essay on banking crisis in india

How to solve issue of rising non-performing assets in Indian public sector banks

Richa roy , rr richa roy finance and public policy lawyer, graduate research fellow - global economic governance, university of oxford krishnamurthy subramanian , and krishnamurthy subramanian senior visiting fellow shamika ravi shamika ravi former brookings expert, economic advisory council member to the prime minister and secretary - government of india.

March 1, 2018

• 10 min read

Content from the Brookings Institution India Center is now archived . After seven years of an impactful partnership, as of September 11, 2020, Brookings India is now the Centre for Social and Economic Progress , an independent public policy institution based in India.

The Indian banking system is beleaguered with non-performing assets (NPAs). According to the Reserve Bank of India’s Financial Stability Report of December 2017 , they currently stand at 10.2 per cent of all assets, while stressed assets, which are believed to be NPAs in effect, stand at 12.8 per cent. Related frauds amount to INR 612.6 billion in the last five financial years and governance failures on account of integrity and competence issues plague the banking system.

Brookings India recently organised a roundtable in Mumbai on NPA resolution; participants ranged from a former Deputy Governor of the RBI, to bankers from public and private sectors, asset reconstruction companies to rating agencies, IMF representatives to financial journalists and academics. In a wide-spanning discussion, a few key themes emerged: the privatisation and governance of public sector banks, the governance and regulatory practices of the RBI and reengineering of banking practices.

i) Public Sector Banks:

Public Sector Banks (PSBs) constitute over 70 per cent of the banking system and are in a state of crisis. Participants believed that fundamental reforms tended to happen when crisis hit and this was an opportune moment for such reforms and expressed optimism that this was likely under this government .

• Bank Holding Company structure : The bank holding company (BHC) structure recommended by the P.J. Nayak Committee, among others, involves divesting the government’s shareholding to below 52 per cent and routing it through a holding company. This one level of distance would not help unless the BHC was itself professionally managed.
• Sovereign Wealth Fund: Rather than the proceeds of privatisation going to the Consolidated Fund of India, a sovereign wealth fund could be created which is professionally managed. This could help “trickle down” good governance practices to PSBs.
• Hive off social sector lending vehicle : The political economy of privatisation remains complex, at least in part because of social sector lending programmes routed through PSBs. Accordingly, it may be useful to consider hiving off all agricultural and social sector lending into a separate entity which may be government owned and controlled and allow the corporate lending part of the PSBs to be privatised. There is an economic rationale for this as well. PSBs (and indeed all banks) are required to lend 40 per cent of their assets to “priority sectors.” Priority Sector Lending (PSL) is deemed unprofitable for several banks leading to a “PSL drag.” On the other hand, microfinance non-banking finance companies (NBFC MFIs) have a cap on their earnings margins. Accordingly, the decoupling of PSL and market lending may allow market distortions in both these sectors to be corrected.
• Recapitalise, Reform and then privatise : PSBs in their current state of impaired balance sheets are unlikely to find any takers. By the same token, recapitalising PSBs repeatedly creates moral hazard issues. Recapitalisation and governance reform can enhance market valuations of PSBs and should lead to a path for privatisation without accusations of “selling off the family silver.”
• Single Big Bank? The idea of a single large PSB mimicking the Life Insurance Corporation of India model in the insurance space may be considered, but such an entity could create serious distortions, such as moral hazard stemming from the too-big-to-fail syndrome, with the next biggest bank being on-fourth its size.
• “Bad Bank” : The idea of a single bad bank where the NPAs of all PSBs may be transferred as a silver bullet to clean up PSB balance sheets must be rejected. Currently, 11 of 21 listed PSB banks are under RBI’s prompt corrective action framework and simply consolidating all NPAs would create an additional level of complexity.

The umbilical cord connecting public sector banks to politicians and bureaucrats, which in turn stems from the ownership structure of these banks, has led to several inefficiencies.

• Nayak Committee : Should privatisation not be on the table, the government should back the recommendations of the Nayak Committee. Presently, only lip service is being done to them by way of example, the Bank Boards Bureau (BBB) uses the nomenclature of the Nayak Committee but none of its substantive governance reforms have been implemented. For example, all the governance functions including selection of bank chairpersons continues to be controlled by the Ministry of Finance.
• Role, purpose and business strategy : PSBs suffer from a severe identity crisis and require business, not just financial, restructuring. They do not operate as commercial banks and do not have a coherent business strategy or vision. The Ministry of Finance must ascertain whether this is the best use of public money. It is crucial to clarify the role and purpose of PSBs and for them to concentrate on specific regions or business segments. By way of example, it is unclear why certain PSBs have branches in South Africa, why a Punjab-based PSB has branches in the North-East. The need for existence of each PSB must be clear and its business and expansion should follow that. This would also force an evaluation of whether PSL lending has been effective.
• Term lengths : The terms of bank chairpersons must be elongated in order to effect meaningful changes and to hold them accountable. Presently, it is observed that as the Chairpersons of State Bank of India (SBI) change, there is an NPA “bloat”- the outgoing chairperson tends to backload NPAs, which obscures the situation of PSB bank balance sheets. (For instance, SBI posted a loss of INR 24 billion in the last quarter on account NPA provisioning). Terms of chairpersons should align with the life of the loan, which would allow defaults to be detected and penalties to be meted out as required.
• Professionalise, Incentivise – Incentives for PSB personnel must be significantly augmented. The SBI chairman’s salary is equal to that of a fresh business graduate in an MNC bank. Better incentive structures will attract better talent.

Penalise for wrongdoing : Although vigilance mechanisms exist, lax enforcement means that wrongdoing is rarely penalized. For instance, the Chairman of Syndicate Bank who was bribed by the promoters of Bhushan Steel was in jail for barely a few months and has not been convicted as yet. Rotation of staff : The Punjab National Bank fraud demonstrates the extent of operational and risk management failures in PSBs. Improvements to HR practices can help mitigate egregious behavior like frauds. For instance, PSBs tend to man the business verticals with the brightest talent and less competent staff in the inspection and supervision roles. If officers are rotated in these roles, this could not only strengthen the supervision of banks, it would also mean that staff on the business development side have experience in supervision and inspection and will therefore self-regulate better. Credit appraisal, monitoring : Basic principles of credit appraisal and monitoring are obviated in PSBs and must be sharpened, to diagnose defects of capital, business purpose and character.

Public sector banks suffer from a severe identity crisis and require business, not just financial, restructuring.

ii) RBI governance and regulation

The RBI as a regulator has had qualified success in the face of structural impediments, including limited control over PSBs. RBI’s internal governance as well as its regulation of NPAs needs improvement.

