The Rs.600-crore Home Trade scam reveals that investments in cooperative banks are vulnerable to misuse as long as regulatory control of these banks vests both in the Registrar of Cooperative Societies and the Reserve Bank of India.
EXACTLY a year after the securities scam involving stock broker Ketan Parekh rocked the Indian financial markets, another rip-off of the kind has been exposed. Under the pretext of gilt trading, almost Rs.600 crores has been swindled from more than 25 cooperative banks - 13 of them in Maharashtra and 12 in Gujarat. It is likely that many more cooperative banks in both the States are entangled in the racket that has exposed a nexus involving brokers, cooperative banks and politicians.
While the latest fraud may not be on the scale of the scams involving Harshad Mehta (around Rs.5,000 crores) or Ketan Parekh (Rs.800 crores), what is alarming is that this time the scammers' tentacles have spread to the Public Provident Fund (PPF) - the repository of the savings of millions of ordinary Indians. More than Rs.92 crores is missing from the Seamen's Provident Fund, which has 26,500 members. Worse still, the regulatory authorities admitted that they were aware of the mess and gave various excuses for not having taken timely action.
At the centre of the scam is the Navi Mumbai-based brokerage firm Home Trade. The company was launched two years ago accompanied by a Rs.24-crore advertising blitzkrieg employing cricket icon Sachin Tendulkar and film stars Shah Rukh Khan and Hrithik Roshan. Home Trade and four of its affiliates lured cooperative banks with two to seven per cent higher returns on investment in gilts. The brokerage firm claimed to have bought government securities (G-secs) for the banks.
The G-secs were not physically delivered and investigations reveal that they may not even exist. On their part, the cooperative banks may have erred in not demanding delivery of the G-secs. Maharashtra's Corps of Detectives said the embezzled money was used to play the stock market, mainly to trade in shares of companies in which Home Trade had a stake or which Sanjay Agarwal, Home Trade's chairman, promoted.
When Home Trade defaulted on payments and the loss of investments began to burn a hole in the pockets of the Nagpur District Central Cooperative Bank, its chairman Sunil Kedar filed a criminal complaint against Home Trade for not delivering G-sec certificates worth Rs.125 crores. The next day, April 26, the scam unravelled further as similar complaints poured in from other parts of Maharashtra.
The Wardha and Osmanabad district cooperative banks had invested Rs.25 crores and Rs.30 crores in G-secs through Home Trade, Pune's Satguri Jangli Maharaj Cooperative Bank Rs.37 crores and the Amravati People's Cooperative Bank Rs.10 crores. Four cooperative banks in Surat and Navsari in Gujarat had invested approximately Rs.80 crores. While these are among the larger banks, several small banks and some regional rural banks may also be involved. Home Trade and its affiliates were also brokers for the Seamen's PPF. No one who dealt with Home Trade seemed to have received actual certificates.
Meanwhile, Sunil Kedar was arrested for bending the rules to invest in G-secs and for preparing false documents. In order to undo the damage, the State Registrar of Cooperative Societies (RoCS) dissolved the boards of the scam-tainted banks on the recommendation of the Reserve Bank of India (RBI). Sanjay Agarwal initially went missing but later surrendered before a lower court in Nagpur. "His interrogation will expose the linkages between many more brokers and banks," a police officer told Frontline. The investigating agency is looking at a possible broker-bank nexus in diverting money from cooperative banks into the stock market. A similar method was used by Harshad Mehta in 1992. He pulled out funds from government-owned banks by issuing bogus Bankers' Receipts instead of G-secs and played the stock market.
"Agarwal could not have pulled this off without the complicity of the heads of banks," said a bank official. Under RBI regulations, banks have to maintain a Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR) on the basis of deposits held. Gilt trading is governed by RBI norms, the most important of which are that purchase of G-secs through a single broker should be limited to 5 per cent of the total value of such purchases and that no money should be credited to the broker's account. Home Trade fictitiously traded in much more than the ceiling set. "Every single bank blatantly violated RBI regulations," said the official. For instance, several banks had given power of attorney to stock brokers to deal in G-secs. The RBI does not permit this. The Nagpur District Central Cooperative Bank did not even obtain the requisite RBI approval to invest in public sector bonds. The bonds stated to have been purchased were never received and were later shown as having been exchanged for G-secs. "As we all know, neither were the G-secs received," said the official.
THE Home Trade fraud is the fourth major financial scam to happen in the RBI's own backyard in recent times. "Either the RBI is wearing blinkers or there is a fundamental flaw in its policies," said the official. "Besides, what was the Securities and Exchange Board of India (SEBI), with which Home Trade is registered as a broker, doing?" Or for that matter, the National Bank for Agriculture and Rural Development (NABARD) - the supervisory authority for cooperative banks? "Clearly, the real fault is with the system. You cannot blame Home Trade for pulling off a fraud in an incoherent system," said the official.
