As Safe As A Bank!

You can be led by the nose; diamantaires Nirav Modi and Mehul Choksi have shown us it can be done by the nose-ring too. The duo’s imaginative scaling up of the Narendra Modi government’s direct transfer benefit scheme has the state-run Punjab National Bank (PNB) mired in a “snafu” — a word whose origin lies in a World War II-era military acronym for “situation normal; all f****d up”. Its lustre though insures against loneliness; PNB will share tent-space with the two big sandstone blocks in New Delhi (North and South) and a wide cast of regulators; two, you see, is anyway defined as company; a crowd is three.

Twenty-six years after the M. Narasimham Committee Report (1992) flagged off capital adequacy, income-recognition and provisioning norms; and latter-day tomes helped chisel an oversight superstructure on financial hygiene, we seem to be — on many levels — very much in the same place. And if you don’t get a sense of déjà vu, blame it on the short attention spans we have come to possess in these times of information overload; or it could be that you are relatively young and yet to catch up on the folklore.

The latest fiasco falls into a long family line that involves non-fund limits, read contingent liabilities that are off-books, but can leave you crimson-faced when they blow up. Harshad Mehta did it innovatively with bankers receipts in 1992. Centurion Bank paid for its sins when it discounted bills under inland usance Letters of Credit opened by state-run banks in 1997. Ketan Parekh exploited the ignorance of bankers who did not know the difference between a cheque and a pay-order (it sank Madhavpura Co-operative Bank that had issued pay-orders worth Rs 1,200 crore to Parekh which he discounted with Bank of India). What’s one to make of all this?

Says K. J. Udeshi, former deputy governor of the Reserve Bank of India (RBI), who was in-charge of two of the most powerful and sensitive departments — the Department of Banking Operations and Development; and Department of Supervision — on why the mess lurks on the contingent liabilities side: “The feeling is, it’s not the banks’ funds that are being used as it is off-balance sheet. Of course, when trouble starts, it’s different”.

Under Udeshi’s watch, Mint Road dismissed the board of Global Trust Bank, headed by managing director & CEO Ramesh Gelli, in 2003 — the only such case in our history. Is there a case for the same at PNB? “No. That case was different as the board was hand in glove… in the case of PNB, the operational people are to fault. The board does not look at day-to-day issues. And anyway, what will this achieve?”.


But lest you think she’s giving a clean chit to Mint Road, take note. “The RBI should have insisted that the SWIFT platform was linked to the Core Banking Solution. That was a mistake”. Yet another issue she raises is, even during her time, it had been made clear that the state of NOSTRO balances was to be presented to banks’ boards — reconciled and unreconciled — at the end of day for the period before the meet. (NOSTRO account refers to an account that a bank holds in a foreign currency in another bank; it’s a term derived from the Latin word for “ours,” and frequently used to facilitate foreign exchange and trade transactions). “Now it’s not that such data is not put forward to the board, but they get aggregated data. How are they (members) to know what’s going on at the operational level?”.

We are on familiar territory in other ways too. Look no further than the appointment of an expert committee to be chaired by the impeccable Y. H. Malegam (a former resident on Mint Road’s central board of directors), to examine the divergences seen in asset classification and provisioning in the credit portfolio, as well as the rising incidence of frauds in banks. He has in the past headed similar committees set up by the banking regulator. Then go through what RBI’s latest Report on the Trend and Progress of Banking (2016-17) points out. That the process of migration of the batch-processed fraud database to a web-based reporting architecture is largely complete with banks and select financial institutions starting the live reporting of Fraud Monitoring Returns from 1 April, 2017. “Banks will submit fraud reports within the specified period in straight through processing mode, which will facilitate faster dissemination of fraud data. Banks will also update developments in fraud cases on ‘as and when required’ basis instead of doing it on a quarterly basis”, it notes. And yet, we are where we are!

“The point is what’s been the outcome of all this wisdom and oversight? The outcome has been below par,” says Probir Roy, co-founder and promoter-director of PayMate who adds. “It’s like the lyrics from the Pink Floyd song. ‘Wish you were here’. As in the lines ‘We’re just two lost souls swimming in a fish bowl, year after year; running over the same old ground; what have we found? The same old fears; wish you were here’.” He’s of the view that what’s called for is for the likes of a Narayana Murthy, Nandan Nilekani, Jerry Rao, K.V. Kamath or Y. V. Reddy — folks with a sense of modern technology — to suggest the way forward.