• Subsidiarisation: The RBI may consider the Bank of England model of subsidiarising its prudential regulatory and supervision functions (the Prudential Regulatory Authourity and the Financial Conduct Authority). However, the recognition that lost synergies from such separation contributed to the global financial crisis demands caution.
• Strengthening supervisory capacity : RBI lacks supervisory capacity to conduct forensic audits and this must be strengthened with human as well as technological resources.
• Preventing Evergreening: RBI regulations have permitted banks to “ever-green” and in effect delay the recognition and therefore resolution of NPAs. RBI regulations must take away incentives of banks to kick the can down the road and “extend and pretend”. This has led to a seizure of new lending and the caving in of credit culture. The recent RBI circular does remove such incentives by ending all other schemes such as CDR that allowed evergreening, which would lead to fewer delays in provisioning. This in turn, would require the recapitalisation of PSBs, which must not be carried out without the reforms set out above.

iii) Reengineering of banking systems

• Secondary Market: A vibrant secondary market for NPAs is crucial. The lack of transparency in price of the assets is holding this back, as is the lack of autonomy in PSBs and the fear of vigilance action.
• Concurrent Audit: There is a real rot in the internal and concurrent audit systems of banks. The latter is intended to red flag risks in real time, but has failed and must be shored up.
• Diagnostics for willful default: Banks need better permanent diagnostics to get to the bottom of willful defaults. This can happen though (a) market intelligence; (b) funds flow analysis; and (c) financial analysis. Most promoters do not have sufficient “skin in the game” and rely entirely on bank borrowing.
• Using technology for maker-checker: Currently, the maker-checker systems require human intervention and are therefore prone to capture and corruption. The use of Artificial Intelligence for the supervision of financial transactions could prevent financial fraud. In addition, linking Core Banking Systems (CBS) with Finacle technology (as recently required by RBI) is crucial.
• Combine with low tech – ears on the ground: Business intelligence must use traditional means- speaking to people in the industry; supplier and customers can be an invaluable source of financial information.

iv) Bright Spots

Amidst the gloom, the functioning of the Insolvency and Bankruptcy Code (Code) is cause for optimism. The Code was passed an implemented in 13 months, which is faster even when compared to Singapore’s amendments to its insolvency law. The Code is also being implemented in full speed- 50 per cent of all NPAs are currently being resolved through the Code, another 25 per cent will soon be. The judiciary has been following the (very tight) timelines prescribed by the Code.

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A crisis that changed the banking scenario in India: exploring the role of ethics in business

• Published: 28 August 2022
• Volume 11 , pages 7–32, ( 2022 )

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• Sushma Nayak   ORCID: orcid.org/0000-0001-9645-3095 1 &
• Jyoti Chandiramani   ORCID: orcid.org/0000-0002-6766-8975 1  

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Digital business has marked an era of transformation, but also an unprecedented growth of cyber threats. While digital explosion witnessed by the banking sector since the COVID-19 pandemic has been significant, the level and frequency of cybercrimes have gone up as well. Cybercrime officials attribute it to remote working—people using home computers or laptops with vulnerable online security than office systems; malicious actors relentlessly developing their tactics to find new ways to break into enterprise networks and grasping defence evasion; persons unemployed during the pandemic getting into hacking; cloud and data corruption; digital fatigue causing negligence; etc. This study adopts a case-based approach to explore the importance of business ethics, information sharing and transparency to build an information-driven society by scouting the case of Punjab and Maharashtra Co-operative (PMC) Bank, India. PMC defaulted on payments to its depositors and was placed under Reserve Bank of India’s directions due to financial irregularities and a massive fraud perpetrated by bank officials by orchestrating the bank’s IT systems. The crisis worsened when panic-stricken investors advanced their narrative through fake news peddled via social media channels, resulting in alarm that caused deaths of numerous depositors. It exposed several loopholes in information management in India’s deposit insurance system and steered the policy makers to restructure the same, thus driving the country consistent with its emerging market peers. The study further identifies best practices for aligning employees towards ethical behaviour in a virtual workplace and the pedagogical approaches for information management in the new normal.

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Introduction

The importance of information management in the banking sector has gained traction among researchers in recent times. Bank depositors place their savings with banks with an assurance to withdraw their funds on demand, based on the nature of contracts. Likewise, banks grant loans of diverse maturities to different borrowers out of the resources received as deposits (Diamond & Dybvig, 1983 ). In this formal arrangement, banks act as intermediaries vested with the responsibility of ensuring disclosure, operational transparency and ethical compliance as an essential practice of corporate governance. Information sharing is important because it propels ethical compliance and market discipline Footnote 1 among banks, and provides all the stakeholders with the information they need to determine if their interests are protected. Retail depositors lack sufficient information about the operational efficiency of their banks and are unable to communicate with fellow depositors, which may impede their ability to collectively guard themselves against potential bank failures.

Before opening an account, banks want possession of copies of various personal documents to know their clients well. However, the depositor never knows how the money mobilised by banks is spent. Bank assets are opaque, illiquid and short of transparency, because most bank loans are typically tailored and confidentially negotiated. Customers are constrained by the information shared by bank managers since financial products are intricate and risky (Tosun, 2020 ). Banks are, thus, at a risk of self-fulfilling panics Footnote 2 due to their illiquid assets (loans, which cannot be recovered from borrowers on demand) and liquid liabilities (deposits, which can be withdrawn by depositors on demand) (Bryant, 1980 ; Diamond & Dybvig, 1983 ; Liu, 2010 ). Lastly, it is assumed that the volatility of one bank might cause a contagion effect, distressing a group of banks or perhaps resulting in a systemic failure altogether.

While banks are inherently volatile due to the nature of the functions they perform (Kang, 2020 ; Santos & Nakane, 2021 ), only few have realised the importance of integrating ethics into their operations. In business, the perspective of ethical concerns has shifted dramatically in the past two decades. If a firm wants to be seen as a truthful affiliate and an esteemed member of the industry, it must exhibit a high degree of ethical compliance and upright conduct (Sroka & Szántó, 2018 ). Nevertheless, the situation gets worse when fraudsters abuse loopholes in banking systems to ride on the coat-tails of critical world events such as the COVID-19 pandemic, and its corresponding speedy digital acceleration driven by community guidelines such as “stay home,” “contactless digital payments” and so forth. Cyber-crime and online data breaches (Patil, 2021 ), unethical lending (Pandey et al., 2019 ), under-reporting non-performing assets Footnote 3 (Agarwala & Agarwala, 2019 ), frauds (Sharma & Sharma, 2018 ; Sood & Bhushan, 2020 ), poor information sharing (Jayadev & Padma, 2020 ) and floppy corporate governance (Agnihotri & Gupta, 2019 ) have been the factors responsible for most bank runs in Asia in general, and India in particular, in recent years. In 2020, when the Philippines was hit hardest by the virus, phishing was estimated to have surged by 302 percent (Mohan, 2022 ). The same year saw online fraud to be the second most common type of offence reported to police in Indonesia; likewise, investment scams had the greatest impact on victims in Singapore, with about USD 52 million defrauded in over 1100 cases (Bose, 2021 ).

