The collapse of a bank

Anxious depositors outside a branch of Global Trust Bank in Coimbatore after the Reserve Bank of India declared a moratorium. - S. SIVA SARAVANAN

Contrary to popular belief, the Reserve Bank of India's response to the crisis in the Global Trust Bank was not swift. In fact, it came after years of dithering.

THOUSANDS of depositors, investors and borrowers across the country were taken by surprise when the Reserve Bank of India (RBI) declared a three-month moratorium on Global Trust Bank, a new-generation private bank, on July 24. But, their anguish was quelled by the announcement, barely 48 hours later, that the beleaguered bank would be merged with the publicly owned Oriental Bank of Commerce (OBC).

Although there was general appreciation of the RBI's apparently swift response to the crisis, those with longer memories insist that the central bank's reaction came after years of dithering. They point to the fact that the RBI itself had in the past few years gathered substantial evidence of mismanagement in the bank. Moreover, other regulatory agencies such as the Securities and Exchange Board of India (SEBI) and the Joint Parliamentary Committee, which examined the stock market scam in 2001, had made pointed references to GTB's malpractices. Although the RBI appears to have overcome the crisis for the moment, systemic issues relating to the functioning of private sector banks have been pushed under the carpet.

Just before the RBI announced the amalgamation of GTB with OBC on July 26, the Union Finance Minister said that GTB had been "sliding for some time". He also hinted that regulatory vigilance may have failed in the past. Referring to the health of OBC post-merger, Finance Ministry sources justified it by saying that OBC, which had only a small presence in South India, would now be able to grow rapidly in the region. The advances made by OBC in 2003-04 amounted to Rs.19,861 crores, compared to GTB's Rs.3,276 crores; the public sector bank made a net profit of Rs.686 crores, compared to a loss of Rs.272 crores registered by GTB in 2003-04; and while OBC had no non-performing assets GTB's NPAs accounted for almost 20 per cent of its assets. Although the top management of the public sector bank said that writing off losses on account of NPAs acquired from GTB would enable it to get tax breaks, sceptics have their doubts. They pointed out that the tax breaks reflect at least a notional loss for the public exchequer on account of the caprices of the promoters of the private bank, which went under.

GTB commenced operations in 1994. Although the banking licence was granted to Jayanta Madhab, who was associated with the Asian Development Bank (ADB), the public image of the bank was always associated with Ramesh Gelli. Gelli, a former executive at Vysya Bank, is reported to have played a key role in mobilising funds when the bank started its operations. In particular, reports indicated that diamond traders contributed substantially to the Rs.100 crores that was mobilised at the time the Secunderabad-based bank started operations. In media circles Gelli acquired the reputation of being a "super banker". Not surprisingly, Gelli quickly attracted controversy. Indeed, one of the key issues that survive the now-dead bank is one relating to a banking institution's relationship to its promoters. Should a bank's operations be determined by the sole objective of generating returns to its promoters?

It appears that this question played a key role in the fortunes of the bank, particularly by forcing it to enter into sharp practices that bordered on the illegal. And, the larger issues relating to bank failures, particularly private bank failures are tied to the way this question is answered. Throughout its decade-long existence, the top management of the bank appears to have concentrated exclusively on generating returns to its key shareholders. This was at the expense of minority shareholders, depositors and borrowers. The rest of the issues, in particular the dressing up of GTB's accounts detected by the RBI as far back as March 2002 and the role of the management in propping up the share price, were indicative of the permissive regime that the private bank was manipulating to suit the interests of a few. Given these characteristics, it is not surprising that GTB was involved in the stock market scam of 2001, in which the lead artist was the stockbroker Ketan Parekh.

The bank had been hit by periodic bouts of reckless lending. The initial problems surfaced in 1997-98 when it was revealed that its advances made to small and medium-sized corporates were highly risky. The beleaguered bank, instead of adopting a more conservative approach to banking, actively fuelled the Ketan Parekh-led bull run in the stock market between December 2000 and March 2001. It lent heavily to players in the capital market and when the market crashed the bank's balance sheet suffered a gaping hole because share prices had dropped dramatically. In 2001, when it was attempting a merger with UTI Bank (which also attracted controversy), GTB lent more than Rs.800 crores. Much of the lending proved injudicious.

