On
July 26, hapless depositors in ''new-generation''
Global Trust Bank (GTB) discovered from the tickers
at the bottom of their television screens that their
money was no longer their own - at least for the next
three months. The RBI had put a moratorium on withdrawals
exceeding a total of Rs. 10,000 by depositors and
on lending by a bank which in any case had no own
funds to base its lending on.
What followed was chaos at the premises of the bank,
at its ATMs and at the offices of those who were thought
to be responsible and could offer a solution. This,
of course, was not the first time such a situation
had arisen. Since the launch of financial liberalisation
in the early 1990s, a string of banks - the United
Industrial Bank, Benares Bank, Nedungadi Bank, Bank
of Karad and a host of cooperative banks - have had
to down shutters with aftershocks of varying intensity.
But, excepting for Nedungadi Bank, which, though older,
shared many similarities with Global Trust, these
failures have been dismissed as the result of the
special characteristics of these particularly weak
banks or the result of inadequate supervision of institutions
such as the cooperative banks.
The most striking feature of GTB is that it epitomises
the new generation private banks that came with the
financial liberalisation of the 1990s. These were
the banks which were being offered permission to enter
the industry with the intention of increasing competition,
improving efficiency of operations with new technology,
offering better services to the customer, and in the
process helping improve the practices of the ostensibly
inefficient, slothful and low-profit public sector
banks.
GTB was established in 1994 by Ramesh Gelli, a high
profile public sector banker who fancied himself as
being among the top and most innovative bankers in
the country. Gelli who was the Chairman and Managing
Director of Vysya Bank at the time when the government
chose to permit the entry of new private banks into
the banking sector, not only staked a claim for licence
but worked out innovative schemes to finance its operations.
For example, interest and repayment on credit for
operations from shareholders were reportedly linked
to the market price of the share. The higher the market
price of the shares, the lower the interest rate,
and lower the market price, higher the interest rate,
with the variation being from zero to 22 per cent.
From the point of view of the creditors, this implied
that they were obtaining an assured return from the
combination of their investments in equity purchases
and the provision of credit. From the point of view
of the promoters of the bank, they were offering investors
an assured return, which gave them access to funds
and could deliver profits so long as share prices
could be kept at high levels and therefore the cost
of funds remained low. To any observer, it should
be clear that in a situation of this kind, there would
be an obvious incentive for promoters to keep share
prices high, either by manipulating accounts or rigging
the market if necessary. On the other hand, the poorer
is the price performance of the share, the greater
would be the pressure to lend to risky projects to
earn the high returns that helped meet the high cost
of funds.
Operations such as these were obviously risky, and
implied that the agents concerned were indulging in
speculative manoeuvres in search of quick profits.
Their fundamental concern was not to serve as robust
and transparent intermediary earning a reasonable
return, but to register rapid growth, invest in high-return
but high-risk areas and earn quick and large profits.
Despite the fact that this substantially increased
the chances of failure, the RBI and the government
chose to encourage banks of this kind, which were
given added credibility because they obtained funding
from institutions like the International Finance Corporation
and the World Bank which were promoting financial
liberalisation and private sector entry into the banking
system. Interestingly, the IFC and the World Bank
chose to exit from their investments in GTB, possibly
because they realised that their investments were
not safe if left with GTB. But, never was there a
word of warning that an institution that was created
because of the policies they were pushing was displaying
signs of potential failure.
Once GTB was created, there was no stopping Gelli
and his associates. The search for high returns soon
took the bank to the stock market, where its involvement
in the speculative activities associated with the
Ketan Parekh scam and its high exposure soon resulted
in substantial losses. Meanwhile, the bank’s promoters
had attempted to merge the entity with the UTI bank,
and in the process the share price was sought to be
rigged so that the promoters could make a profit despite
the state of the bank. By then it was clear that unless
some drastic measures were taken, the bank was heading
for closure. This led to the exit of Ramesh Gelli
in 2001, but matters did not improve under the new
management. The bank, which was under instructions
to clean up its balance sheets by inducting new capital
and reforming its practices reported a net profit
of Rs. 40 crore and a positive net worth of Rs. 400
crore at the end of the financial year in March 2002.
However, the RBI soon discovered that even the certified
auditors of the bank had allowed a set of manipulated
numbers to be reported and that actually the bank’s
net worth was negative.
This put the RBI in hands-on mode, with monthly scrutinies
besides the annual inspection. A year later, GTB reported
an overall loss, but also substantial reduction in
non-performing assets, significant provisioning against
loss-making assets and an operating profit. The RBI
welcomed these developments, suggesting that under
a new management the bank was on the mend. But soon
the RBI discovered that the net worth of the bank
was turning worse and that it had no capital to sustain
its operations. Circumstances had ensured, despite
the forbearance of the RBI in the hope of a solution,
that unless substantial new capital was infused into
the bank, there was no hope of revival.
Under pressure from the RBI, the bank soon found an
international suitor in the form of Newbridge Capital.
But Newbridge’s conditions required that India’s already
lax laws on foreign investment had to be revised or
violated. Reportedly, Newbridge wanted full management
control as well as the right to report to the regulator
of its parent than to the RBI. If this had gone through,
the victory of international finance capital which,
in collaboration with the World Bank, the IMF and
the IFC, has been pushing through the liberalisation
which creates the likes of GTB, would have been total.
In the circumstance, the RBI was left with the same
option that it has resorted to in the case of other
failures such as Nedungadi Bank: that of getting a
public sector bank to take over the failing bank through
its merger. In this case, Oriental Bank of Commerce
with a zero NPA record and a strong capital adequacy
ratio was brought in, just as Punjab National Bank
had been brought in to rescue the depositors of Nedungadi
Bank earlier.
Needless to say, these acts of bailing out, through
merger, of banks that have failed because of private
speculation and mismanagement, results in what the
economic literature terms ''moral hazard'' - knowing
that the government would step in to prevent a crisis
using the public sector, investors, depositors and
promoters would continue to seek high returns through
risky ventures. If their speculative bid succeeds
they make a huge profit; if it does not the government
would step in to bail them out. What is more, the
RBI has declared that it is not contemplating action
against the promoters and directors of the bank. Meanwhile,
Gelli, who is still a shareholder and has reportedly
been remotely influencing/controlling the bank over
the last three years, is demanding that shareholders
too must be paid off when the merger occurs. Why not?
Can a truly benevolent reformer avoid indirectly using
tax payers’ money to protect investors and speculators
and not just depositors?
