What went wrong at the bank?
The RBI issued directions from 24th Sept 2019 on Maharashtra and Punjab cooperative Bank (PMC) owing to serious financial irregularities.
- More than 75% lending to one group company i.e. HDIL which is way higher than the limit of 40% set by RBI. Furthermore, HDIL is a real estate development company whose primary focus is on construction, development of residential, commercial and retail projects. As a norm banks are averse to lending to such companies due to high risk associated with such projects.
- There was no mention of any default by HDIL on servicing interest payments in any of the audit reports. Apparently, the bank was growing; and the auditors were checking only incremental advances and validated the accounts shown by the board.
- Many dummy accounts were created in order to hide HDIL NPA’s. Moreover, the bank continued to extend credit despite HDIL going NPA.
And the list goes on… Much has been written and discussed about how things went this bad. Actually speaking, in any scam, the list of what went wrong is more or less the same. Money laundering, siphoning off of huge sums of money to dummy accounts, political interference, using the company as a personal financial institution by promoters etc. It would be beyond the ability of most individual investors to understand the risks involved in any institution. Hence, retail savers and investors should manage this risk in a simple and easy way as follows:
What should retail investors learn from all these scams and frauds?
While, the scam is yet another example of the greed, dis-regard for rules by promoters and abandonment of responsibility by Board of Directors and auditors, the most important lesson for retail investors is the need to diversify their savings.
Follow these simple rules and save yourselves from most of the financial crisis and scams
- Diversify across banks – Depositors insurance covers only upto 1lakh per bank account. Make sure your savings and fixed deposits are invested across at least 3-4 banks with more or less equal amounts in each. Thus, you will be better off diversifying your life savings in different banks rather than keeping all your money in one.
- Be aware of risk of higher returns – If you want a higher yield and therefore want to keep deposits with co-operative banks, that is absolutely your choice. But be conscious that a higher return always comes at a higher risk.
- Diversify across public and private sector banks – Ensure that the list of banks includes at least 1 (preferably 2) of the established private sector banks such as HDFC Bank, ICICI Bank, Kotak Mahindra, Axis Bank etc.
- Diversify between Company fixed deposits and bank deposits, mutual funds etc – Limit the amount invested in Company fixed deposits to not more than 25% of your total savings. Company deposits provide 2-4% higher return compared to banks but are also inherently more risky. Similarly, it is better to invest in atleast 2-3 mutual funds rather than invest everything in one best performing fund.
- Diversify from your Employer – Bank employees tend to maintain savings and fixed deposits with their employers. This doubles concentration risk (if your employer fails, both your income and savings will be under threat). You should ensure that limited amount is kept with your employer and balance across other banks. Similarly, employees tend to buy shares of their own companies. This should only be a small part of your overall share portfolio.
- Diversify across products – Many banks also sell insurance and mutual funds of their subsidiaries. Make sure, you are not buying all your financial products from one institution.