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?