Don't fall for 1 or 2 per cent more FD rate at small banks

The recent case of PMC Bank brings forth a lot of learnings. This cooperative bank had over one hundred branches and was present in many states. Typically, cooperative banks are either single branch are a handful of branches. Very few scale up. India has over 1,500 cooperative banks! And many have a lot of branches. Nearly 50 of them are officially bankrupt (negative net worth) and about 35 of them are under Prompt Corrective Action (PCA). PCA means that the regulator has found out (after the bank is broken) that this bank is also insolvent, but if no panic is created, they can gradually dig themselves out of the hole Grow deposits, stop lending and be happy.

It would be a nightmare to monitor these many companies. And the nature of companies is such that none can be just ignored or classified as low priority. Many of them are linked to promoters of large business groups and most have some dealing or another with the banking system and can be a source of potential trouble or wrong doing. And further, imagine the number of frauds a branch can hide from the main records. It is perhaps unfair to expect RBI to monitor and give early alert on frauds and scams.

Our problem is that we are permitting too many different entities to engage in the business of lending and borrowing money. We have moneylenders in every town who do not seem to have caused any regulatory worries in their long history, in spite of having an unpleasant reputation. Organised ‘white collar’ banking is the one that seems to encourage wrong doing since the employee has no personal stake in either the deposit or the lending. If he can line his pockets, he will. The moneylender operates with his family money, family people. So he can take his risks knowingly and is immune to frauds.

The regulator clearly has too much on his plate and is not equipped to detect wrong doing in a timely fashion.

Thus, we are left to the mercy of the individual promoters. And the RBI gives licenses blindly on a subjective basis  rather than objective basis. And the entry barriers for someone to start a business in lending/borrowing of money is very low. This naturally attracts the good and the bad. And our reporting systems are such that they are historical. Audit is done for the past incidents. There is no external check on what is going on. Credit monitoring is lax and liberal. There are businessmen with their poor reputations as public knowledge, but the banks will lend them money.

Clearly there are too many moving parts in this business of taking public money, lending it to someone and making a profit out of it. Except the one whose money it is (depositor), everyone else seems to be involved in the business. The owner of the money has no clue and no say in what happens to his/her money. The intermediaries and other parasites have controlled legislation to ensure that depositors are kept away from the running of the bank. And there is no disclosure to the depositors.

As a depositor, it would be useful to know the names of everyone who takes a loan from the bank. That itself would act as a deterrent to many frauds. But, they hide under ‘secrecy’! Precisely in a zone where there should be no secrecy. It is enough to keep the depositor name ‘secret’ from the public. The depositor must know who are the borrowers. It is his money.

Well, I am sure the above accountability will never happen. Too many vested interests and a system built on graft will not let itself be threatened by a mere depositor.

As a depositor, our goal should be clear. Hide under the strongest tree. This would mean that we avoid Cooperative Banks and Private sector banks unless we have strong basis to trust a bank or NBFC owner or promoter. Government-owned public sector banks are safe. Not because they lend well. But the government of the day will not be able to withstand a bankruptcy of a public sector bank. They will use taxpayer money and bail out the depositors.

The same cannot be said for private banks. Unless there are some compelling reasons (too big to fail is a oft touted reason).

In the past, the government has not let any depositor lose from a bank.

The problem is the RBI has no sense of outcome and merely puts restrictions on a cooperative bank before it finally gets absorbed by another bank. So for some time, you cannot access your own money. This is one strong reason (Section 35 of the RBI Act gives them powers to limit cash withdrawals from a bank) why we should not keep any money in a cooperative bank or a small private sector bank.

Size is a good criterion, because the more the numbers, the more likely that the government cannot afford to let a bank fail. Do not chase a one or two per cent extra interest. you will most likely lose your money.

(The writer is a veteran investment adviser. He can be reached at balakrishnanr@gmail.com)