During the period 2009–2021, 69,433 cases of bank fraud were reported in India; in the financial year 2021, the central bank of India confirmed that until mid-September, the value of bank frauds amounted to ₹1.38 trillion (Statista, 2021 ). According to the National Crime Record Bureau, the overall number of incidents of online fraud in India was 2093 in 2019, but it jumped to over 4000 in 2020 after the COVID-19 outbreak. It is interesting to note that five cities such as Ahmedabad, Delhi, Hyderabad, Mumbai and Pune, which had 221 incidences of online frauds in 2017, experienced a massive hike to 1746 cases in 2020 (Dey, 2021 ).

“Organized crime has been quick to respond, mounting large scale orchestrated campaigns to defraud banking customers, preying on fear and anxiety related to COVID-19” (KPMG, 2022 , p. 1). The COVID-19 pandemic has wreaked havoc on the banking industry, increasing fears of online frauds and spiralling bad loans—as consumer and business debt levels soar. In early 2022, while India was staring the Omicron-led third wave of COVID-19, the Central Bureau of Investigation registered four major cases of bank fraud involving Bank of India, Union Bank of India, Bank of Baroda and Punjab National Bank for siphoning of funds that resulted in losses worth ₹ 939 crore for the said banks (Financial Express, 2022 ).

A bank is expected to foster public confidence by providing demand-driven services while adhering to ethical practices such as transparency, honest and timely disclosures for customer retention, security and trust. This is likely to lessen the risk of bank runs, Footnote 4 which serves in upholding the security and stability of banks—necessary for consumer protection. Previous studies have rarely investigated how seamless information sharing with the public—by banks, government and regulatory bodies—may moderate the opacity of the bank’s financial performance and inhibit panic runs through informed decisions by the customers. This is particularly important in the current times of risk and uncertainty wherein ethical concerns are perturbing the stakeholders of most businesses, particularly banks.

The present study shall explore the importance of business ethics, information sharing and transparency to build an information-driven society by scouting the case of Punjab and Maharashtra Co-operative (PMC) Bank, India, which defaulted on payments to its depositors and was placed under Reserve Bank of India’s (RBI) Footnote 5 directions due to a massive fraud perpetrated by bank officials. The auditors, too, were deemed lacking in their duties because they failed to notice the bank’s serious infractions. Since the depositors were permitted to withdraw only ₹ 1000 from their accounts (suspension of convertibility) and banking operations were stalled until further directions, there was panic among investors. In fact, “PMC was also India’s first crisis related to a bank which played out on social media” (Kaul, 2020 , p. 256). The crisis worsened when uninformed and panic-stricken investors advanced their narrative through fake news peddled via social media channels, WhatsApp and Twitter, resulting in alarm that caused deaths of numerous depositors.

Based on the aforementioned discussion, the authors of this study shall explore answers to the following questions:

What are the gaps in risk-management systems in India’s banking sector, specifically in the slackly regulated cooperative banks?

What are the best techniques for aligning employees towards ethical behaviour in a virtual workplace, and how should they be assessed?

What are the pedagogical approaches for information management and ethics education in the new normal?

The rest of the paper is as follows. The next segment explores theoretical background, followed by methodology, case study, discussion, directions for future research and conclusion.

Theoretical background

Evolving paradigm of business ethics.

The impact of the COVID-19 pandemic on global health, organisations, economy and society is intensifying relentlessly (Mahmud et al., 2021 ). The current pandemic has compelled businesses to embrace virtual space to a greater extent than earlier. This needs a comprehensive review of business ethics, among other things. An ethical decision is one that is accepted by a larger community because it adheres to moral guidelines (Reynolds, 2006 ). With the bulk of the personnel working online and maybe indefinitely in the future, a paradigm shift in business ethics, values and social responsibilities seems imminent and looming round the corner. Remote employees are expected to be disciplined with the ability to fulfil their duties with minimal supervision. Remote workers must also comprehend the nature of the task they would be undertaking and what it requires for a business to flourish. Finding solutions to reconcile the demands of work and personal life is the main problem of the new work-life model (Aczel et al., 2021 ).

The idea of an organisation’s social responsibility swings between two extremes: one that limits the organisation’s obligation to maximising profit for its shareholders, and another that broadens the organisation’s responsibility to encompass a wide variety of actors with a “stake” in the business (Argandoña, 1998 ). From an ethical standpoint, the stakeholder notion of social responsibility is more engaging for the common good (Argandoña, 1998 ; Di Carlo, 2019 ). “An individual or group is said to have a stake in a corporation if it possesses an interest in the outcome of that corporation” (Weiss, 2021 , p. 153). Stakeholders are persons or groups with whom the organisation intermingles or works together—any entity capable of influencing or being influenced by the organisation’s activities, preferences, strategies, objectives or practices (Gibson, 2000 ). Therefore, a firm is responsible for value creation for all its stakeholders, not just shareholders (Freeman et al., 2018 ). The importance of stakeholder interactions on corporate performance is particularly highlighted by instrumental stakeholder theory (IST), which calls attention to the effects of high-trust, high-cooperation, and high-information-sharing (Jones et al., 2018 ). Although IST is contested by Weitzner and Deutsch ( 2019 ), Harrison et al. ( 2019 ) claim that few firms have the ability to maintain strong economic performance while also treating their stakeholders ethically at all times. Through communal sharing ties, societal welfare can be improved in a Pareto-optimised manner, meaning that shareholders and some stakeholders benefit without any other stakeholders getting worse. Building strong relationships with stakeholders becomes an appealing strategy even for managers who are fixated on bottom-line results.

The importance of business ethics and moral conduct among leaders is evident in light of the recent high-profile ethical scandals (e.g., Enron) and growing expectations for ethical standards in management. Having a strong self-concept as a leader fosters ethical leadership, which is helpful to organisations as it encourages employees to perform well—both in their roles and outside of them (Ahn et al., 2016 ). Ethical frameworks encourage managers to modify salaries to the “efficiency wage” point, which is the best compromise between the interests of shareholders and employees, and hence the best way to sustain stakeholder relationships (Zhong et al., 2015 ).

Business ethics in banks

Banks and financial institutions are transforming digitally at a rapid pace employing new technologies and developing digital business models that are eventually helping them to create and add more value to their organisations. Given the pace at which workforce skills are being enhanced in the digital reality, these institutions are advancing towards a significant dearth of ethical skills. “The ethical peril of unfair contract terms is evident from the abuse of banks’ dominant position relative to bank consumers in dictating contractual terms and conditions, and asymmetrical information that causes significant imbalance of rights and obligations of bank consumers as the weaker contracting parties, placing them at a detriment” (Bakar et al., 2019 , p. 11). The three pillars of ethics in banking are “integrity”, “responsibility” and “affinity”. Integrity is imperative because it helps build the trust that any banking system needs to thrive. Responsibility necessitates contemporary banks to consider the effects of their lending policies. Affinity refers to fresh approaches to bring depositors and borrowers closer than they are in traditional western banking (Cowton, 2002 ). Herzog ( 2017 ) presents a duty-based explanation of professional ethics in banking. According to this viewpoint, bankers have obligations not just to their clients, who traditionally represent the core of their ethical obligations, but also to prevent systemic harm to entire societies. In order to best address these issues, regulation and ethics must be used in conjunction to align roles, rewards and incentives and produce what Parsons refers to as “integrated situations”.

