Banking Scams ft. Banking Tracker

‘Don’t be afraid to give up the good to go for the great’, quite a thought provoking quote isn’t it? Problem occurs when ill intentioned folks misconstrue the definition of good and great to turn things into a scam. Well yes, scam has been a buzzword in India since the 1990s. In this piece, we will highlight a few banking scams that have taken place in India. While a handful of these scams have been earth shattering for the concerned bank, few of them have just managed to scrape the surface. The objective of the writeup is to convey how we track such scams and make sure that your money is not invested in frothy companies. 

First, let’s turn our attention towards three banking scams/crisis that proved to be fatal for the respective banks – 

1. Yes Bank

The Yes Bank saga is one of the most unexpected business blunders that one saw unfold. From rags to riches to rags. 

Established in 2003, the bank grew a whopping 26 times in size between 2003 and 2018. The stock price rocketed from ₹9 to ₹400 between 2008 and 2018 making it India’s 4th largest private sector bank. Yes Bank’s loan book ballooned from ₹55,000 crores in FY14 to ₹2.4 lakh crores in FY19. All’s good, where’s the problem then?

The CEO of the bank, Rana Kapoor was actually siphoning off funds under the pretext of great business. In collaboration with DHFL promoters, Rana Kapoor siphoned as much as ~₹5000 crores from the bank. Huge sums of money were sanctioned towards stressed companies like DHFL, IL&FS, Essel Group, Anil Ambani’s group for Kapoor’s monetary benefits. 

In 2017, when things started to get out of hand, RBI decided to investigate Yes Bank’s books. They found out that Yes Bank was grossly under-representing its non performing loans or NPAs. In FY16, Yes Bank reported NPAs worth ₹748 crores, however RBI found that number to be at ₹4925 crores, 557% higher! One thing led to another, soon Kapoor was ousted from the company and in 2020 the stock price crashed to ₹5 from ₹400 at one point of time. Later it was found out that Kapoor had pledged a sizable chunk of his Yes Bank shares to get loans from different banks, which were defaulted on. Hence, these institutions sold these shares contributing to the downfall of Yes Bank stock. 

The meteoric rise of Yes Bank made it an obvious choice for us to include it in our Banking Tracker smallcase. We were monitoring the situation closely and got rid off the stock in September ‘18.

2. Punjab National Bank

Punjab National Bank (PNB) was struck with a classic scam of close to ₹12,000 crores by Nirav Modi, a diamond merchant. It all started in 2011, when Modi produced fake PNB Letter of Understanding (LOUs) to different banks to garner loans from them. What is LOU?

LOU is like a guarantee slip provided by one bank to another on behalf of the former’s client. An LOU ensures that if the person taking the loan defaults, the LOU issuing bank will repay the debt to the other bank. 

Now, with the help of a few PNB employees, Nirav Modi managed to get fake LOUs and produce it to different banks for getting the loan sanctioned. This continued till 2018, when finally the curtains fell on this scandal. PNB management got to know about the fake LOUs and they decided to report it to the CBI for further investigation. CBI came back with the entire thesis on how fake LOUs were issued and these loans were actually taken from overseas branches of Indian banks itself. After the scam was unearthed, PNB stock saw more than 55% correction wiping billions of investor wealth. 

We held PNB in our smallcase but we were quick enough to identify problems with the company. The fundamentals began to deteriorate and NPA levels began to inch up. We managed to drop the company in 2017 as we had kept a close eye on its developments.

3. IL&FS

Infrastructure Leasing & Financial Services (IL&FS) was a non-banking financial institution who used to lend money to businesses for major infrastructure projects, as the name suggests. While things were running smoothly for the company for close to two decades, IL&FS collapsed in 2019 due to a string of irregularities. 

In the quest of becoming the best, the core problem started to occur for IL&FS when they started to finance any and every infrastructure project without actually considering the viability of those projects. The IL&FS failed to gauge the business risk that they were getting exposed to. As a result, by 2019 IL&FS amassed debt of close to ₹1 lakh crores. Matters became so worse that the company was taking on short-term debt to finance long-term projects. This is a classic recipe for disaster. The first default took place in June 2018 worth ₹450 crores. And subsequently, it was a chain reaction.

