Case_Study_on_Obc

Abstract: The case describes the growth and collapse of Global Trust Bank, a leading private sector bank in India. Since 2001, GTB's name was associated with scams and controversies, thereby casting shadows over the credibility of the bank and its management. Due to the overexposure to capital markets and huge NPAs, the bank was in a financial mess. When GTB tried to cover up its monumental NPAs through under provisioning, RBI - the Central bank and the regulatory authority for banks in India, appointed an independent team to review the finances of the bank. The review revealed various financial discrepancies kept covered by the bank. RBI imposed a three month moratorium on GTB on the ground of "wrong financial disclosures" and within two days the bank was merged with Oriental Bank of Commerce (OBC), a public sector bank. With the merger becoming effective, GTB's identity came to an end and it became a part of OBC. Issues: » The case aims to teach students how financial mismanagement can lead to significant losses for a bank. The case is designed to enable students to: » Analyze the reasons that led to the fall of Global Trust Bank » Discuss the importance of proper supervision and control systems in a bank to mitigate risks » Understand how overexposure to capital markets can lead to huge NPAs for a bank » Appreciate the need for financial institutions to uphold the ideals of transparency and absolute scrupulousness where public money was involved » Examine the role of RBI as a regulating authority and debating on the justifiability of its actions in the GTB fiasco "GTB had been sliding for several months now. Perhaps enough vigilance was not maintained in the past." - P Chidambaram, Union Finance Minister of India. "I would have loved to see Global Trust Bank remain as an independent entity, but in the best interests of depositors and employees this is the best decision." - Ramesh Gelli, Founder Promoter, Global Trust Bank (GTB). "It is a big relief that GTB is to be merged with Oriental Bank of Commerce. I have decided never to park any money with a private sector entity." - A Depositor of GTB. The Moratorium On July 24, 2004, the Government of India imposed a moratorium on Global Trust Bank (GTB), a leading private sector bank, on the grounds of 'wrong financial disclosures The moratorium was for three months from close of business on July 24, 2004 till October 23, 2004. Earlier, the Reserve Bank of India (RBI) had announced that GTB's net worth had turned negative as it had incurred huge losses and accumulated a significant number of non-performing assets (NPAs). RBI stated that the numbers reported in GTB's balance sheet did not match its audited figures. Moreover, GTB failed to provide satisfactory explanations to most of RBI's queries regarding its capital market exposures and why prudent lending norms were not observed in disbursing huge amounts for investments in the stock market. RBI said the moratorium was imposed in public interest and to protect the interests of depositors All operations of GTB were frozen and it was ordered not to give loans without RBI permission. It was allowed only to make payments for day-to-day operations or for meeting obligations entered into before the order. BACKGROUND NOTE The liberalization process initiated by the Government of India, during the early 1990's witnessed the entry of several private players in the Indian banking sector. GTB was one of the earliest private sector banks to be incorporated on October 30, 1994, in Hyderabad. GTB was promoted by Jayant Madhab (Madhab), Ramesh Gelli (Gelli) and Sridhar Subasri (Subasri). Madhab, a development banker, was employed with the Asian Development Bank, Manila. Gelli who was Chairman of Vysya Bank for10 years had played a major role in transforming that bank into one of India's top private sector banks. Subasri was a former bank executive and a close friend of Gelli. Though the liscence to GTB was given in the name of Jayant Madhab and Associates, Madhab's involvement with GTB was affected by the loss of his only son. The bank's operations were managed by Gelli. Apart from the three promoters, the International Finance Corporation (IFC) and the Asian Development Bank (ADB) were the bank's major shareholders. GTB offered an array of products and services in retail, wholesale, corporate, treasury and investment banking and products for non-resident Indians, apart from depository and advisory services. The bank specialized in lending to the software, energy, telecom, textiles, pharmaceuticals and gems and jewelery sectors. Since its inception, GTB had been in the news several times. The three promoters raised Rs 400 mn, considered a substantial amount for individual promoters. With two international financial institutions – IFC and ADB - as shareholders, GTB became the first Indian private sector bank to attract equity participation from international investment banks. The initial public offer (IPO) in late 1994 was oversubscribed 60 times. Subscription worth Rs 62.40 bn from over one mn investors was received as against the original size of Rs.1.04bn. On opening day, the bank reportedly received deposits worth Rs one bn, which increased to Rs 10 bn by the end of the first year; and Rs 27.06 bn in three years. In three years of operations, the total business exceeded Rs 43.02 bn, making it one of the fastest growing banks in India. It was also the first among Indian banks to raise Tier II capital11 from multilateral institutions. In five years, GTB's deposits were worth Rs 40 bn out of which 70 per cent were from retail investors... The Fall The collapse of GTB resulted from many mistakes committed by the bank's management. GTB's problems started in 2000 and the imposition of the moratorium finally ended its independent existence RBI's probe into GTB's accounts revealed a significant erosion of the bank's net worth and huge number of NPAs reflected its weak financials. Moreover, GTB's attempts to strengthen its capital base through investments from overseas failed due to regulatory problems, resulting in the total collapse of the bank. The major factors that led to the fall of GTB included: NEXUS WITH