Collins and Kanashiro ( 2021 ) emphasise the importance of ethics in banks by explaining how they follow a practice of secrecy in maintaining cash vaults by informing the branch manager of the first three digits while the assistant manager informed of the remaining three digits. If the managers violate the policy and collude to know all the six digits, they would be fired. Likewise, studies also suggest that employees are less likely to quit their jobs when they believe their organisation is empathetic and accommodating and provides an ethically supportive setting (Jeon & Kwon, 2020 ). A sustainable job performance can be reached by workers only through strong work ethics (Qayyum et al., 2019 ). It is necessary for employees to encourage ethical practice and prevent unethical deeds that can harm the company’s image and performance, particularly with respect to small organisations (Valentine et al., 2018 ). Work ethics contribute to employees’ job performance depending on how much an individual fosters honesty, prudence, quality, self-control and cooperation while discharging their duties (Osibanjo et al., 2018 ). Even so, the banking business is plagued by a variety of ethical problems, including a lack of adequate ethics training, problems with trust and transparency, increased pressure of competition, the complexity of financial operations and the problem of money laundering, among others (Kour, 2020 ).

Ethically responsive education: challenges and way ahead

Business schools have traditionally assumed that executive education is either delivered online or in-person and that online executive education programmes are substandard than in-person programmes (González-Ramírez et al., 2015 ). This is no longer true. Drawing from their experiences during the pandemic, educators and their institutions are shifting to “omnichannel” programme models, where executive learners have a seamless and engaging learning experience across all channels and platforms through which they participate. While ethical practices are important for an enterprise, business schools face numerous hindrances in their efforts to promote ethical standards in their students (Sholihin et al., 2020 ). Virtual technology allows students to learn practical skills without leaving the classroom. Furthermore, moving from a physical class to a virtual setting can give real-time imagery and interface in a simulated world that is extremely close to the real world, allowing students to gain practical insights without having to leave their homes. Simulations give students room to test out their course knowledge and make leadership decisions through the lens of real-life situations—all in the safety of a virtual class. As a result, virtual technology might be one of the learning media to motivate students studying at home during a pandemic (Chuah et al., 2010 ). However, as pointed out by Bhattacharya et al. ( 2022 ), the support that the institution offers during the transition to online learning, faculty acceptance and adoption of the new technology, and adaptation of the teaching and learning pedagogy to the new medium, are factors that determine whether the abrupt shift to online learning is successful in meeting the needs of students with various learning preferences and abilities. The effectiveness of online learning depends largely on how interesting and dynamic the class sessions are designed by getting students to participate in discussions, role plays, browsing online links, engaging in polls, taking quick quizzes, etc.

Methodology

This study draws upon secondary sources and adopts a case-based approach to explore the role of ethics in business in a dynamic world that is gradually shifting towards virtual technology in the milieu of the global pandemic. The advantage of a case study is that it aims to investigate a current occurrence in its natural setting (Yin, 2017 ). In this study, papers dealing with a wide range of diverse themes relating to business ethics were reviewed. Also, relevant press releases by RBI and Deposit Insurance and Credit Guarantee Corporation (DICGC), newspaper accounts, videos, media narratives, annual reports and recast balance sheet of the PMC Bank were examined. Every fact was cross-checked from two different sources in order to establish the accuracy of the case information. Anything that did not meet this criterion was left out of the analysis. The data was gathered over a period of 2 years to track the changes in the work environment—before and during the pandemic—and to closely examine the multifarious developments that occurred ever since the crisis at PMC Bank came to light. Despite the authors’ attempts to speak with the irate PMC Bank customers to solicit their responses and reactions, the latter declined to do so due to the emotional trauma they had already experienced, and the sense of utter helplessness they felt following numerous unsuccessful attempts to knock at the doors of the relevant authorities. As a result, they denied to participate in the survey, a major limitation of this study.

The authors selected the case of PMC Bank as it featured among the top bank frauds in India towards the close of the previous decade (Sengupta, 2022 ). The PMC bank failure exposed several loopholes in information management in India’s deposit insurance system (DIS) Footnote 6 and steered the policy makers to restructuring the same, thus driving the country consistent with its emerging market peers. In March 2020, the Banking Regulation (Amendment) Bill was introduced in the lower house of the Indian Parliament to avoid a PMC Bank–like crisis in the future. While administrative matters would continue to be governed by the Registrar of Cooperatives, the bill aimed to apply banking regulation principles of the RBI to cooperative banks. Additionally, it suggested that cooperative banks be strengthened by raising professionalism, facilitating capital access, enhancing governance and assuring sound banking through the RBI. Following the failure of PMC Bank, the Union Cabinet amended the DIS in India and addressed an enduring concern of the depositors of troubled banks. In 2020, the deposit insurance (DI) cover was raised from ₹ 1 lakh to ₹ 5 lakhs with the approval of Government of India (RBI, 2020 ), and banks were mandated to disclose this information on their respective websites. Since July 2021, the depositors of distressed banks were permitted to withdraw their holdings from the accounts—up to the highest insured amount—within 3 months since a bank was placed under moratorium by the RBI (Kumar, 2021 ). The RBI also got the ball rolling to prevent scams such as the one perpetrated by PMC by enforcing a set of criteria for the hiring of managing directors and chief risk officers in banks; levying fines (for regulatory lapses); calling for higher reporting standards; developing a big data centre that could access data from banks’ systems; and proposing differential deposit insurance premium for banks, contingent on their risk profile. Likewise, the RBI issued new provisioning norms for primary cooperative banks’ inter-bank exposure as well as valuation of their perpetual non-cumulative preference shares and equity warrants, directing them to continue making provisions of 20% for such exposures, in the aftermath of the PMC Bank’s bankruptcy.

The case of Punjab and Maharashtra Co-operative Bank, India

About pmc bank.

The PMC Bank was functioning as a multi-State scheduled primary co-operative bank in India, with its area of operation extending over seven states viz., Andhra Pradesh, Delhi, Goa, Gujarat, Karnataka, Madhya Pradesh and Maharashtra. With a modest beginning in 1984 as a unit bank, the business later expanded over a vast network of 137 branches in less than four decades. Empowered by a mission “to emerge as a strong, vibrant, most preferred premier co-operative bank, committed to excellence in serving the customers, and augmenting the stakeholders’ value through concern, care and competence”, the bank gradually gained the trust of its customers by reaching numerous milestones such as earning the “Scheduled” Footnote 7 status by the RBI and consent to venture into the forex business (PMC Bank, 2021 ). The following years brought laurels to the bank in the form of recognition for “lowest dispute ratio” as well as “work ethics oriented to depositors’ service” by the All-India Bank Depositors’ Association; “Best Bank Award” by diverse State Co-operative Banking Associations; and so forth.