Take the case of SWIFT (Society for Worldwide Interbank Financial Telecommunications), a global communication network that facilitates 24-hour secure international exchange of payment instructions between banks, central banks, multinational corporations, and major securities firms. A member-owned cooperative organised in 1977 under Belgium law, it now includes over 6,500 participating members from more than 180 countries which processes in excess of a billion messages every year (or about 300 million messages every day).

Ever wondered who make up the shareholders of SWIFT India? It’s Axis Bank, HDFC Bank, ICICI Bank, Bank of Baroda, Bank of India, Canara Bank, State Bank of India, Union Bank of India and yes, PNB! It gets even more interesting. Axis Bank has asked its president and chief information officer Amit Sethi to step down after a complaint from a whistle-blower. But there’s not a squeak over the fact that Sidharth Rath, the bank’s group executive-head of corporate relationship and the transaction banking business, continues to be on the SWIFT India Board (mind you, Axis Bank also had an exposure to the Letters of Undertaking (LoU) issued by PNB which it sold down later); so too, Debadatta Chand, general manager at PNB (of treasury, no less!), who continues to warm his seat out here.

It’s hilarious to note that after SWIFT’s India and subcontinents regional conference to discuss the digitisation of the country’s financial services on 13 June 2017, it said banks trade processing platforms needed to be enhanced through digital innovation involving end-to-end customer journey for trade. “Digitisation would not only fasten the movement of goods, documents and funds, but also help lenders make an informed credit decision as data would be easily available and supply chain timelines will shrink. Initiatives such as SWIFT GPI are also expected to further assist Indian corporates grow their overseas business by enabling them to receive enhanced payments services directly from their banks, making funds available for use on the same day, giving transparency on fees and offering end-to-end tracking of funds in real-time.” We know, we know!

Then what are you to make of the Centre’s recent claims that most shell companies had been shut down; to the extent we now know, there were scores of them in the studded poker game. Or the high-pitched “threat” that the authorities have it in them to sniff out if the monies deposited in banks post-demonetisation were legit or not. If it were so, we would not be hand-wringing over PNB.

It doesn’t end here. You have other variables such as a spate of global laws to deal with; and we have no idea what their implications will be. It’s a much-changed financial turf, especially given the links between high finance and terror. It’s not to suggest that the principals in the ongoing saga are in any way connected to it, but money being fungible, you need to track its movements.

Take the esoteric FATCA — Foreign Account Tax Compliance Act (2012), a US regulation that all banks need to comply with; it requires foreign financial institutions to report directly to the IRS certain information about financial accounts held by US taxpayers, or by foreign entities in which US taxpayers hold a substantial ownership interest. How does this kick in? Well, our banks are signatories to it; then, Nirav Modi’s wife, Ami Modi, is a US citizen. And as on date, little is known about the nature of their overseas business or cross-country linkages.

Then you have the Anti-Money Laundering and Countering Financing of Terrorism Act (2009) of the Financial Action Task Force (FATF). India was placed in the regular follow-up process for mutual evaluation purposes because of partially compliant ratings on certain core and key recommendations. Since the publication of the mutual evaluation report (adopted on 24 June 2010), India had been reporting back to the FATF on a regular basis on the progress made in the implementation of its action plan to tackle money laundering and terror financing. We were seen to have made noteworthy progress on the implementation of this plan, and at the June 2013 Plenary meeting, the FATF decided, “India had reached a satisfactory level of compliance with all of the core and key recommendations and could be removed from the regular follow-up process. The decision by the FATF to remove a country from the regular follow-up process is based on updated procedures agreed in October 2009.”

What’s the worry in all this? If more muck were to come out after the recent probe ordered by South Block and Mint Road on the contingent liabilities and non-fund business of banks; if it’s found that more LoUs were issued based on love and fresh air, there could be a fallout under FATCA and FATF. Anyway, these are early days, and we have no precedent of these laws being tested under the circumstances we find ourselves in. In any case, what’s important is that PNB is a classic case of Foreign Exchange Management Act (1999) violations.

