Indian banking’s chequered history

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Bank scams and debacles were common in the early history and development of modern banking in India. That may not be surprising since banks then were privately owned. But even though most banks have since been nationalised, complicity between bankers and favoured borrowers persists, with covert deals often suffering exposure only when a downturn in business fortunes calls attention to them.

Today, as in the past, the banking industry has produced prominent personalities who used the system to their own advantage. Vijay Mallya, whose Non-Performing Assets (NPAs) amount to over Rs 9,400 crore, jeweller Nirav Modi and most recently, Videocon Industries chairman Venugopal Dhoot left the Indian banking system red-faced and bearing the onus of dealing with default in repayment. The striking feature in almost all recent banking scandals is that loans were advanced by bankers against highly inflated or non-existent collateral. This has made the recovery of money an uphill task.

Nineteenth-century history of modern banking also is full of examples of lopsided loan portfolios that favour a few individuals and businesses. Despite improved regulations and the increased use of digital technology, human folly, recklessness, and nexus between bank officials and big debtors with political connections still defines banking today. It seems even a good system of regulation cannot overcome human nature.

While most 19th century banks have failed, a few barely survived, often through recapitalisation or reconstitution. The Bank of Bombay, which was founded in 1840, became the New Bank of Bombay, for instance.

The agency house crisis in Calcutta (1830 to 1834)

Much before Anglo-Saxon banking took root in Bombay in 1840, there existed two types of banks in Calcutta at the turn of the 19th century. Most were established by agency houses, the most famous one being the Bank of Hindoostan, established by Alexander & Co. in 1770. There was one quasi-governmental bank, the Chartered Presidency Bank of Bengal (established in 1809), which unlike the private agency-house banks, enjoyed limited liability due to a charter granted by the British governor-general in India. Akin to a central bank, it performed banking functions on behalf of the government.

A painted view of an indigo plantation. With the decline of Bengal manufactures, agricultural commodities like indigo became the main exports from this Presidency.
A painted view of an indigo plantation. With the decline of Bengal manufactures, agricultural commodities like indigo became the main exports from this Presidency.
The agency house banks and the Presidency Bank were legally different entities, but equally vulnerable when crisis engulfed the Bengal Presidency after the international demand for indigo began falling in 1826. Indigo was a highly speculative commodity, both in the global and domestic markets, but local demand for it was high: it was among the very few goods from Bengal that could be used to remit earnings from India to England, and Calcutta’s agency houses had invested heavily in the presidency’s indigo plantations. When international demand for indigo stagnated, they suffered.

The Presidency Bank disregarded its own charter and bent backwards to accommodate the agency house of Alexander & Co., whose partners had a dominant presence on its board. The charter limited loans for one individual or firm to Rs. 1 lakh, but the bank lent Rs 23 lakhs to Alexander & Co. Matters got worse because other agency houses—Fergusson & Co., Cruttenden & Co., and Mackintosh & Co.— also guaranteed the Alexander & Co. loans with assets that included indigo plantations. They feared a repeat of the panic caused by the 1830 closure of the reputable house of Palmer & Co. Although immovable property could not be accepted as collateral, according to the Presidency Bank’s charter, the Bank was now left running these properties in hopes of keeping their value from declining.

Alexander & Co. and its Bank of Hindoostan collapsed in 1832, leading to the failure of its three guarantors. As a result, the Presidency Bank ended up managing all the agencies’ indigo interests for some time, eventually writing off amounts of Rs 7,61,917 (1829-1833) and Rs 7,96,382 (first half 1834).

Union Bank, founded in 1829, through a merger of Calcutta Bank and Commercial Bank, had much the same experience. Just a year after its founding, the agency houses that had founded the merged bank failed, leaving Union Bank with a large volume of bad loans. Union Bank managed to stay afloat through a stringent overhaul of its loan portfolio.

The case of the Presidency Bank of Bombay

The Presidency Bank of Bombay, established in 1840, was modelled on the same lines as the Bank of Bengal. It was also a chartered presidency bank, and like its counterpart in Bengal, it issued currency notes that were legal tender, accepted by the government treasury as payment.

The Presidency Chartered Bank of Bombay on 1 Rampart Row was founded in 1840 and was one of three presidency banks that were the precursors of the State Bank of India (1955)
The Presidency Chartered Bank of Bombay on 1 Rampart Row was founded in 1840 and was one of three presidency banks that were the precursors of the State Bank of India (1955)
When the cotton boom was triggered by the outbreak of the American Civil War in 1860, the task of issuing currency notes was taken away from all three presidency banks. To compensate Bank of Bombay for a loss of income, the Bombay government enacted Bombay Act X (1863), which quadrupled its capital and opened new avenues to deploy its funds.