In the early weeks of September 2019, the RBI received information from a whistleblower that the PMC Bank was undertaking fraudulent activities which involved the bank’s board of management (Hafeez, 2019 ). The complaints pointed out that certain loans of PMC should have been classified as non-performing assets (NPAs) but were concealed in the bank’s loan account system. In response to these complaints, the RBI started investigations. On September 23, 2019, RBI placed restrictions on the PMC Bank citing “major financial irregularities, failure of internal control and systems of the bank, and wrong/under-reporting of its exposures under various Off-site Surveillance reports to RBI” (RBI, 2019 ). The RBI acted in quick time and took control of the bank’s operations to assuage any risk of a bank run. To protect the interests of depositors, RBI placed PMC Bank under “Directions” vide Sect. 35-A read with Sect. 56 of the Banking Regulation Act, 1949 (RBI, 2019 ). Subsequently, PMC was refrained from fresh lending, accepting deposits and making investments for six months Footnote 8 (Singh, 2021 ). According to a report by BloombergQuint ( 2019a ), at the heart of the PMC Bank crisis stood the fact that several bank officials manipulated their books and their IT system to conceal the loans given to the real estate developer Housing Development and Infrastructure Limited (HDIL). A primary cooperative bank Footnote 9 could lend up to 15% of its total capital to a single company—a norm violated by PMC (Kaul, 2020 ). The bank’s then Managing Director, in his confession letter to the RBI, claimed that PMC Bank’s exposure to the large corporate group—HDIL—was just about ₹ 2500 crores (Gadgil, 2019 ). However, PMC’s actual exposure to the HDIL group stood at ₹ 6500 crore, accounting for 73% of the aggregate loan book size of ₹ 8880 crore and nearly four times the regulatory cap as of September 19, 2019 (Rebello, 2020 ). The six board members of PMC had approved loans to HDIL, the largest borrower of the bank, by breaching the RBI’s exposure limit not just to HDIL, but also the Uttam Galva Group and Abchal Group (Rajput & Vyas, 2019 ). PMC had extended loans worth ₹565 crores Footnote 10 to Uttam Galva Group—an exposure in excess of the limits set by the RBI (BloombergQuint, 2019b ). There is limited public information on the Abchal Group or its promoters.

Things changed around in 2012–2013 when HDIL started defaulting on the dues owing to cancellation of a slum rehabilitation project near the Mumbai airport—a major setback to the real estate group. Even though the outstanding loans with the group swelled, the bank’s management did not classify them as NPAs, fearing a hit in the balance sheet. They were also apprehensive of reputational loss and facing regulatory action from the RBI. The Economic Offences Wing of Mumbai Police uncovered that the bank’s management had replaced 44 loan accounts of HDIL with over 21,000 fictitious loan accounts—all this in an effort to camouflage defaults by the HDIL group (Ozarkar, 2019 ). PMC bank incurred losses to the tune of ₹ 4355 crores (Seetharaman, 2019 ). Despite these losses, PMC continued to support HDIL owing to the relationship shared between the duo.

The relationship between the PMC Bank and the promoters of HDIL group dated back to the 1980s when the latter had first aided the bank by infusing capital of ₹13 lakh, and also placed a huge sum of deposits for the bank’s revival. Furthermore, when the bank was facing a run on its deposits in 2004, HDIL pumped in ₹ 100 crore to deal with the liquidity crunch that enabled the cash strapped PMC bridge over the crisis. As a result, more than 60% of the bank’s transactions were with the HDIL group. The PMC Bank would charge 18–24% interest from the group accounts and make good profits. Meanwhile, the HDIL group maintained that its banking relations with PMC were clean and the audits presented a true and fair picture (BloombergQuint, 2019b ).

Although HDIL had an impressive record of clearing dues despite certain delays, PMC Bank continued to report the loan accounts as standard assets—albeit they were gradually downgrading to substandard and doubtful categories. All this went unnoticed as statutory auditors were looking at only incremental advances and scrutinised accounts shown by the management (Dalal & Sapkale, 2019 ). Prior to 2015, RBI looked at only the top accounts of the bank. Since loans to HDIL were spread across multiple accounts, they never showed up in the RBI’s inspection. Post 2017, when RBI started looking into the “advances master”, PMC replaced the accounts belonging to the HDIL group with dummy accounts—of small amounts—to escape detection by the regulator (Ozarkar, 2019 ).

The modus operandi

According to a report by BloombergQuint ( 2019a ), experts claim that whenever an auditor or an RBI inspector looks at the books of a bank, they examine the top 50–100 accounts that the bank is exposed to. In the case of PMC Bank, these accounts were masked by holding too many accounts with little funds to avoid any suspicion, by manipulating the bank’s core banking system, officially known as the “core banking solution (CBS) Footnote 11 ”. All bank employees have access to the CBS—from a teller to the branch manager, to loan officers and risk managers—but their access and what they can do with the system is limited to their exact area of function. The CBS is essentially a back-end intelligence software. It provides the analytics for decision-making to the bank staff whenever bankers physically input data. So, the CBS has a “rule-engine” which is controlled by an access-control framework, letting only certain people alter the rules. Usually, every bank appoints an IT administrator for managing the CBS, who is the only person allowed to modify the software. According to forensic experts, whenever there is fraud at a bank, the “rule-engine” is compromised. Therefore, by giving limited access to the rule-engine, other employees—such as those in the credit department or risk management division—have little information of the changes made to the CBS. Thus, by creating 21,000 dummy accounts in bogus names to conceal from the auditors and RBI inspectors, other departments of PMC were perhaps in the dark the whole time the bank was exposed to the HDIL group.

The RBI in its investigation established that out of 1800 bank employees, only 25 employees had access to the loan accounts of the bankrupt real estate developer and its group entities (Hakim, 2019 ). These bank officials assigned specific codes to the accounts belonging to the HDIL group in order to disguise the money in the loan accounts. When the suppression of true accounts became too much for the employees, the management decided to come clean to the RBI. PMC was instructed to recast its balance sheet to present an accurate and honest portrayal of the bank’s assets (PMC Bank, 2019 ). Investigating agencies promptly arrested several bank executives including three top officials of the PMC bank, as well as two promoters of the HDIL group.

Depositors’ backlash

The cap on withdrawals came heavily on depositors, particularly those who held all their savings with the PMC Bank. The deposit withdrawal restrictions sparked off a massive public outcry as customers were unable to pay their bills. Ironically, the bank that clients had trusted to keep their money safe had now become the source of their woes. It was difficult to survive on minimal amounts. Businesspersons reported how their business operations had stalled, leaving them to survive on loans from relatives and friends. Several account holders could not access savings, much needed to meet their medical needs. Likewise, deaths due to cardiac ailments and suicide were reported. Footnote 12 Distressed depositors held protests outside the PMC Bank and the RBI quarters to permit withdrawals of their lifetime savings. During the same time, numerous WhatsApp videos started circulating among the aggrieved depositors and the news fired up on mainstream and social media (Kaul, 2020 ). Poor lending norms and questionable governance had afflicted the banking system, in part due to professional incompetence to assess project viability, and in part due to the political economy that permits, even nurtures, credit to privileged parties (partisanship). A fake news that went viral on online platforms was the speculation that the government was proposing to close nine public sector banks. This raised qualms about the systemic stability of banking in India, which compelled the RBI to issue a press release that no such plan was in the offing. “PMC Bank is too tiny to pose a systemic threat, but a small, dead canary in a coalmine is still a large warning sign” (Mukherjee, 2019 ).

