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RBI pulls up BoI on Rs 1.37 billion Madhavpura pay order scam

Tamal Bandyopadhyay

The Reserve Bank of India has squarely blamed the Bank of India management for the Rs 1.37-billion Madhavpura Co-operative Bank pay order scam.

In a communication dated June 21, signed by KL Khetarpaul, chief general manager-in-charge, department of banking supervision, RBI expressed its displeasure at the "failure of the management control of the bank." A copy of the letter has been sent to the finance ministry. The bank placed the RBI letter before its board on Monday.

When contacted, BoI chairman-cum-managing director KV Krishnamurthy refused to comment on the issue. Sources in the RBI said BoI has always been maintaining that the Rs 1.37 billion pay order scam was not the result of failure of risk management in the bank but the fallout of a settlement risk.

The clearing house returned 13 pay orders worth Rs 1.37 billion in two batches in March under Rule 11, which implied that Madhavpura Bank did not have the funds to honour the pay orders.

Despite the Rs 1.37 billion hit, BoI posted a 46 per cent rise in its net profit at Rs 2.58 billion in the fiscal. Its operating profit zoomed to Rs 11.02 billion, from Rs 6.53 billion.

In an earlier communication in April, RBI had blamed the bank for giving unlimited powers to its branch managers for discounting bankers' receipts. The stock market branch of BoI had reportedly discounted Rs 65.50 billion worth of pay orders, 65 per cent of which were drawn in favour of Madhavpura Bank. The central bank had pointed out BoI's failure in risk management and said the bank did not put in place any counter-party risk.

The bank, according to RBI sources, defended its stance saying bankers' receipts are the most secured instruments and the branch managers have been enjoying unlimited powers since November 1986, subsequently vetted by the National Institute of Bank Management in April 1997. Over the one-and-a-half decade since then, no pay order has bounced and the Madhavpura case is an aberration, it said.

It also defended the high turnover of discounted instruments saying the stock exchange branch is one of the bank's busiest. It has discounted over 4,000 instruments out of which only 13 remain unpaid.

RBI, in its April communication, had also pointed out that the stock exchange branch of BoI did not have a concurrent auditor since October 2000 and that its branch head BH Somaiya had earlier been pulled up for some lapse in 1988. It blamed the bank for deficiencies in its risk management system and the lack of internal control.

BoI is putting up a risk management system. It has already fixed the counter-party limit for discounting all money market instruments and stopped all transactions with co-operative banks.

However, according to RBI sources, the bank still maintains that the Madhavpura fiasco was the manifestation of a settlement risk. The bank is also unwilling to challenge the sanctity of pay orders as an instrument of settlement. The bank had reportedly pointed out to the RBI that the clearing house should evolve a procedure of issuing warning signals.

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