At the time, a boom in stock prices was well underway, as money was pouring in because of the huge global demand for Deccan cotton, a major export from Bombay. The big bull on a very nascent Bombay stock market was a director of the Presidency Bank of Bombay, Premchand Roychand, a highly reputed trader whose every move, whether in the stock or bullion or cotton markets, was closely watched. To many, it seemed anything Roychand invested in turned to gold. Roychand was also a business partner of Sir Cowasjee Jehangir Readymoney’s, a leading guarantee broker and financier in the city.

Roychand, with the complicity of the Bank of Bombay’s management, withdrew as much as Rs 40 lakhs over a short period of time from six of the Bank of Bombay’s branches. This money fuelled the first and wildest stock market bull run in the city. To expand the base of investments, numerous banks, financial institutions, reclamation companies and development schemes were launched in quick succession, often by little-known business entities in the city. Their shares were purchased at highly inflated rates, although most were just companies on paper.

What was not foreseen was the abrupt end to the American Civil War in 1865 and the opening of its southern ports to resume shipping of superior American long staple cotton to mills in Europe and England. This burst the stock market bubble, leading to the collapse of almost all the newly launched companies, the bankruptcy of many of the city’s leading merchants (including Roychand) and the downfall of the Presidency Bank of Bombay.

When accounts were squared, Roychand owed the Bank of Bombay Rs 25 lakhs. During liquidation hearings it was apparent that he had been given a free hand to arbitrage on the markets with the Bank’s funds. He did this with the full knowledge of its secretary, the one person aware of his almost daily transactions.

Eventually, the old Presidency Bank of Bombay was reconstructed in 1868 as the New Bank of Bombay, after losses of Rs 1,88, 99,334 were written off as irretrievable debts.

These instances of irresponsible banking, combined with the tendency of banks to desist from spreading risks, to fail to exercise due diligence in assessing collateral, and to make sweet deals between big clients and their bankers required recapitalisation and large-scale write-offs of bad debts to resuscitate banks.

This history resonates strongly with contemporary times when the Indian government undertakes elaborate extradition procedures to bring defaulters to justice. The clean-up of the banking system may lead to it emerging stronger, just as it did in the past. But human nature, safeguards notwithstanding, will always be an unknown factor, as history has amply demonstrated.

 

References

  1. According to The Hindu timeline independent MP Vijay Mallya resigned from the Rajya Sabha on 2 May 2016 citing a loan default of over Rs 9400 crore. This was two years ago. Accessed on 3 May 2018: http://www.thehindu.com/business/Industry/kingfisher-airlines-crisis-timeline/article14380262.ece1
  2. The first modern bank in Bombay was the bank set-up by the English East India Company’s Bombay government in 1720, within the premises of Bombay Castle (today the Indian Navy’s base INS Angre). This was probably for the convenience of its employees but it functioned till 1778 before going into oblivion. The next bank to be set up by the Company was again in Bombay Castle in the year 1835, but this bank seemed to have a limited function as just 5 years later the chartered presidency Bank of Bombay was set up by a mix of expats and native merchants
  3. Agency houses were originally set up by private English traders and were financed with capital from the EEIC servants. It facilitated the remittance of funds of the EEIC employees either through exports of goods to Europe and England and the employment of their funds (often far in excess of their salaries) in the intra-Asian trade. The portfolio of these Agency Houses grew to include shipping; indigo, sugar, silk, cotton and opium trading, and banking. After the Agency Houses crisis in Calcutta, many of the Agency Houses set up in the 1830s and 1840s had Indian partners, like Carr, Tagore & Co.
  4. The government had a one-fifth share in this Bank and three government directors on its board. It replicated this shareholding pattern later in the Bank of Bombay (1840) and Bank of Madras (1843). Presidency chartered banks were not allowed by their charter to participate in the foreign exchange business though an exception was later made in the case of the Bank of Madras with regard to Ceylon. In 1921, the three presidency banks were merged to form the Imperial Bank of India, which in its post-independence avatar was renamed the State Bank of India in 1955.
  5. Bagchi, Amiya, The Evolution Of The State Bank of India: The Roots 1806-1876 (Bombay, Oxford University Press/State Bank of India, 1987) pp. 133-34.
  6. Ibid, Bagchi, p. 138.
  7. The Union Bank eventually closed down due to another business crisis in 1847.
  8. The American Civil War (1860-65) triggered a huge demand for short staple Deccan cotton because shipments of American cotton ceased due to the War.
  9. The Paper Currency Act (1861) gave the function of issuing currency notes to a newly formed government currency department.
  10. The Bombay Native Stock & Share Brokers Association was incorporated only in 1875, ten years after the first bull run and bust in stocks in Bombay.
  11. Gazetteer (1909), Vol III, p. 215.

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