In response to people’s anxiety and backlash, the RBI raised the withdrawal limits for PMC depositors from time to time, as illustrated in Table 1 . Deposit withdrawals were permitted to ₹ 1 lakh in exceptional situations such as wedding, education, livelihood, and other adversities. At the same time, in February 2020, the DICGC Footnote 13 was authorised to raise the deposit insurance coverage for a bank depositor, from ₹ 1 lakh to ₹ 5 lakh per depositor—an amendment brought into force after 27 years—since the previous one was initiated in 1993 (Nayak, 2020 ).

Simultaneously, depositors of insolvent or stressed banks that were placed under a central bank moratorium were entitled to recover their funds (up to ₹ 5 lakh) within 90 days of the commencement of the moratorium. The 90-day span would be split into two periods of 45 days. The RBI mandated: “The stressed bank on whom restriction is placed is expected to collate all information regarding the number of claimants and claim amount and inform DICGC about it within the first 45 days. Within the next 45 days, DICGC is mandated to process the claim and make payment to each eligible depositor” (Motiani, 2021 ). However, customers of PMC Bank were exempted from receiving ₹ 5 lakh in the first lot as the bank was under the resolution process.

Following the PMC debacle, the RBI strengthened its control by necessitating primary cooperative banks to submit quarterly reports of individual loan exposures above ₹ 5 crore to the Central Repository on Information on Large Credits (The Economic Times, 2020 ). The RBI established a big data centre to retrieve data from banks’ systems. The data centre would aid in the prevention of scams such as the one perpetrated by PMC Bank, in which data was camouflaged through the use of phoney accounts (ETBFSI, 2021 ).

The PMC bank takeover

In the second half of 2021, nearly 2 years after the PMC scam had come to light, Centrum Finance Services Footnote 14 was given “in-principle” approval by the RBI to establish a small finance bank that would take over the scam-plagued PMC Bank. Two distinct entities—the Centrum and BharatPe Footnote 15 syndicate (with 51:49 stake)—were collectively permitted to acquire the PMC Bank. Accordingly, Centrum and Resilient Innovation Private Limited (a BharatPe enterprise) were authorised to set up a small finance bank—which would hold the assets and liabilities of the PMC Bank (Panda & Lele, 2021 ). In October 2021, the Unity Small Finance Bank (USFB) got licence from the RBI and started its operations in record time with an equity capital of ₹ 1100 crore (Banerjea, 2022 ). The RBI came up with a draft plan for the merger of the beleaguered PMC Bank with the new entity, USFB. Depositors could claim up to ₹ 5 lakhs over a 3- to 10-year period, according to the proposal. They could receive up to ₹ 50,000 after 3 years, ₹ 1 lakh after 4 years, ₹ 3 lakh after 5 years, and ₹ 5.50 lakh after 10 years (The Economic Times, 2021 ). On January 25, 2022, the amalgamation of PMC Bank with USFB officially came into force. All the branches of PMC Bank would operate as branches of USFB, ensuring job security and stability to the employees of the merged entity, alongside consistent services to the clients. Since the draft amalgamation plan was opposed by an umbrella body of cooperative societies, the lead bank—USFB—came up with a press release: “96 percent of depositors, have deposits up to Rs 5 lakhs, will be paid upfront (subject to completion of the requirements as per DICGC rules). These depositors can choose to either withdraw or retain this amount with Unity Bank; or make additional deposits, and take advantage of the attractive interest rate up to 7%, being offered on savings accounts” (CNBC, 2022 ). Thus, the long-drawn-out scandal that stretched over 2 years ended up with the PMC takeover by USFB that was enforced in the larger interests of all the stakeholders.

The ethical stance

The PMC Bank failure is a classic case of ethical collapse, wherein the board of management and a few employees took a drastic step of compromising the interests of diverse stakeholders, with little thought to the ramifications it would have on those involved with the bank. This was earlier exemplified by Harris and Bromiley ( 2007 ), as well as Murthy and Gopalkrishnan ( 2022 ), while discussing the behavioural theory of the firm and the factors driving financial misrepresentation in the corporate world. The integrity and ethical commitment of senior management, the ethical policy of an organisation and the external pressure it is exposed to, have an impact on the ethical behaviour in the organisation, which further has an impact on the overall performance of small and mid-size enterprises (Abalala et al., 2021 ). Employees are not recruited on the basis of ethical considerations. Just as they acquire job skills through education, training and practice, they learn to be more or less ethical based on events and individual experiences over a period of time. Companies devote the most resources to environmental policies, but the fewest to actions that promote ethics and deter unethical behaviour (Abidin et al., 2020 ). From the standpoint of human resource development, several organisations consider ethics education as a one-time affair by developing an ethical code of conduct and stating it in their bye-laws. If they do address ethics later, it is mostly by instituting whistleblower laws (Schultz & Harutyunyan, 2015 )—similar to “being wise after the event” instead of “being safe than sorry”. Such practices may check unethical conduct or castigate the outlaws, but they may not help the employees evolve as moral individuals at workplace. Ethical education is a lifetime process and is not a cramming exercise. Employers should create an environment that nudges employees to be morally sound by reflecting moral values. They should make honesty, truth, fairness, sincerity, community service, moral mettle and reverence for others their guiding principles in business dealings (Okpo, 2020 ). The benefits of ethical establishments are manifold. Employees find such businesses more appealing than others as they are seldom involved in scams. They are also favoured by investors, who target good governance and strong cultures as foundations of enduring value creation. Ethical codes have been lauded as a clear path to more sustainable and sound organisational behaviour (Adelstein & Clegg, 2015 ).

Cases of cooking the books such as Enron (Arnold & De Lange, 2004 ; Benston & Hartgraves, 2002 ; Reinstein & McMillan, 2004 ), World Com (Wang & Kleiner, 2005 ), Tyco (Sorkin & Berenson, 2002 ), Sub-prime Mortgage Crisis (Adjei, 2010 ), Satyam (Bhasin, 2016 ) and the garment industry disaster in Bangladesh (Taplin, 2014 ) have raised ethical awareness and demonstrated that companies can suffer acute reputational and financial loss when their unethical transactions are discovered (Banerjee, 2015 ). When such incidents come to light, they frequently include a huge scandal that has a significant influence not just on the organisation, but also the entire industry or even the global economy (Halinen & Jokela, 2016 ). The PMC Bank crisis was a signal to the nation of a larger problem in the Indian banking system that needs to be fixed with basic governance reforms (Gupta, 2021 ). The regulatory body should have acted sooner to avoid a situation that caused panic among depositors, some of whom had deposited their entire life savings in the bank. Despite its immense resources and power, the RBI chose to focus on routine checks rather than digging further. According to Dastidar ( 2016 ), despite the fact that appropriate law has been adopted to control banking activities in India and to provide a fairly competitive environment, the regulations and penalties are insufficient to guarantee operations in a disciplined manner. While bankers receive behavioural training, the routine monitoring of staff behaviour is insufficient. Customers are either unaware of how to file a complaint against bank employees with a higher authority or simply disregard the process, believing it to be inconvenient.

