The Indian banking system has escaped a meltdown by the skin of its teeth.
While the government aims at bank credit-led economic growth on one hand, and nudges everyone to bank their savings on the other, by all means, the PNB and Rotomac scams have brought India's banking at the crossroads. India has no option, but to introduce a radically new financial transparency architecture for banks and enterprises to keep the banks credible for the common man.
In order to ensure justice for banked people in a credit-driven growth set-up we need to find out the answers to three questions:
1) Why do we have rigorous transparency norms only for companies with public equity while debt-financed privately held firms are allowed to go easy on financial openness?
2) Why can't we have universal financial disclosures norms for companies and firms, irrespective of their business financed by debt or public equity?
3) How can we bring bank depositors and customers on a par with shareholders and investors in terms of financial transparency?
The answers to these questions lies in the anatomy of the ongoing PNB scam and Rotomac default.
How transparency worked
How many of us have noticed that the first information about the massive swindle in India's second-largest public bank came out via an unusual channel. While the government vows zero-tolerance against corruption, the fact remains that action against the fraud started only 15 days after the first FIR (January 31) and safe escape of Nirav Modi and Mehul Choksi from India.
It was the stock market that blew the lid off the scam. Going by the disclosure norms set by the SEBI, on February 14, the PNB informed the Bombay Stock Exchange that it has detected some "fraudulent and unauthorised transactions" in one of its branches in Mumbai to the tune of $1771.69 million (over Rs 11,000 crore).
Following the announcement, the share price of PNB plunged 10 per cent and thus the government and regulators woke up from their slumber.
How opacity cheated
Fast forward to Rotomac Global Group NPA case.
Why the CBI and the ED took two years to become active (October 2015) after the company defaulted (or defrauded) on loan repayments, and almost seven months after the Allahabad Debt Recovery Tribunal's (DRT) order against the company?
Without going into the merit of the case, the answer would be - it's the opacity of the Indian financial system that is responsible for this delay.
Two worlds of transparency
PNB and Rotomac are two conflicting faces of India's financial transparency.
The strict disclosure norms prescribed for companies listed in stock market forced PNB (a listed company), after a dawdle of two weeks, to disclose the disaster in its full magnitude while the second FIR was still on the way.
However, in the case of Rotomac's default, given that banks are allowed to keep information on defaulters confidential (they only disclose magnitude of NPAs) the non-payment case stayed out of the public scrutiny for over two years. The Rotomac rot remained under wraps as the latter is a private limited company and was not liable to reveal its decay in the public despite risking huge money of bank depositors.
Compliance versus complacency
India's financial transparency set-up for enterprises is marred by bizarre inconsistencies. As disclosure norms are generally guided by the ownership pattern; the public, private and propriety business enterprises fall under different set of standards for regulatory disclosures.
With back-to-back major scams in 1992 and 2001 (Harshad Mehta and Ketan Parekh), market regulator SEBI has forced elaborate disclosures metrics on companies approaching to tap public equity or listed in stock exchanges with public holdings. Under the SEBI's norms companies are not only follow an entrenched financial metrics, but they are also forced to share every small bit of information with the public via stock exchanges. The PNB scam could not remain in secret confines of both companies, as it has involvement of two publically held companies - PNB and Gitanjali Gems.
On the other hand, irrespective of the size of their business, the private (including limited and one-person) firms are benefitted by highly relaxed norms of financial transparency. They are supposed to simply file an annual set of documents which include balance sheets, profit and loss accounts etc.
The Common people can access these documents only after paying a fees to the government.
During the last two decades, the Indian economy has seen massive growth in banks providing debt-financing to enterprises. With access to cheaper credit companies heavily leveraging on bank (borrowed) funds to start or expand their business, thus making millions depositors an indirect stakeholder in their business. However, unlike the shareholders, depositors do not get any direct benefit of company's success, but bear the risk of failure through their banks' credit exposure in a company.
The problem of transparency is more pronounced in the cases of private limited firms (like Rotomac), which are heavily leveraged, but barely transparent in comparison to their SEBI-regulated peers. We have got private limited companies (Nirav Modi's Firestar Diamond International Pvt Ltd) of turnover and debt running in crores with very little information in the public.
Since banks and private limited firms observe "confidentiality" in their dealings, depositors get to know only when a default hits their face.
What is required
In the light of the PNB and Rotomac scams, the government has to radically alter the commercial credit metrics and transparency norms for the enterprise under various legislations.
1) Ideally, the disclosure norms for enterprises should be based on the mode of financing of business, not on the ownership.
2) Entirely self-financed tiny firms can be incentivised, but debt and equity financed firms must follow similar elaborate standards of financial disclosure. To begin with, separate disclosure norms for bank-leveraged companies can be put in place.
3) The banks' governance has to be more transparent in sharing information about their debt portfolio with shareholders and depositors.
4) The companies having business turnover above certain limit (say, Rs 100 crore and above) can be asked to compulsorily list in the markets. Special exchanges can be created for them. This will bring them to public scrutiny and augment new investment opportunities for investors.
5) Reforms are also required in debt-financing. Project finances took a heavy toll on banks. It's high time to force promoters to take risk on their own funds, instead of putting at risk the bank depositors' savings.
The Reserve Bank of India has issued guidelines to nudge corporates to access bond market. As announced in the Budget 2018, the SEBI has to mandate corporates to meet about one-fourths of their financing needs from the bond market. A robust bond market can replace the burden on banks and force companies towards transparency.
India's NPA problem has already turned explosive, with 21 PSBs together accounted for about 88 per cent of the total gross NPA value for banks. The total amount of bad loans given by PSBs was about Rs 7.3 lakh crore. This is a huge 370 per cent increase since March 2013, when the number stood at Rs 1.5 lakh crore.
If scams are required to nudge transparency, the PNB scam and Rotomac default have brought in the Harshad Mehta or Ketan Parekh moment for the commercial credit system in Indian banking industry.
Banks are the bedrock of trust in any financial system. It's high time the RBI and the government do to banks what the SEBI did to the stock market after the scam in 2001. And that changed Indian stocks markets forever.