Suddenly, the funding tap closed down for IL&FS and one default after another kept happening. The senior management had no answers. The amusing part is while IL&FS was piling debt to glory, credit rating agencies were honoring the company with the best (AAA) rating making it seem that everything is hunky dory. The systemic rot within various stakeholders led to the collapse of the mighty IL&FS. 

In this case, because of the elevated debt levels, our red flags indicator never passed the stock for us to consider.

Now, let’s talk about a few companies that we hold in our smallcases currently and where recent frauds have been reported – 

1. Can Fin Homes 

Can Fin Homes is a housing finance company in India. It primarily focuses on providing financial assistance for individuals looking to buy or construct homes. Can Fin Homes offers various home loan products and services to help people fulfill their housing needs. 

In July ‘23, the company reported a financial fraud of ₹38 crores wherein three employees were reported for misappropriation of funds. On the day of the news, the stock tumbled close to 9%. However, since the crisis is on a smaller scale, the stock price has stabilized although it has not reached the previous peak. This case of employee fraud has occurred twice in the past 18 months.

2. Bank of Baroda

Bank of Baroda’s mobile banking app was in the news recently, albeit for the wrong reasons. A couple of weeks ago, the bank discovered that in order to meet sales targets, bank employees had linked customer bank accounts to random phone numbers. These employees in the quest to meet sign up targets for the app linked customer bank accounts to phone numbers of staff, security personnel. 

This is a serious threat to financial safety as phone number linking is instrumental to digital banking transactions. When the crisis got public, RBI ordered the bank to stop on-boarding any new customer onto their digital app until the mess gets cleared up. On the day of the news, the stock fell by around 3%, suggesting that the crisis is not earth shattering for Bank of Baroda. 

There is another famous banking scam relating to ICICI Bank which sent shock waves to the entire Indian banking industry. However, given the size and brand of ICICI, the bank managed to recuperate from the shambles of the scandal. Well, it was no different than the cases we have discussed earlier. Chanda Kochhar was appointed as the MD & CEO of ICICI Bank in 2009. 

While ICICI was thriving under her leadership, the ship started witnessing turbulence in 2016 when unviable loans from ICICI Bank to the Videocon Group came to light. It was found that more than ₹3000 crores worth of loan was sanctioned to Videocon and its group companies between 2009 and 2012, in spite of the knowledge that Videocon would not be able to repay the debt, Kochaar kept sanctioning the loans. Finally in 2017, the Videocon Group was declared as an NPA. Why did Kochhar do this? Because in lieu of these shoddy loans, the Videocon Group transferred cash and other material benefits to herself and her spouse. ICICI Bank shares saw market capitalization of more than ₹10,000 crores getting wiped out in a single day. That being said, given the huge size of the bank, the Kochhar fiasco did not derail them completely and the bank has managed to be one of the finest running banks in India again.   

You see, we hold Can Fin, Bank of Baroda, ICICI Bank in our smallcases. The natural question would be – why? The reason behind it is that we believe that these irregularities do not have the potential to derail the company altogether. We have an extremely meticulous process when it comes to tracking red flags because we aim to stay ahead of the curve. No doubt this is a red flag and we are vigilantly tracking these companies. If we notice further irregularities, we will not shy away from removing these companies from our portfolios. 

To conclude, our focus at Windmill Capital is to protect our investors’ wealth. As per track record, we have always managed to stay away from frothy companies that have destroyed shareholder wealth. While it’s not possible for one to discover an internal scam before it’s actually unearthed, however fundamentals do help in order to gauge if anything extraordinary begins to occur with respect to a company. Not only that, we actually track our universe’s companies on a day to day basis to check up on everything that the company is up to. The second point we wanted to convey was that not all negative news or employee mishaps warrants an immediate reaction from us. The cases being discussed in the second half of the writeup is primarily to make you understand this aspect of the puzzle. At the end, as analysts we have to separate wheat from the chaff and make an informed decision.