Therefore, business ethics and corporate governance should be a part of all accounting and business curriculums (Abdolmohammadi, 2008 ; Acevedo, 2013 ), particularly in the current times, when the line between our personal and professional life has gotten increasingly blurry. Work and life are more linked than they have ever been (a trend invigorated by the COVID-19 pandemic). This is partly because Millennials and Generation Z spend a large time at work and are far more connected through video-communication and social media platforms such as Google, Facebook, LinkedIn, Twitter and WhatsApp. There are rules to follow, clients to serve, contracts to honour and communities to interact with, at jobs. Eventually, exposure to each can help enhance the understanding about ethics. A significant question that begs to be answered is “How can companies assist their employees in using the workplace as a character-developing laboratory?”.

One of the ways is experiential learning. For instance, in January 2002, social media went gaga after a video of a farmer being mistreated at a Mahindra car dealership went viral. The Chairman of the Mahindra Group was also informed of the occurrence. He stated that the key value is to protect an individual’s dignity, and that if someone violates the policy, it would be dealt with quickly. The Chief Executive Officer of the Mahindra Group was quick to respond too: “Dealers are an integral part of delivering a customer centric experience & we ensure the respect & dignity of all our customers. We are investigating the incident & will take appropriate action, in the case of any transgression, including counselling & training of frontline staff” (Khatri, 2022 ). Thus, learning by doing is hands-on and engaging, with the instructor acting as a guide. Nevertheless, experiential learning has been sluggish to take off as a technique for business ethics training (Meisel, 2008 ), although it has been popular in academic circles and management development programmes.

Professor Scott Reynolds proposes “a neurocognitive model of the ethical decision-making” (Reynolds, 2006 ) by initially pointing out his findings to the four-step process first theorised by Rest ( 1979 , 1986 ). The recognition of the ethical dilemma, according to Rest, is the first step in making ethical decisions. The individual then takes an ethical decision, declares an intention to act ethically and ultimately acts ethically. Ethics education, however, is a contentious topic. Some people argue that ethics cannot be learned (McKenzie & Machan, 2003 ). Others feel that ethics can be imparted, although they differ with respect to the method of delivery (Gautschi & Jones, 1998 ; Pfeffer, 2003 ).

According to the neurocognitive paradigm (Reynolds, 2006 ), ethics education is feasible—ethical decision-making can be enhanced through a variety of methods. However, the model recommends that methods of instruction should be tailored to the situation at hand. Ethics education should concentrate on the “mental structures of prototypes” (Reynolds, 2006 , p. 745) and moral standards in order to be effective, but it should be accomplished through a variety of methods. Employees may join an organisation with strongly ingrained preconceptions about managerial challenges such as corruption, scam, deception and harassment, which, regrettably, may not reflect what the organisation considers to be the morally suitable outcome in some situations. This is not to say that these prototypes cannot be changed. Ethics education must confront deep-rooted stereotypes and dig them out of unconscious processing of the employees so that they can be reviewed and modified accordingly. Role-playing and small-scale group discussions are examples of activities that can help achieve these goals (Gioia, 1992 ).

Likewise, the organisation must offer fresh prototypes for new ethical circumstances as they arise, and employees must be exposed to such prototypes on a frequent basis (Reynolds, 2006 ). As a case in point, there is growing consensus on previously uncharted ethical territory such as inspection of electronic mail, staff supervision and genetic screening (Beauchamp & Bowie, 2004 ); employees can consolidate them into their decision-making based on the extent to which organisations impart these norms consistently. The intense, yet gradual, indoctrination of ethically sound prototypes will spontaneously result in ethical outcomes by employees. Regardless of the significance of prototypes, the neurocognitive model supports an age-old pedagogical belief that ethics education should offer broad principles or benchmarks for decision-making (Sims, 2002 ). The corporate environment is always changing, and in the virtual workspace, employees are frequently working in new environments where conventions have yet to be formed and prototypes are limited. Therefore, employees frequently count on their higher-order cognitive skills (Stenmark et al., 2020 ), and, as any skilled tradesman, they require the tricks of the trade to do so effectively (Stenmark et al., 2019 ). The more an organisation can equip employees with moral norms to apply in diverse circumstances (as well as opportunities to apply them), the more likely they will utilise them to effectively solve their issues. To effectively mould ethical behaviour, organisations must offer tools for innovative ethical decision-making and a steady stream of pre-set paradigms with built-in moral implications (Reynolds, 2006 ).

Organisations can also adopt “Performing a Project Premortem” which, in a corporate setting, occurs at the start of a project, allowing it to be enhanced rather than autopsied (Klein, 2007 ). For instance, in the virtual space, a bank conducted a session to identify the best possible practices of serving the customers seeking financial statements by contacting customer care via phone. In this session, the bank manager sought responses from customer care executives, asking them how would they prevent unauthorised access and confirm the authenticity of a customer—establishing contact through phone—before releasing a financial statement via email. One of the executives responded that he would ask the account number, branch address, date of birth, registered mobile number and email credentials before releasing the statement to the customer. Another executive stated that apart from seeking the aforementioned details, he would also encrypt the financial statement with the account holder’s Customer ID Footnote 16 so that only the legitimate person could access it. The premortem allowed the customer care executives to adopt best practices while rendering services in the new normal so that third parties might not use confidential data in ways that were inconsistent with the bank’s ethical values. Such exercises can be undertaken from time to time to assess the employees’ ethical compliance and elicit a paradigm shift in the way people think about character development in the virtual workplace.

• Information management

In this age of widespread digitalisation, an individual intending to open a bank account is expected to submit numerous personal documents to confirm their domicile. While this information is expected to remain confidential, the bank assumes control over the shared data, and indicates a possibility of using it for internal purposes if it so chooses. Likewise, if an individual avails credit from a bank, the latter may seek myriad information, considering itself to be a majority stakeholder in the transaction. However, if a depositor enquires about how the bank uses their funds and who it lends to, the bank is likely to respond with a frigid silence (Bakar et al., 2019 ). The average person rarely has the opportunity to question the bank, which is a biased practice given that deposits are the lifeblood of the Indian banking industry. They hold more than half of the nation’s savings and greater than 80% of a bank’s liabilities. In comparison to China, Hong Kong and Singapore, India’s reliance on deposits is the highest among emerging economies (Karthik, 2021 ). However, depositors have few options to safeguard their deposits. Simply said, deposits are critical to the banking system, but banks rarely go to the same lengths to safeguard depositors’ interests and privacy as they do for major firms. The failure of PMC Bank in India, along with many others from the private and the cooperative sector, makes for a compelling reason for transparency and fair disclosures on the part of banks as well as regulatory authorities. In each of these circumstances, several rules had to be relaxed in order to prevent the bank’s failure from affecting the country’s financial system. The PMC Bank case raises important concerns about the monetary authority’s efficacy as a regulator. Additionally, it draws attention to the critical flaws in Indian banking industry’s risk-management procedures (Hafsal et al., 2020 ), particularly in the loosely regulated cooperative banks.

