The PNB scam is seeing repercussions for PSU banks, with many of them coming under scrutiny for their internal processes and controls. PSU banks have already been heavily scrutinised for their lending practices, leading to a stifling of credit growth especially to the corporate sector.
PSU banks will now slow down all transactions relating to LOU’s that can affect foreign trade in the country. Banks will also go into a deeper shell on providing credit to corporate borrowers. This will force all good borrowers to go to the private sector for loans and services.
Working capital loans have already shifted to the CP market (chart 1) and will shift further as banks lending becomes slow. NBFC’s and niche lenders will take advantage of PSU banks credit aversion and grow their SME books aggressively.
Given the government’s support to the PSU banks with the Rs 2.11 trillion recapitalisation plan, depositors will not have to worry for their savings in the banks. However deposit rates will stay low for a long while as banks are flushed with excess liquidity given lack of credit growth. Chart 2 and Chart 3.
Equity investors in PSU banks will see the value of their holdings fall and stay down as banks growth falters. Investors are better off shifting to well managed, growth driven companies that deliver consistent shareholder value.
Punjab National Bank (PNB) in the last week was hit with the news of a Rs.113 billion fraud at one of its Mumbai branches. The Stock of PNB has fallen 41% from levels of Rs.194 reached in the month of January 2018 to a low of Rs.114 today.
The main reason behind the mismanagement or negligence in operations of PNB is due to bad corporate governance practices followed by these companies which eventually gives way to big scams or frauds in their systems.
Corporate governance is the system of rules, practices and processes by which a company is directed and controlled. Corporate governance essentially involves balancing the interests of a company’s many stakeholders, such as shareholders, management, customers, suppliers, financiers, government and the community. Since corporate governance also provides the framework for attaining a company’s objectives, it encompasses practically every sphere of management, from action plans and internal controls to performance measurement and corporate disclosure.
What should Investors Do in such a scenario?
The broader market or sector specific indices may witness a correction due to such news. In the case of PNB the Public Sector Banks have witnessed fall in their stock prices as many of these Banks are facing rise in NPA levels for quite sometime now. To add to the existing worries if more and more such scams in the public banks are uncovered there might be a further fall in the stock prices of these banks.
If there are issues faced by any company about corporate governance then such a stock should not be purchased even though revenues and profitability is growing on a continuous basis.
If there is anything fundamentally wrong with any company that is listed on the exchanges then the investors should not hold on to such stocks even for a brief moment of time. Apart from these if investors are holding other stocks in other sectors and segments then the correction in the broader market due to such reasons is an opportunity to buy in these companies from a long term perspective. If the broader market is witnessing a continuous fall then investments can be done in a staggered manner to take advantage of the situation as no one in the market knows at what levels will the broader market form a bottom for the next rally.
What Exactly happened in the PNB Scam?
The alleged fraud was carried out through misuse of Letters of Undertaking or LoUs issued by Punjab National Bank.
In trade finance, which is the business of imports and exports, companies need funds to pay overseas suppliers in foreign currency. When an Indian company approaches its banker for such funding, designated officials will approve a credit limit for which an LoU can be issued. Once the LoU — essentially an undertaking by a bank to the overseas branches of other Indian banks to meet a liability on behalf of a customer — is issued, a message regarding the funding is sent from India to the bank abroad using the Society for World Interbank Financial Telecommunication (SWIFT) platform. SWIFT is a secure global financial messaging service used by over 11,000 financial institutions in more than 200 countries.
On receiving the SWIFT message, the branch (which is mostly of an Indian bank in the case of Indian companies) abroad provides credit against import documents, normally for 90 days. (It could be that the LoU-issuing bank does not have operations in a particular foreign country.) Margins on the borrowing depend on the risk profile of the borrower and the company’s credit rating, and the terms of the credit limits set by the issuing bank. This is essentially a short-term foreign currency loan, on which banks charge 60 to 90 basis points over the London Interbank Offered Rate or Libor, the international benchmark for pricing loans or lending.
This facility is used regularly by companies in the business of gold, gems and jewellery. Companies prefer this form of funding also because the costs of raising money overseas are relatively less compared to rupee funding. And for banks, this is good business — if all goes well.
SWIFT transactions are linked to the Core Banking Solution (CBS) of banks, which contains transaction histories and other data of all customers and can be accessed by all branches where a customer has an account. SWIFT transactions, therefore, are automatically recorded, and are seen by officials from regional managers to general managers and, when the amount is big, by the top management. In the PNB case, the scamsters allegedly delinked SWIFT from CBS in the case of companies that were linked to Nirav Modi and Mehul Choksi. However, LoUs of other companies were routed through the SWIFT-CBS system. This meant that funds were provided to the Modi-Choksi companies without being recorded in the bank’s CBS.