An RBI spokesperson told Frontline that it became aware of the mismanagement of funds last November. "We alerted NABARD, which discovered the irregularities in the Nagpur bank during its audit," she said. She claimed that by February the RBI knew enough but had to verify material and do some investigation before publicising the problem. "There is no problem with the RBI's policies. There are no loopholes in the system. These banks clearly violated RBI regulations," she said.
Nevertheless, it is clear that much of the fault lies in the RBI's policies. It put in place a Delivery versus Payment (DVP) system for G-sec trading by commercial banks, but continued to allow the cooperative banks to deal in physical securities. Under the DVP system, every buy or sell is matched. A mistake triggers a deadlock and the RBI is alerted immediately. In the case of a cooperative bank, it credits funds to the account of the broker, who can default in physically handing out the government paper. This calls for constant monitoring by the RBI.
The lack of vigilance by SEBI and the bourses is also responsible for the mess. In 1999, according to a report, the Bombay Stock Exchange rejected the listing application of Home Trade, then known as Euro Asian Securities. It later got listed on the Pune Stock Exchange, where it promptly began to ramp up its stock price. In September 2000, the National Stock Exchange rejected the listing application of Ways India, a sister concern of Home Trade, when it failed to provide answers to several queries. But the most obvious cautionary signal was Home Trade's high-profile launch in 1999. An unknown company, it used celebrities in television advertisements and left people asking what the company was all about and what it was selling.
In spite of the so-called tight regulations and vigilance measures in place, cooperative banks seemed to be instrumental in the scams. Last year, the Madhavpura Mercantile Cooperative Bank lost Rs.800 crores in the Ketan Parekh scam. "The real issue is the duality of regulators," said Kirit Somaiya, president of the Investor Grievance Forum. "The multi-layered monitoring system, by the State and Central governments, of the cooperative banking sector has led to confusion with regard to responsibilities. This has worked to the advantage of scammers." Cooperative banks come under the RoCS. And because they have banking functions, they must adhere to RBI norms. This dual regulation often leads to there being no regulation at all. RoCS officials allege that the RBI does not look closely at these banks, while the RBI says it waits for government recommendations as the State's Cooperatives Department has its auditors on the boards of the banks.
The responsibility, Somaiya told Frontline, should be fixed with one body and preferably the RBI should be given the lead monitoring role. He said the entire cooperative structure in the State had to be overhauled. "Most of the heads of banks and cooperative societies don't know how to deal with liberalisation. They have no idea where to invest or how to manage their funds in this economic environment," he said.
COOPERATIVE banks across the country face similar problems of poor management and political interference. Meant to be a primary financial support structure to farmers and small depositors, cooperative banks have been consistently criticised by the RBI for their weak performance. According to the RBI, collectively the banks have Rs.5,500 crores of non-performing assets. Yet the central bank appears to be doing little to implement suggestions made by several committees. In 1999, the RBI appointed a high-power committee on urban cooperative banks to study the viability of this sector. The committee's recommendations included aligning the cooperative bank sector with other segments of the banking sector, removal of preferential treatment and "removing the irritants of the dual control regime".
More recently, the Monetary and Credit Policy for 2002-03 has sought to address directly the issues concerning cooperative banks. The report states: "The events of the last two years have made it abundantly clear that the present system of dual/triple regulatory and supervisory control is not conducive to efficient functioning...." Mincing no words, the policy document adds: "The managements and boards of several cooperative institutions continue to reflect political interests rather than genuine cooperative spirit." It recommends that a separate supervisory authority be set up with representatives from the Centre, the States and other interested parties.
Maharashtra has more than 616 cooperative banks, the largest number for any State in the country. Most of them are completely controlled by politicians. It requires only Rs.1 lakh to start a cooperative bank. The depositors are mainly farmers and local people. Some banks are offshoots of the sugar and dairy cooperative societies, which are also controlled by politicians. Sunil Kedar, for instance, belonged to the Nationalist Congress Party (NCP). In fact, three senior members of the NCP have found themselves in the midst of the current scam. According to a police agency, 16 of the 23 board members of the tainted Nagpur bank are NCP members.
It is unlikely that the scam will affect individual depositors immediately, said Vivek Monteiro, a member of the Centre of Indian Trade Unions (CITU). But the loss will reflect in the deficit of the State, he added. However, the bottom line is that the money belongs to depositors who trust banks with their savings.
The Central government, meanwhile, is going ahead with its plan to recapitalise cooperative banks to the extent of Rs.7,000 crores. This will bail the banks out for some time. Kedar may probably slip through the cracks and go free. "If we cannot prove mala fide, he will be let off," said a police source. With the banks recapitalised, and politicians like Kedar and brokers like Parekh walking free, the next scam may be just waiting to happen.