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RBI may ban co-op banks from dealing with brokers

K Ram Kumar & Yashajit Saha

The Reserve Bank of India may ban urban co-operative banks from dealing with brokers in the bond market. Apex co-operative banks at the state-level are expected to play the role of intermediaries for these banks' bond dealings.

The objective is to break the "unholy nexus" in the government securities market, recently unearthed between some brokers and banks.

Co-operative banks that are not members of the negotiated dealing system are likely to be directed by the central bank to buy or sell government securities only through the state-level apex banks.

The apex banks will open constituent securities general ledger accounts with the RBI on behalf of small banks for gilt transactions.

The link between some directors of at least half-a-dozen urban co-operative banks and three district central co-operative banks in Maharashtra, on the one hand, and brokers, on the other, has reached such a stage that transactions between the two parties are often by way of book entries only.

No purchase of government securities takes place, industry sources say. Transactions are not put through the RBI's public debt office for settlement.

These banks might have lost around Rs 200 crore (Rs 2 billion) in fraudulent transactions in government securities, a senior banking official said.

"Brokers offer hefty commissions to the brass of urban co-operative banks. What is unfolding in the co-operative banking sector is reminiscent of the bogus bankers' receipts route used by brokers to divert funds to the stock markets from the now defunct Bank of Karad in the early 1990s," the official pointed out.

Trouble for the sector started in February after the auction of the 8.07 per cent 2017 paper. Following the auction, gilt prices across the board moved in a very narrow range, rendering co-operative banks unable to liquidate them at higher prices.

"Since then, the prices have more or less stabilised, and now it is difficult to liquidate the portfolio without booking losses," a co-operative banker said.

Money market dealers suspect that brokers are even taking part in the primary auction of government securities through co-operative banks. These intermediaries cannot take part in the auction directly. They enter into verbal contracts with officials of scheduled urban co-operative banks, which buy securities on their behalf.

Later, brokers buy this paper from co-operative banks and offload them at a much higher price than the current market rates to district co-operative banks which do not have any statutory liquidity ratio obligation to meet.

Sources also said a few brokerage firms had increased their branch networks in the past six months to palm off irrelevant and illiquid gilts to urban co-operative banks, taking advantage of their lack of understanding of how the market worked.

After the Ahmedabad-based Madhavpura Mercantile Co-operative Bank went under in March 2001, the RBI asked urban co-operative banks to unwind their deposits, which were deemed SLR investments, with bigger co-operative banks.

These banks were asked to gradually increase their minimum SLR holding in two stages by September 30, 2002. However, district banks have no compulsion to buy government securities because they are not subject to any SLR stipulation.

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