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April 22, 2002 | 1340 IST
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Co-op banks may get burnt by bonds

BS Banking Bureau

A time bomb is ticking for co-operative banks. Although the scars of the Madhavpura Co-operative Bank incident have not yet healed, some co-operative banks, both urban and rural, are inviting fresh trouble by building huge exposures in the bond market.

Last year, co-operative banks had an unbridled exposure in the stock markets.

The problem lies in the quality of their exposure. The root of the problem is the nexus between some government security brokers and a few officials of co-operative banks. The brokers are facilitating negotiated deals on gilts between companies and the banks.

In most cases, these firms are their own enterprises. The banks are mostly buying long-ended illiquid securities at a higher price. Some co-operative banks have incurred huge losses while individuals involved in such deals are pocketing kickbacks.

The Reserve Bank of India has set up an investigation into the involvement of co-operative banks in bond deals.

"Both Nabard and the RBI are looking into the issue because it involves several rural co-operative banks. Since bond dealers do not come within the RBI's ambit, the latter has involved the Securities and Exchange Board of India to probe the phenomenon," said an official.

The RBI has unearthed a scam whereby a Nagpur-based co-operative bank may have lost around Rs 1.25 billion because, after having paid the money, it did not get the securities from its broker.

An Internet-based gilts trading firm is said to have brokered the deal.

The role played by a handful of new private banks in lending money to bond dealers is also being investigated. At least one broker confirmed he was summoned by the RBI though he was not under its purview.

Sources said his terminal at the National Stock Exchange had been shut down. However, this could not be confirmed.

The co-operative banks are buying illiquid securities from the brokers at the price of liquid securities. The difference between the market price and the price at which the co-operative banks are buying these securities could be more than Rs 5.

In most cases, the counter-party involved in such transactions is a direct subsidiary of the brokers or is related to them.

Sources said the RBI had hauled up at least three broking entities and more than half a dozen co-operative banks. Money market dealers say some co-operative banks have bought securities disproportionate to their size and requirements.

"We have observed that co-operative banks with net worth of Rs 4-5 billion are buying government securities in excess of Rs 1.50 billion. As the prices paid for them are higher and most of the purchases are illiquid securities, they are bound to book heavy losses if they try to offload these in future," said a dealer at a new private bank.

Scheduled co-operative banks are required to meet the statutory liquid ratio requirement of 25 per cent of their net time and demand liabilities by April 1, 2003. This stipulation, however, is only applicable to urban co-operative banks.

Several district co-operative banks involved in large-scale buying of government securities are not required to maintain such SLR in the form of gilts. However, some of these banks have recently been observed buying government securities well in excess of their needs.

This is despite the RBI cautioning that the co-operative banks should put in place proper safeguards and an asset-liability management system before becoming actively involved in government securities trading.

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