Jammu and Kashmir Bank: What lies beneath the carpet?

Sat Pal Malik, Governor of Jammu and Kashmir, converted the Jammu and Kashmir Bank (JKB) into a Public Sector Undertaking soon after he imposed President’s Rule in the State. The government of J&K holds 59 percent shares in the bank.

The State government appointed a number of directors on the board of the bank. Therefore, JKB is de facto a Public Sector Undertaking (PSU) since the J&K government holds majority shares. However, for various historical reasons, it was classified as a private bank.

That meant that the ‘government’ could appoint the members of the board in view of its shareholding, but the government could not issue administrative directions to the JKB.

Now, the Governor has classified JKB as a PSU thereby bringing the bank under the administrative control of the government. One important consequence of this is that JKB would now be covered under the RTI Act and also come under the scrutiny of the Central Vigilance Commission.

The JKB is one of the few State-owned PSU of J&K that is running in profit regularly for decades. The profitability of the bank is a heroic attainment given that most PSUs in the State are running in loss. However, there are reasons to believe that the real story may be different.

As recently as three weeks ago, the Reserve Bank of India (RBI) imposed penalties of Rs 3 crore each on Deutsche Bank AG of Germany and The Jammu & Kashmir Bank for violating various norms. The heavy fines came for the two banks’ ‘non-compliance with the direction’ of RBI on Income Recognition, Asset Classification and Know Your Customer norms. 

The Income Recognition norm specifies whether a receipt is income or loan taken by the bank. For example, a bank receives a Fixed Deposit of Rs 1 crore which it has to repay in due course. It is a liability of the bank. However, the bank can show this receipt as interest income.

That would reduce the liabilities and increase the income of the bank in the Balance Sheet while truly the bank may have a liability instead of income and may have increased its losses. Similarly, the Asset Classification norm States whether an outstanding loan would be considered as “good” or “bad.” Let us say the JKB has given a loan of Rs 10 crore to one Mr X.

The borrower has not paid the interest and also not repaid the principal amount even after 10 years. This amount should be classified as a “Non-Performing Asset” (NPA) and the Bank should consider this as a loss. Now, the JKB would incur a loss of Rs 10 crore if it classified this loan as an NPA.

The JKB can create an artificial profit by not disclosing that Mr X has not paid interest for 10 years. That would get disclosed if the JKB adhered to the Asset Classification norms. The banks of the country are required to examine the identity of a borrower under the Know Your Customer (KYC) norms. Let us say the JKB has given a loan of Rs 10 crore to a persons named XX.

It may be that Mr XX has “disappeared.” However, JKB does not have the ID proofs of Mr XX. This possibility gets credibility because the names of the borrowers and defaulters are not disclosed by the JKB at present since it is outside the ambit of the RTI Act.

The imposition of a huge fine by the RBI for the violation of these norms creates suspicion that all is not well with the JKB and the profitability being flouted around could be fake. The possible rot in the JKB could now get exposed since it will come under the RTI Act.

It is surprising that the major political parties of J&K have opposed bringing of JKB under the PSU umbrella and the RTI Act. One reason could be that the JKB has given large “hidden” loans to the leaders of these parties and this stands to get exposed. Otherwise, I do not see any reason why the political parties would oppose bringing the JKB under the administrative control of the J&K government. 

The appropriate model of a bank may be assessed on the criteria of (1) efficiency and (2) accountability to the public for government shareholding. We can assess three models on above criteria. First model is that of private-bank-with-government-shareholding. The government holds equity in a bank but does not exercise administrative control over it — as was the case with JKB till now.

This model fails on the criteria of accountability. The people of the State have a right to know about the workings of the JKB if they have contributed 59 percent to the share of the bank. The second model is of a PSU — a bank under the administrative control of the government — like JKB has become now. This model fails on the criteria of efficiency.

The sad state of the public sector banks in the country is essentially due to the bureaucratic culture. There is no reason to believe that the JKB was or will be different. As said above, the present claimed profitability and efficiency of the JKB may be fake. The third model is outright privatization.

The J&K government could make a strategic sale of its shareholding in the JKB and hand over the control of the bank to a private entrepreneur. This model succeeds on both criteria. The issue of accountability does not arise since no public money would be invested in the bank anymore.

The private owner of the bank is likely to be more efficient as seen in the relatively better performance of private banks in the country. Therefore, the present shift from private-bank-with-government-shareholding to a PSU is like jumping out of the frying pan into the fire. We get rid of the problem of accountability but invite in the problem of inefficiency. The correct way was to privatise the JKB.

Question is how with the social dimension be managed if JKB is privatised? The JKB has a place in the hearts of the people. It is accessible to the people. This unique heritage of Kashmir would be lost. The solution is for J&K government to create a culture of wanting not only for the JKB but other banks as well. The J&K government could come up with interest subsidy schemes to support local businesses instead of living in a make-believe world of possibly fake profitability.

Author was formerly Professor of Economics at IIM Bengaluru