The point is despite tonnes of sums being invested by banks on compliance, Chet Kamat, the managing director and CEO of Oracle Financial Services Software, told BW (albeit in a different, but not unrelated context), “If you look at IT growth investment in compliance systems — be it operational risk, KYC (Know Your Customer), anti-money laundering, capital adequacy — it’s significant. Every Indian bank needs to comply with FATCA. And that’s another area where the data supply-chain of banks is in a real mess”. Don’t we now know?! There could well be another casualty — Aadhaar. If our systems are so weak, why should you trust our banks with sensitive data? Not many are aware that in the contract signed between banks and the Unique Identification Authority of India (UIDAI), you have an “unlimited liability” clause on banks if there’s to be a breach of security, or data is stolen. Technically, this is a contingent liability on banks. Have you ever asked how a bank is to account for this payout? Or why you as a customer can’t have a like clause put on a bank? And given that you have to give your Aadhaar details to even throw a stone going ahead, just how is a bank to know where exactly the breach has happened from? If a bank were to claim that it’s not at fault, where does that leave the bank with the unlimited liability clause? Or thyself?

Simply put, you are to brace for a multi-tiered blowout that will hit the gems and jewellery industry, India Inc., and the wider banking turf including the regulatory from here on. That it will more than singe those in the political ring should be the least of our worry.

Grime And Glitter
Diamonds may or may not be a girl’s best friend; but for boys, it’s been drilled into their heads with no help from moonshine (!) over the past fortnight that there’s nothing to beat a bank. And two idioms also stand demolished — ‘As safe as a bank’; and ‘He’s a real gem’.

If you were to add up the fund and non-fund bank limits that’s been vend to the luminaries in the star-cast, our wallets will be lighter by Rs 11,000 crore to Rs 20,000 crore. Modi (not our Great Leader) states that it’s just a Rs 5,000-crore pothole to be tarred over, but then PNB made haste to reach out for the vuvuzela; not a mere whistle. As for Choksi, he’s just too great a poet to put a price on his Gitanjali. It should not dazzle if the collective artwork sets ‘We the People’ back by a handsome Rs 25,000 crore. Drain the swamp, did you say? Well, you may well find buried an Augean stable in it.

The share of gems and jewellery sector in banks credit has ranged between 2.5 per cent and 3 per cent. It saw a drop during 2009-2010 (post the global flu in 2008), but after 2011, it picked up with annual growth in bank credit being better than the secular growth in overall credit till fiscal ’14. It fell off in the next two years due to a glut in the business, but by end of fiscal ’17,  had moved up to Rs 72,738 crore (from Rs 72,700 crore).

Says Madan Sabnavis, chief economist at Care Ratings, under whose watch the rating agency has prepared a note on the gems and jewellery sector: “You are now saying a third of the exposure to the industry is dodgy. There could be a rethink by banks on further exposure to the sector.” Do recall, the sector has caught the interest of private equity (PE) and global biggies too.

Sample this: the local arm of the US PE firm Warburg Pincus has picked up a minority stake in the Kerala-based Kalyan Jewellers for Rs 1,200 crore. Kalyan Jewellers plans to invest Rs 500 crore to add 15 new showrooms as part of their on-going expansion locally and in West Asia; and intends to invest Rs 900 crore over the next three years to widen its footprint in Sri Lanka, Singapore and Malaysia. Similarly, Joyalukkas too plans to invest Rs 1,500 crore to set up 20 stores in India and ten overseas.  

Creador, a PE firm focused on long-term investments in growth-oriented businesses in India,  Indonesia, Malaysia and Singapore, has pumped in Rs 135 crore for a minority stake in PC Jewellers. KSS, a digital and entertainment player, has forayed into the jewellery retailing business under the franchise model and is planning to open 500 stores under the brand ‘Bjewelz’ which is owned by Birla Jewels, a wholly-owned subsidiary of KSS. Melorra, a Bengaluru-based online jewellery startup, has raised $5 million funding from venture capital Lightbox Ventures. Global luxury brand Montblanc International has entered into a joint venture with Titan to start retail operations in India by opening five boutiques. The London-based ultra-luxury jeweller for the super-rich, Faberge, owned by the world’s top emeralds and rubies-miner Gemfields Plc., is to enter the country and hawk through select trunk shows for the uber rich in Delhi and Mumbai. What happens to this bandwagon?

The Gems and Jewellery Export Promotion Council (GJEPC) points out what’s at stake here. The Indian diamond industry with tens of thousands of factories, 6,000 exporters earn us $23 billion with value addition more than $7 billion. It puts up a brave front when it says that “the Council strongly believes that this incidence will not have any contagion effect to the gems and jewellery export industry”. It then points out that bank finance to the trade is already guided by stringent norms with detailed internal audits in place on quarterly and annual basis. This, in turn, is followed by external audits and a special audit by RBI every few years. That every SWIFT transaction by a bank is intimated to NOSTRO and international division (treasury). That Mint Road launched Export Data Processing and Monitoring System in March 2014 to monitor payments against export and import bill. That it is a system where all export and import transactions are captured and followed up till their realisation by banks and customs. Well, all of that failed!

