Timely action can avert Madhavpura Bank type scams

A stitch in time saves nine, says an old adage. Timely action could have avoided the fate of the little known Madhavpura Mercantile Co-operative Bank. At least this is the view echoed by experts in stock market operations.

Madhavpura Bank would have remained in the realm of obscurity but for the pay order scam that landed the Big Bull Mr. Ketan Parekh in jail. How did the scam come about? It happened when the pay order issued by it bounced.

A little elaboration will put things in perspective. Instead of using cheques, Mr. Parekh and the like use the pay order route to settle their dues. All that is required to do this is to have an arrangement with the bankers. Perhaps, they are using this methodology to acquire some legitimacy.

In this instance, Mr. Parekh used a Gujarat branch of Madavpura Bank to settle his dues with a Bank of India branch in Mumbai. Banks oblige clients and issue pay orders as this fetches some revenue in the form of commission. But banks do this only if the clients have loan accounts with them or if they pay the money upfront. Ipso facto, a pay order, for all practical purposes, assures cash payment on presentation. Pay orders are normally meant for use within a city. For inter-city payment/settlement, demand drafts are issued.

Let us ignore the fact that the Ahmedabad branch of Madavpura Bank chose to issue a pay order payable in Mumbai. How did it bounce? One is led to believe that Madhavpura Bank issued the pay order without collecting the matching money from Mr. Parekh. If it had done so, it is in clear violation of rules. Since Mr. Parekh is a broker, it is quite plausible that the bank issued the pay order after taking adequate security in the form of shares. It is doubtful, however, whether rules permit this kind of security.

If indeed he had actually lodged his shares, could the authorities have prevented Madhavpura Bank from falling into the pits? They could have, argue an informed section. Regulators, more often than not, precipitate a crisis. Quick thinking would have saved the day in this instance. A view is that the authorities should have let Madhavpura Bank to square up the outstanding position as soon as the crisis was spotted. Assuming that it had Mr. Parekh's shares and been allowed to sell them off immediately, the bank could have recovered at least a part of its debts.

What the experts advocate to get over a crisis in bourses can apply equally here. It is suggested that in a crisis situation, all positions must be converted into monetary positions. If still there is any outstanding position, it must be squared up. It essentially boils down to taking a quick decision on disposing of the securities and cutting losses. If the authorities had done this in the Madhavpura case, the magnitude of the scam could have been contained. In fact, many argue that the impact of Harshad Mehta-induced Security Scam I in the early 1990s could have been contained if only the regulators had allowed the squaring up of positions.

Similarly, the plight of depositors in finance companies of unincorporated varieties in Chennai could have been mitigated to a large extent if only the authorities concerned had acted quickly to dispose of physical assets at reasonable prices. The failure to do so has seen many a good physical asset degenerate into mere junk in police custody, much to the misery of depositors.

A solution will come only when there is a provision for delivery versus payment system, say experts.