Govt banks lose ~1 trillion in five months

Increased investor interest after bank recapitalisation plan dissipates on news of PNB fraud

Over the last five months, it seemed like the Nifty PSU (public sector undertaking) Bank Index was gaining, with increased investor interest on account of the government's recapitalisation plan.

However, after the Punjab National Bank (PNB) scam, the indication of possible systemwide fraud has caused the index to fall 22 per cent from its January high, erasing ~1 trillion in value.

The government’s recapitalisation plan, announced on October 24, raised the PSU Bank Index to a high of ~3,965.60 by January 24. After which, it was stable for a while, each trading session’s closing price being lower than on the previous day.

On February 14, the government-owned Punjab National Bank (PNB) revealed some rogue employees had issued letters of undertaking (LoUs) via the SWIFT (Society for Worldwide Inter-Bank Financial Telecommunication) system on behalf of companies belonging to diamantaire Nirav Modi and associate Mehul Choksi.

The bank told regulators its foreign exchange department in Fort, Mumbai, had issued $144 billion worth of fraudulent LoUs since 2011, against which buyer credit was extended by overseas branches of others Indian banks. These SWIFT messages were sent to the latter without being entered into PNB’s core banking system (CBS); hence, the fraud went undetected for years, the management said.

As reported by Business Standard on February 20, the department of financial services is likely to hold a meeting with the information technology teams of all PSU banks soon, having already communicated that they must integrate their CBS with the SWIFT system.

This development has made investors and the wider public wary about the future of PSU banks. There is a sense that the scam is not restricted to PNB and that: i) there is no clear indication that the LoU service was not exploited by employees at other banks; ii) that there are numerous undetected (fraud) SWIFT messages that have not been accounted for by the CBS of various banks and; iii) that the LoU arrangement is in itself heavily compromised, as there is little diligence, compliance and oversight by banks at both ends of the transaction.

Indian banks on the other end of the fraud have chosen to settle this issue bilaterally with PNB, with the latter open to seeking legal remedies. Business chambers and bank employee unions argue over the issue of privatising the country’s second largest PSU bank.

The sentiment and belief that there is a lack of accountability, little due- diligence and that political patronage runs public banks has caused the Nifty PSU Bank Index to turn downward since endJanuary.

Reveals the PSU bank-wise market capitalisation erosion since details of the fraud emerged. State Bank of India has lost ~162 billion, followed by PNB losing ~109 billion, Bank of Baroda losing ~55 billion and Bank of India losing ~18.5 billion. The government, the majority shareholder in PSU banks, has seen its holding fall by ~590 billion in value. Life Insurance Corporation saw its stake shrink in value by ~120 billion, according to a BloombergQuint report.

Since the PSU Bank Index's recent high in January, around ~1 trillion in market capitalisation has been wiped out, while ~406 billion in market capitalisation has vanished since PNB’s revelation.

Analysts say rising bad assets have increased the fragility of public sector banks. And the slow nature of the Insolvency and Bankruptcy Code process has not provided comfort to institutional investors. Also, that the scam indicates a seeming inability of PSU banks to be both efficient and accountable.

It is interesting to note how two different news events affected the PSU Bank Index. The first one, triggering fierce interest and confidence in these banks, was the government's announcement of a ~2.11 trillion recapitalisation plan. This spurred investor interest and made the index jump.

The second news item was PNB's revelation of a massive fraud, which dampened investor sentiment and caused many to sell their positions. And, it brought to the fore the fact that the underlying issues of banking governance, transparency, accountability and oversight mechanisms, and trust, still needed to be addressed. More so now than ever before.