Unlike a manufacturing company, the gems and jewellery businesses are basically of value-add; real estate by way of showrooms are rented by franchisees. To the extent, the play is on the brand, any erosion in it — whatever be the reason — means realisable valuations too take a tumble. Let’s look at the haircuts that banks take on bad-loans under the National Company Law Tribunal; Mint Road had last month made it clear this will be the only route for dud-loans resolution.

Says Nikhil Shah, managing director of advisory firm Alvarez & Marsal: “It varies across industries and can range from 20 per cent to 80 per cent assuming it is a resolution plan approved.” Shah though agrees that in the case of PNB, it remains to be seen what kind of asset cover Modi (Nirav) had given that it is not a manufacturing entity with assets on the ground.

Implications For Banks, India Inc.
Playing truant is not uncommon. The report of the ‘Committee to Recommend Data Format for Furnishing of Credit Information to Credit Information Companies (2014)’ under the chairmanship of HDFC Bank’s managing director Aditya Puri, had observed: “Borrowers have, in general, not been forthcoming in sharing such information with lenders, particularly with banks that are not part of the consortium”. That, by the way, is also an off-balance-sheet item.

It’s part of a larger malady. In July 1997, Tata Tea did away with its unwieldy decades-old State Bank of India-led consortium of a dozen banks to sip on Mint Road’s new brew for India Inc — multiple banking. You could shop for loans bilaterally from banks and if your stars were good, avail of a “bespoke” structure and pricing for it. Two decades on, these galactic arrangements are in disarray — the lines between consortium and multiple banking have blurred; and its bankers who now see stars. Its fallout is one of the worst kept secrets in our banking — “visibility” on the state of credit (fund and non-fund) is less than adequate.

And the huge information asymmetry on matters of credit is one of the key reasons for the dud-loan pile up which could tip over $120 billion shortly. Senior bankers have raised the matter with the RBI to correct what is nothing short of “delinquent behaviour”. In a consortium, the lead-bank keeps an eye of what’s going on and there are inter-creditor ground rules; in multiple banking, a borrower gets independently assessed on credit-limits by banks. But as on date, banks within a consortium also offer “multiple banking” or get into “club deals” with the same borrower. What you now have is a platypus — a semi-aquatic egg-laying mammal which the naturalist George Shaw was inclined to dismiss as hoax as “there might have been practised some arts of deception in its structure.” At the systemic level, it has led to banks being blind-sided even as it encourages a high level of corporate debt leverage that comes back to bite them.

It’s now a game of self-interest. “It (information asymmetry) poses a systemic risk in itself, but as banks’ asset covers on loans erode, it’s used in a strategic and proprietary manner to get a good deal for yourself as a lender at the cost of other banks,” says Suhail Nathani, managing partner at Economic Law Practice. Reshmi Khurana, Managing Director and Head of South Asia in Kroll’s Investigations and Disputes practice cites “the inability to take legal recourse due to what’s often perceived as a tedious and unwieldy judicial process,” compounds the issues as “companies can get away from borrowing from Peter to pay Paul, until the proverbial music stops”.

What you can’t get away from is that banks will slam the brakes on credit. The bulk of Rs 2.11 lakh crore recapitalisation of state-run banks will be eaten by provisioning. When BW asked Uday Kotak, executive vice-chairman and managing director of Kotak Mahindra Bank, what  his assessment of the amount of capital required by banks was, he had said, “My sense regarding the stress in the economy is around 20 per cent of loans, which is give or take Rs 14-15 lakh crore. I would say that you’d recover about Rs 7 lakh crore. Let’s assume that the total is Rs 15 lakh crore, and you recover Rs 7 lakh crore. Therefore, what is not recovered is Rs 8 lakh crore. What is provided till date is about Rs 4 lakh crore. What has not been recovered has to be provided for. Now, you need capital for growth. I think that what has been provided takes care of the current requirements of getting your balance on capital. But not enough to see growth”. Do we need to say more?

What now? Says Udeshi: “Remember the lines from the great movie ‘Casablanca’. What does the cop say? Round up the usual suspects!”

Déjà vu, did somebody mention it?