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.
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