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, in 2004. 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 Secunderabadbased 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 nowdead 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 windowdressing. 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 NonResident 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.

2012: The year that wasnt for the banking industry:

The high point of 2012 was Indian central banks resounding victory over inflation. After a three-year dogged fight, the Reserve Bank of India (RBI) was finally able to bottle the inflation genie that was hurting growth in Asias third largest economy, paving the way for an expansive monetary policy. The wholesale price inflation dropped to a decade low and retail inflation, though relatively high, slipped considerably. Most importantly, the so-called core inflation or the non-food, non-oil, manufacturing inflation dipped dramatically in mid-year and to the surprise of all of us, the final figures of inflation have always been lower than the provisional estimates. A confident RBI went for a deep rate cut. While the central bank is happy that inflation continues to remain below its zone of comfort, many analysts feel it may not be able to continue with its accommodative monetary policy any more as too much of liquidity is sloshing the system and abundance of cheap money may impact price stability. RBI started the rate cut cycle with a half a percentage point cut in April and aggressively followed it up with a series of baby steps of quarter percentage point cuts with the government pushing for fiscal tightness. What is more, along with the rate cut, RBI also pared banks cash reserve ratio (CRR), or the portion of deposits that commercial banks need to keep with the central bank, to its historic low of 1%, freeing up money. This was done following the recommendations of the Chakrabarty committee. The committee, headed by RBI deputy governor K.C. Chakrabarty, had another member, State Bank of Indias (SBI) chairman Pratip
Chaudhuri. Constituted by RBI governor D. Subbarao, the panel submitted its report in record time, just about a

week. Chakrabarty, a staunch believer in the central banks autonomy and its absolute power to regulate the banking industry, was convinced by Chaudhuris persuasion that CRR is a tax on banks and its abolition will release funds that can be used for productive purpose and give a fillip to growth. A convert, Chakrabarty, according to his colleagues, was in favour of total abolition of CRR but Subbarao prevailed on him. Chaudhuri got the kudos from the industry not only for his crusade against CRR but also his ability to bring down bad assets of SBI. The nations largest lender had earned the dubious distinction of accumulating the largest pool of bad assets but Chaudhuri cleaned the balance sheet through aggressive recovery of bad loans and massive provisioning. As he had to set aside money to clean up the balance sheet, SBIs net profit is expected to drop sharply but analysts are not complaining. They are, in fact, happy that Chaudhuri has stopped comparing his banks net profit with large Indian corporations such as Oil and Natural Gas Corp.
Ltd and Reliance Industries Ltd.

The other big development of the year was Hongkong and Shanghai Banking Corp. Ltd (HSBC) sealing the deal for the Indian retail and commercial banking businesses of Royal Bank of Scotland Group Plc(RBS). The proposed deal could have expired had it not been completed within 30 November. The deal was hanging in the balance for almost two and a half years as RBI had strong reservations about transfer of RBSs 31 branch licences to HSBC. The regulators reasoning was that the proposed transaction was a portfolio sale and not a complete buyout. RBS got the India branches after the global acquisition of Dutch bank ABN Amro NV in 2007 by a three-bank consortium that it was a part of, along with Fortis Banque NV and Banco Santander SA. It was the largest

acquisition in the global financial sector at that time. RBS which needed a bailout by the British government after the global financial crisis broke out in September 2008 has since been winding down its international operations. The India retail and commercial business was classified as non-core and put up for sale. HSBC was fined by US federal authorities over accusations of money laundering early this year and the US government recently slapped $1.9 billion fine on it for transactions that involved laundering Mexican drug money and dealing with a Saudi bank linked to terrorist-funding. There have been media reports about wealthy Indians keeping accounts in the Geneva branch of HSBC. Indian government is investigating this. Against this backdrop, RBIs clearance of the deal raised many eyebrows but HSBC which has not been given any branch licence in past two years will get two and a half dozens of branches at one go, strengthening its Indian operations. The biggest surprise of the year, however, was the release of new bank licensing norms by the banking regulator. RBI went ahead with this despite the governments failure to push through the amendment to the banking laws which would have given the Indian central bank power to supersede the rogue bank boards. This was, in fact, a necessary precondition for opening up the sector. The licensing norms will allow industrial houses to enter into banking, something they are extremely keen on. The original idea behind opening the sector though was expansion of banking services when former finance minister Pranab Mukherjee announced it in February 2010. But that is not required any more as with rapid branch expansion and smart use of technology, Indian banking industry has been able to expand services dramatically this year and covered almost the entire adult population. Hence, the new banks are unlikely to focus on the so-called financial inclusion. Instead, they are expected to focus on urban India. But thats not a bad idea as post collapse of Lehman Brothers, banks have stopped distributing credit cards and unsecured personal loans at street corners and petrol pumps.

Cash transferare banks ready?