A bank in trouble could have chosen either to implement a course correction or to indulge in window-dressing. It is evident that the management preferred the latter course whenever the bank faced problems. For instance, the RBI, during the course of its inspection of GTB's accounts for 2001-02, found that GTB's net worth had turned negative. This was in sharp contrast to the claim of the bank's management that its net worth was about Rs. 400 crores. In fact, the central bank removed the bank's auditors and made a complaint about the auditor to the Institute for Chartered Accountants of India. Earlier, the RBI had asked Gelli to step down as the chairman of the bank after revelations before the JPC showed that he had acted in concert with Ketan Parekh. The JPC found that Gelli and other promoters of the bank colluded with Ketan Parekh to push up GTB's share price. The promoters, it must be emphasised, would have benefited directly from this because the price of the GTB share would have been a key variable determining the terms of the proposed merger. Indeed, the stink raised by the JPC proceedings was so strong that the deal fell through. Reports indicate that Gelli's successor quit after six months because Gelli and his supporters in the bank hampered him. However, Gelli's son was elected to the bank's board. In fact, Gelli managed to re-enter the board in February 2004 but had to resign again when several complaints were made to the RBI about his induction.

In September 2001, while investigating the role of the GTB in the stock scam, the JPC observed that the bank was guilty of not monitoring the end-use of the funds that it lent. The chairman, S.P.M. Tripathi, told reporters after deposition by GTB's top officials that the bank ought to have acted because JPC members felt there was "definite evidence of misappropriation" of funds. Depositions by bank officials before the JPC confirmed SEBI's finding of diversion of funds lent by GTB to several companies, among them Ketan Parekh-linked companies, Zee Telefilms and Himachal Futuristic Communications Ltd. (HFCL).

There are two versions of GTB's association with Ketan Parekh. The more charitable view regards GTB as a high-stakes gambler playing recklessly. The less sympathetic view is that GTB acted as the fulcrum for Ketan Parekh's transactions in the market. This version is backed by the claim that Ketan Parekh's corporate associates, their investment companies, and his network of numerous investment firms had accounts with GTB. The JPC proceedings revealed the tremendous velocity with which funds were transferred among these entities, often within a day. GTB's lending to corporate groups was dictated by the logic of the stock market and not the business potential in their sectors of operation. The shares of many companies such as Zee Telefilms and HFCL were Ketan Parekh favourites. But the scheme also had a circular logic, which was bound to collapse at some point. The lender of funds, GTB, would lend money to Ketan Parekh and Parekh, in turn, would drive up share prices for these companies.

THE terms of the OBC-GTB amalgamation are such that the existing shareholders of GTB will not get anything as a result of the merger - referred to in market parlance as a swap. Meanwhile, there was unusual trading activity in GTB shares in the stock market after the announcement. This was certainly unusual for an institution that was on its last legs. Meanwhile, reports from the market indicated that large entities including promoters, foreign institutional investors and Overseas Corporate Bodies and Non-Resident Indians, had offloaded their holdings in the GTB scrip in the weeks before the moratorium was declared by the RBI. According to some reports, nearly 16 per cent of GTB shares were offloaded by these investors between June 14 and July 24. As a result, the holdings of smaller investors increased from 44 per cent to 51 per cent by the time the bank was declared dead. In fact, there are some reports that these holdings could account for almost 60 per cent of the shares.

SEBI has announced that it is examining trade data during the last six months to see whether the activity in the market is indicative of insider trading. However, speculation is rife because it is now known that OBC gave the RBI its letter of intent in mid-July. The possibility of insider trading in an entity such as GTB is not difficult to fathom. If the promoters and the well-connected knew of the impending merger, it would explain their exit from the GTB share. However, ordinary investors were being told by the management of its new proposal of offering a stake to a foreign investing entity, New Bridge Capital. There were reports that the investor was agreeable to investing Rs.1,500 crores in GTB. Obviously, those who were in the inside track knew where the bank was headed and quickly dumped their stock. But as it happens always in the stock market, those outside the loop were the losers.

Meanwhile, it is not clear how much of a burden the dead bank will be on OBC. Although the losses are said to be in the region of about Rs.1,200 crores, there is already speculation that they could end up being much more. That would be entirely in keeping with the track record of an entity that always surprised its clients.