KETAN PAREKH In mid-2000, GTB disbursed loans of Rs 1.4 bn to Ketan Parekh (KP), a leading stockbroker at the Bombay Stock Exchange (BSE). He used the money to purchase GTB shares from the BSE and the National Stock Exchange (NSE)... The Merger All these factors resulted in the imposition of moratorium by RBI on GTB. On July 26, 2004, RBI announced that GTB would be merged with the Oriental Bank of Commerce (OBC). As per the scheme, OBC took over all the assets and liabilities of GTB on its books. It acquired all 104 branches of GTB, 275 ATMs, a workforce of 1400 employees and one million customers at an estimated merger cost of Rs. 8 bn. OBC's total business volume was expected to reach Rs 65 bn and the total branch network to cross 1,100. All corporate accounts including salary accounts were transferred to OBC. The entire amount of paid-up equity capital of GTB was adjusted towards its liabilities. There was no share swap between GTB and OBC, which meant that GTB shareholders were the ultimate losers, as they did not get any shares of OBC. Moreover, OBC enjoyed a huge tax break by acquiring GTB's NPAs worth Rs 1.2 bn and impaired assets of Rs. 3 bn... The Aftermath Though RBI's decision to merge GTB with OBC came as a relief for the former's depositors, analysts and industry experts raised concerns about the way RBI handled the entire issue. They said RBI had announced the merger of GTB and OBC, in less than 48 hours of the imposition of the moratorium. If the deal was already in process, they wondered why RBI took the extreme measure of imposing a moratorium instead of announcing the mandatory merger straight away. This step would have prevented panic and anxiety among GTB's depositors. Analysts also wondered why RBI rejected the proposal of equity injection from New Bridge, which would have solved the re-capitalization problem of GTB easily and could have prevented the bank's eventual collapse. They wondered why RBI favored the merger with OBC and did not try for competitive bidding to acquire GTB. Moreover, though the interests of GTB's depositors were protected, its shareholders lost their total investments in the bank overnight. | Impact Analysis—GTB-OBC merger Impact on GTB Depositors: The Finance Minister and the Reserve Bank of India had assured GTB's 1 million depositors that their interest would be protected; this scheme appears to have realised that assurance Under this scheme, all GTB depositors (savings, current, term deposit, etc) will become OBC deposit holders on the prescribed date. OBC will credit interest due to GTB deposit holders according to the rate determined by RBI, for the period from July 24, 2004 to the prescribed date. From the prescribed date, the rate of interest would be similar to that offered to OBC deposit holders. In this entire transaction, there are three periods — one up to July 24, 2004, another from July 24, 2004 till the prescribed date (merger date) and the last period will be post the prescribed date. For deposits held till July 24, 2004, depositors will earn interest according to the rate determined by GTB; between July 24, 2004 and the prescribed date, interest will be paid as per the RBI determined rate. In the period post the prescribed rate, the interest rate will be as per the prevailing rate at OBC. Under such an arrangement, depositors will maintain their principal, but they would lose some interest. RBI has not yet determined the rate of interest payable for the intervening period. Even if the rate declared by RBI is similar to the existing GTB rate, the post merger period will witness a drop of almost 75-100 bps in interest rates. Comparison with other South India-based private sector banks reveals that there is a 50-75 bps difference between interest rates. Shareholders: As per the draft scheme of amalgamation, the entire amount of the paid-up capital and reserves of the transferor bank would be treated as provision for bad and doubtful debts and depreciation in other assets. There would be no swap of shares between the shareholders of the bank. OBC will take all necessary steps to recover the bad assets. The net proceeds from the recovery of bad assets would be utilised to make good the shortfall borne by OBC towards meeting the liability of GTB depositors. Any surplus will be used to make pro-rata payments to GTB shareholders, with a first priority to the preference shareholder. There is no preference share capital Impact on OBC The merger will have a favourable impact for OBC in terms of an increase in its reach and presence in South India and an addition of 1 million retail deposit holders to its tally. With the bank focusing on retail in 2004-05, it can utilise this opportunity to sell its retail products to GTB depositors. On the technology front, OBC is in the process of implementing Finacle, a core banking solution from Infosys, while GTB has already implemented the same. With both banks having the same technological platform, the transition of operations will be smooth. Capital adequacy: OBC's capital adequacy at 14.47 (2003-04) is well above the stipulated norm of 9 per cent. With this merger, OBC’s risk weighted assets are expected to increase by approximately 60 billion, but there would be no corresponding rise in capital. With this increase in the risk weighted asset base, the combined capital adequacy ratio (CAR) will fall by 223 bps, pulling down OBC's CAR to about 12.24 per cent, which is still over the stipulated 9 per cent. Hence, the impact on CAR will not be significant. Capital adequacy ------------------------------------------------- Particualrs (Rs in billion) GTB OBC Combined Risk weighted assets (approx) 60 390 450 Capital adequacy ratio 0 14.47 12.24 Source: CRIS INFAC Profitability: The profitability of the bank is bound take a hit on account of NPA provisioning. But OBC has approximately Rs 16 billion unrealised profits on investments as of June 30, 2004, which could be utilised for reducing the impact of NPA provisioning. Customer service: GTB was known for its excellent customer service. OBC will have to maintain this expectation; otherwise, it might lose customers and consequently, the reach advantage gained from the GTB merger.