the new joint venture.

The RBI has now called for sweeping changes in the Banking Regulation Act, and will be actively looking into the regulation of cooperative banks to avoid such a future debacle. But the problem doesn't stop there, the problem only begins here. India massively lacks transparency in the financial sector and this often puts a lot of wrongdoings away from the eyes of the public and regulatory bodies. There are more important questions that this mess raises. The first being, will the public institutions continue to show vigilance only after the chaos unfolds or will they ever learn to step in the moment the lines are crossed?