Sitting on too low capital; no count on bad loans
By CL Jose
KOCHI: The past couple of weeks saw loan scams posing threats to the stability of certain primary agircultural cooperative banks (PACS), the major being Karuvannur Service Cooperative Bank, followed by Moospet Cooperative Bank in Thrissur district.
Many other names from this cooperative banking sector in the state are being rumoured to be destined for the same fate. There are about 1600 primary cooperative banks in the state falling under (PACS), which are also the primary shareholders of Kerala Bank.
While the leaders in the industry are genuinely discussing ways to nail down such frauds and pre-empt their repeat in the future, the larger question the policy makers should address at this juncture is whether the very cooperative banking system in its present format is viable or will it collapse for want of a stricter regulatory regime.
While the estimated loss in Karuvannur Bank is said to be Rs300 crore and upwards, the Moospet Coop Bank loss is estimated to be much lower at around Rs13 crore, if media reports are to be taken seriously.
However, the chairman of Kerala Bank, Gopi Kottamurikkal while talking to businessbenchmark.news recently has scaled down the Karuvannur Bank ‘scam size’ (deficit) to a little over Rs150 crore. Moreover, Kerala Bank has an exposure of Rs46 crore to the ailing Karuvannur Cooperative Bank as does with several other coop banks falling under the primary agricultural cooperative societies (PACS).
Where is this cooperative banking headed for?
Setting aside these isolated scams, is the cooperative banking system in the present format all hunky-dory?
According to experts in the financial services industry, the primary cooperative banking in the state has been running without a rule book and the system could soon come to a grinding halt unless a tighter regulatory regime is brought in place.
The primary cooperative banking system could be a ‘ticking bomb’ and the gravity of the insidious pain points in the system is much more than meets the eye.
The real issues within the cooperative banks in the state are being comfortably swept under the carpet or have failed to bother the governing boards of those banks.
Obscurantism may allow the managements of these banks to hide under a temporary comfort but could lead to irreversible damages when the call for real stocktaking comes.
Huge bad loans
A big chunk of the loans within the primary cooperative banking system has already turned ‘bad’ and a large number of revenue recoveries are deliberately put ‘on hold’ in order to maintain ‘political correctness’, and the sources aver that the continuous rejection of revenue recoveries could snowball into a financial chaos later.
Counter-intuitive it may sound, revenue recovery in cooperative banking is less cumbersome than within scheduled banks as the securities are in the form of registered hypothecation or Gehan. “That said, recoveries haven’t been implemented for years, and I don’t think recoveries will take place in the foreseeable future as it has huge political ramifications,” director of a cooperative bank in Thrissur said.
But how long and how far these banks can survive by closing eyes against these unpleasant facts?
Several top officials and members of governing boards of different banks in the sector confided with businessbenchmark.news that most PACS banks are running without a rule-book or without bothering to follow any such rules.
The recent scams have amply laid bare the loose policies followed by the governing boards of the so-called banks; they have also triggered debates on how audaciously many of these credit institutions have thrown to the wind all rules on capital adequacy and non-performing loans (NPAs).
A realistic measuring and providing of bad loans in the system could land hundreds of these cooperative banks in dire situation sending them begging for funds as these banks are bound to book losses year after year.
Many are confused about these rules as to whether they do exist or even if they do exist, whether they are meant to be followed at all.
This is viewed as a major dereliction on the part of such credit societies as scheduled commercial banks (SCBs) operating in the same market space follow these rules stringently with higher standards and despite this, many banks still remain helpless witnesses to thier soaring bad loans.
While the banks are required to maintain capital in the range of 9 per cent to 12 per cent of their respective risk weighted assets, they are also obliged to begin recognising and providing for ‘bad loans’ as early as from the non-payment of the third instalment or 90 days since availing such loans.
(In between the 90-day cut-off period had been increased to 180 days in the wake of the moratorium). Talking to BBN, the director of a well-run cooperative bank said their capital against loans or capital adequacy ratio (CRAR) is minuscule; maybe, at the most, 4 per cent of the risk-weighted assets.
More seriously, identifying and recognising bad loans within the cooperative banks begin only after 6 months of non-payment, and the provisioning against such bad loans is very minimal, at about 10 per cent after non-payment for a period of one year.
He also said many banks are unaware of these provisioning rules and hence unlikely to know what their real profit level at the end of a given year or the size of the capital base at a given point of time. There are cooperative banks whose latest audited report is more than four years old.
Credit-Deposit ratio (CD ratio)
CD ratio or the loans to deposit ratio at 80 per cent is one measure these institutions follow religiously – which mandates the lending at 80 per cent of their deposits and borrowings put together. Most banks are said to be following this norm without fail.
Low Capital base
Since most of the profit is distributed among the shareholders at the close of each financial year, the capital remains the same at the size of thier paid-up share capital without much growth, but for the small financial reserve (FR) they set aside each year.
This practice leaves the size of the capital meagre perennially for most cooperative banks even after years of operation, and hence lending in terms of the size of capital (leveraging the capital) could prove unworkable for most cooperative banks since they will be restrained to lend only limited funds.
There is no denying that a lending system with total disregard to the size of capital could lead to collapse of the bank in the event of a strain on repayments.
“Linking loans to deposits alone will fail to serve the purpose in the event of large losses or pressure on liquidity. Banks inevitably need good capital base to keep their head above water during periods of poor financial performance,” said K Parthasarathy, a financial expert based in Thrissur.
The members and the governing board are essentially part of a vicious cycle weaved through political affiliations. The governing board members are elected by the members and this puts the board members in a tight spot whereby they can’t say ‘no’ to the loan requests from members as the election of board members is an on-going process.
The same logic drives the need to distribute most of the profit earned by the bank to the shareholders at the end of each year disallowing the capital to grow meaningfully, thus locking the capital base at low level – not substantially larger than the size of the paid-up share capital.
Arbitrary security valuation process
The risk element in the loan processes is exasperated due to the sloppy valuation exercise of the securities that is predominantly carried out by the ‘unprofessional’ governing board members, who are essentially obligated to the shareholders, who elect them to such boards
Hence, many failures within the cooperative society banks so far could be traced to frauds in the form of inflated valuation of collaterals, multiple pledging of same securities for different loans and so on.