Ten Years Later, RBI Struggles With Scandal (22 April 2002)
Last Friday, there was a flutter in the securities markets when a business daily reported that the Reserve Bank of India was examining an “abnormal spurt” in the trading of government securities by co-operative banks and their questionable deals with some bond market brokers. This followed a series of revelations, allegations and denials by brokers and banks, which boil down to two major issues. Firstly, those cooperative banks are rampantly indulging in questionable deals in the securities markets, which hint at corruption and collusion with a few brokers; the second is that it is RBI’s own regulatory failure and technological backwardness has allowed such a nexus to develop.
The RBI to its credit has been working hard at finding a way to check co-operative banks ever since it discovered the dangers of their market operations. But its efforts would yield better results if it did some introspection. The RBI is inherently suspicious about brokers and would like to eliminate them from the securities market altogether. This distrust however means that RBI’s market intelligence is poor and it is unable to detect malpractices and fraud very quickly.
Let us go back in time to 1992 when that late Harshad Mehta had helped himself to several hundred crore of rupees from the State Bank of India. Harshad claimed to have put through some non-existent government securities transactions by taking advantage of the delays caused by the primitive manual entry system at the RBI’s public debt office. Ten years later, the PDO operations are automated, as are the main G-sec transactions of banks. But physical trades and slow transfer procedures have yet to be eliminated from the securities markets. While 99.7 per cent of trades in the secondary capital markets are in dematerialised mode, the RBI is lagging behind.
The RBI is so pre-occupied by trivial issues such as the separation of regulatory jurisdiction that it has spurned the use of the National Share Depository Ltd systems to dematerialise securities transactions by smaller banks (SGL-II transactions). As the debt market expanded rapidly in the last couple of years, these physical trades opened up a window for another scam.
Having said that, the recent spate of co-operative bank failures did force the RBI to investigate co-operative banks and alerted it to dangers in securities trading. It discovered that the Nedungadi Co-operative Bank was completely controlled by a rather notorious broker of the Bombay Stock Exchange and used to fund his speculative activities. Similarly, it was clueless about Madhavpura Mercantile Co-operative Bank’s dangerous nexus with the discredited bull operator Ketan Parekh until it collapsed and ran up losses of over Rs 1,000 crore.
Barely had it come to grips with Madhavpura, when the head of the Charminar Co-operative Bank of Hyderabad hit the headlines by committing suicide. Again, an investigation revealed that RBI was unaware of the poor finances of most co-operative banks in Andhra Pradesh. Then there is Maharashtra; again the RBI is worried at co-operative banks’ irrational enthusiasm for treasury operations when they have little knowledge or training. It suspects that banks are again colluding with securities brokers in shady deals. What is worse, from the RBI’s point of view is that regulatory powers over brokers vest with the Securities and Exchange Board of India and not itself.
Given that cooperation between the two regulators was down to the minimum in the last few years, the RBI has been working on its own separate dealing system for the securities market. The Negotiated Dealing System and Clearing Corporation of India Ltd headed by Dr R H Patil, will operate exclusively for banks and has the grand plan of eliminating brokers altogether. To the RBI, brokers are the root of all market-related mischief and it constantly strives to do away with them.
Unfortunately, the problems with co-operative banks have not waited for the RBI’s new system sans brokers, and it is forced to conduct messy investigations. My sources say that it has been working on three fronts. It began detailed inspections of co-operative banks and confirmed that there were indeed several deals at prices out of line with the market. It then forced some of the small co-ops to conduct their treasury operations through the aegis of the Maharashtra State Co-operative Bank to limit collusive deals. It also warned the Fixed Income Brokers Association about the sharp practices by some of its members and asked it to put in place a code of conduct for brokers. RBI’s main suspicion is allegedly over the nexus between cooperative banks and certain brokers in the auction at par of 8.07 per cent Government Securities of 2017.
Securities dealers say that this was an ideal paper for immediate appreciation and it spurted in post issue trading Rs 100.20 to Rs 101.20 or so within a few hours. The large number of co-operative banks trading actively in the security led the RBI to suspect that they had previously negotiated repo deals with the largest securities broker. The broking firm denies that is conducted repo trades or that it is under investigation by the central bank, but more interestingly, the brokers themselves are unclear whether the repos themselves are objectionable unless the RBI finds evidence of kickbacks or other shady dealing by the broker.
While it is not clear if the RBI can find much that is wrong with the 2017 deals, brokers are more worried about another fraud that is reminiscent of the fake bankers receipts of 1992. It is said that some brokers have claimed to purchase G-Secs for cooperative banks and diverted the money to their own accounts. They manage to buy time for 6-8 weeks by blaming delays on the RBI’s cumbersome transfer procedures for physical securities. When the buyer turns restive, these brokers strike similar deals with other co-operative banks and use the funds used to complete the earlier deal. Many brokers are allegedly running such Ponzi schemes by taking advantage of credulous and corrupt managers at co-operative banks.
However, the whispers relate to one particular brokerage, which ran an astounding brand building campaign using most expensive celebrity endorsers in the business. The company has helped itself to funds from the co-operative banks and is allegedly struggling to fill a Rs 100 crore plus hole in its books. While the scandal is expected to hit the newspapers, the question is, can the RBI escape responsibility? A little more cooperation with other regulators, faster automation and better market intelligence would have served the system far better than post-facto investigations. -- Sucheta Dalal
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