From 1 January, the subsidy amount for 29 of 42 welfare schemes of Indian government will go directly into the bank accounts of the beneficiaries in 51 districts across 16 states. The electronic cash transfers will be based on the 12-digit unique identification number or Aadhaar, a proof of identity and address anywhere in the country. The districts being covered in the first phase include five each in Andhra Pradesh and Maharashtra; four each in Himachal Pradesh and Jharkhand; three each in Karnataka, Madhya Pradesh, Rajasthan and Tripura; and two each in Haryana, Kerala and Sikkim. The basis for selecting these districts is 80% coverage of the Aadhaar scheme. The second roll-out at more districts will be launched in April. The plan is to cover the entire country by the end of next year. If implemented well, the scheme will enhance efficiency of welfare schemes as the government will be able to reach out to identified beneficiaries and plug leakages. Subsidies on cooking gas and kerosene, pension payments, scholarships and employment guarantee scheme payments and quite a few other benefits under welfare programmes will be directly transferred into the bank accounts of the beneficiaries. Food and fertilizer subsidy is not yet covered under this scheme. The beneficiaries are expected to use the money to buy goods and services from the market. The pilot projects for the so-called electronic benefit transfer (EBT) have already begun in Andhra Pradesh, Chhattisgarh, Punjab, Rajasthan, Tamil Nadu, West Bengal, Karnataka, Puducherry and Sikkim and, going by the governments version, the results are encouraging. Two issues are critical for the success of this ambitious programme. One, only Aadhaar cardholders will be entitled to the get the cash transfer facility, but at this point only 220 million Indians have Aadhaar cards. And, two, is the lack of banking facility. Nandan Nilekani, who drives the Aadhaar initiative, is confident that it is achievable. According to him, in three years since the launch of the project, it has enrolled 270 million people. At the moment, at least a million Indians get enrolled a day. Finance minister P.Chidambaram said the database of the beneficiaries will be digitized by the respective ministries and money will reach the targeted people through business correspondents, including women selfhelp groups, panchayats and even individuals like a school teacher. The banking correspondents, according to him, will carry hand-held automated teller machines (ATMs) to enable the beneficiary to withdraw cash. Is the banking sector prepared for this? Lets take a look at the data. Indeed, penetration of banking services has been improving. For instance, the number of bank branches multiplied 12-foldfrom about 8,000 in 1969, when the first set of banks was nationalized, to at least 99,000 now. And there are at least 110,000 ATMs. The average population covered by a bank branch was 15,583 in 2001. In 2012, it has come down to 12,601. Going by the latest census report, 58.7% Indian households had access to banking services in 2011, up from 35.5% a decade ago. For every 100 new branches opened in fiscal 2012, close to 70 branches were in rural and semi-urban pockets. The comparable figure was 23.2 in fiscal 2005. So, the scene is improving, but is the system ready to move to the cash transfer scheme? It will be the biggest challenge for the Indian banking sector in recent history. A cross-country analysis of financial inclusion by the International Monetary Fund shows 100,000 adult Indians were covered by 10.64 bank branches and 8.90 ATMs against Brazils 46.15 bank branches and 119.63 ATMs in 2011. Household loan accounts with banks

per 1,000 Indian adults have been 21 against Brazils 747 in 2011. Brazil runs a successful programme that provides monthly cash payments to poor households if their children are enrolled in school. The Reserve Bank of India (RBI) has been trying hard to expand banking services across the nation. Till June this year, about 147 million basic accounts or the so-called no-frills account have been opened and 121,000 banking correspondents have been appointed. Despite these, about 40% of Indias adult population still does not have access to banking services. About 13% Indians are using debit cards and only 2% credit cards. The efficacy of the banking correspondent model, on which the success of the cash transfer scheme depends, is not proved as yet for various reasons, including the fees that banks pay to such representatives. One way of meeting the challenge could be allowing new banks to open shops. The banking regulator is not willing to do so unless the law that governs banking regulation in India is amended and RBI is empowered to supersede the board of a rogue bank. It is insisting on this as a precondition to allowing industrial houses to open banks as it feels that without this power, it will be difficult to supervise smart corporations who can divert money to their own group companies and deny funds to competition. Incidentally, among the first set of banks that was allowed to set shops in 1994 there was at least one corporate house. If the amendment to the law takes time, there are other ways to tackle the industrial houses who want to enter banking. For instance, the supersession clause can be part of the licensing norms. Also, it will take years for a new bank to get the confidence to fool the regulator and by that time, the lawone can expectwill surely be amended. India needs many banks to cover its 1.2 billion population. If the regulator is not confident of its ability to supervise large business houses, at the first stage it can allow relatively smaller firms such as nonbanking financial companies and microfinance institutionsif they are found fit and properto set up banks with small capital base in rural pockets.