Public awareness of deposit insurance is abysmally low in India, which limits informed decisions by depositors (Nayak et al., 2018 ; Singh, 2015 ). Moreover, India follows a partial deposit insurance system; in the event of a bank failure, only a capped amount is received by the depositors of a single bank. However, people believe their money is safe the moment they deposit it with a bank, ignoring the fact that banking is just another business (Kaul, 2020 ). Quantitative statistics are frequently included in the banks’ annual reports. They include information on deposits, loans and advances, capital adequacy, income recognition, asset quality, provisioning against bad debts, etc. Nonetheless, when it comes to loans and advances, it is generally the qualitative part that causes a bank to fail. PMC Bank was one of the several banks in India where blanket lending practices resulted in capital erosion. The case right now is a call for more transparency in India’s banking system, particularly in a virtual world marked by extensive digitalisation.

Future research directions

Studies so far have examined the role of ethics in diverse situations and sectors. However, there is limited research on whether ethics education should be conducted differently for stakeholders in remote workplace as against on-site work. Also, if organisations are attentive to goodwill and brand name, what are the causes that deter them from ethical conduct? Furthermore, if performance-linked incentives can motivate employees to achieve promising outcomes, can an organisation introduce ethics-linked incentives to boost employee productivity? Previous studies have rarely investigated how seamless information sharing with the public may moderate the opacity of an organisation’s performance and reinforce informed decisions by the customers. This is particularly important in the current times of risk and uncertainty wherein ethical concerns are perturbing the stakeholders of most businesses, particularly banks. In the banking industry, assessing behavioural characteristics for risk mitigation is still unexplored. The personality factor can aid in understanding the mental aspects as well as the reasons for the association of dark triads with economic crimes. Researchers can explore these uncharted areas.

Conclusion and recommendations

The PMC Bank crisis is only the most recent manifestation of deeper, unresolved issues in India’s banking industry. The persistent concern of non-performing assets (NPAs), which was exacerbated in the case of cooperative banks in India due to poor governance and a risky business strategy, lies at the core of the crisis. Regulators have, sadly, just responded to symptoms thus far; there is little indication that they have a thorough knowledge of the underlying condition. In order to prevent crises like the one that has befallen PMC—where an astonishing 73% of the loan book was represented by one corporate group with close relationships to the bank—cooperative banks need substantial restructuring in their governance. The direct appeal made by numerous irate depositors, which was widely shared on social media, is another intriguing aspect of how the public has responded to the PMC Bank situation. Some of the viral videos show utterly upset, destitute depositors literally screaming and begging for aid. Such a response is difficult to envisage in developed economies, where the unsatisfied public’s response would more likely be indignation at the incompetence of politicians and regulators, than one of entreaty.

While the COVID-19 pandemic has compelled businesses to embrace virtual space to a greater extent than earlier, this calls for a comprehensive review of business ethics, among other things. Ethics education is feasible, and ethical decision-making can be enhanced through a variety of methods. The corporate environment is ever changing, and in the virtual workspace, employees are frequently working in new environments where conventions have yet to be formed and prototypes are limited. Organisations must offer fresh prototypes for new ethical circumstances as they arise, and employees must be exposed to such prototypes on a frequent basis. To effectively mould ethical behaviour, organisations must offer a steady stream of pre-set paradigms with built-in moral implications.

At the same time, bankers must be transparent for customers to receive the pertinent information they need to make sound financial decisions. Customers frequently lack the resources and financial language expertise necessary to grasp the complex financial products and services. As a result, they are unable to comprehend or obtain accurate, understandable and/or thorough information regarding a variety of products, thus leading them to choose poorly or inadvertently. There are inherent information asymmetries in the financial sector, with bankers having more information than customers, which burdens the latter due to low financial literacy and complexity of financial products. Therefore, thorough disclosures regarding the product and its features become a crucial component to close this gap. At the same time, these disclosures should not result in information overload, which could reduce the value of the advice given. Fair and forthright disclosures give clients the ability to compare various products from different service providers, enabling them to make an informed choice. An enhanced customer knowledge would also encourage competition, which would improve the standard of services provided by the digital platforms. Fair customer treatment typically entails moral behaviour, appropriate sales tactics and handling of client information. Even though fair treatment concepts are well understood, it is challenging to hard-code these in regulations. However, the fundamental idea that the consumer should always be treated fairly and with respect persists. This takes on increased significance in digital banking, because the target clients may comprise typically small customers with little access to or knowledge of grievance redressal mechanisms. Banks can set up cyber security awareness initiatives to inform clients of the risks associated with phishing, malware, wire fraud, and more when using online banking. Customers can have access to a distinctive online library of learning aids, which includes newsletters, email campaigns, movies, posters and articles on information security awareness. The first essential step towards effectively managing risks, reducing fraud and ensuring compliance is to educate the board of directors and customers about social engineering risks and best practices in information security.

Market discipline refers to a practice by which market actors, such as depositors and shareholders, oversee bank risks and take steps to minimise unwarranted risk-taking.

In fractional reserve banking systems, banks hold limited amounts of cash hoping that all depositors will not withdraw at the same time. Nonetheless, banks are exposed to the risk of self-fulfilling panics caused by mass hysteria that leads their customers to withdraw the funds at the same time for fear that the institution may go kaput.

A loan for which the principal or interest payment is more than 90 days past due.

Depositors who attempt to withdraw their money from a bank in a coordinated effort because they believe the bank will fail.

Central Bank (Monetary Authority) of India.

A deposit insurance policy that protects against losses on bank deposits if a bank goes bankrupt and has no funds to pay its depositors, forcing it to liquidate.

Banks registered in the second schedule of the Reserve Bank of India Act, 1934.

The “Directions” were later extended up to June 30, 2021.

Urban Co-operative Bank.

Since it is a classic case of cooking the books, diverse sources have claimed different figures.

Core banking system is the core ledger and account management system for banks. It collects relevant financial as well as non-financial information, data and documents for all the depositors and borrowers. It also automatically prepares daily accounts for a bank as a whole, which are used for regulatory and compliance purposes. “As on March 31, 2019, of the 1542 primary cooperative banks in the country, over 1436 banks had implemented CBS”.

The exact number of deaths is still unknown, although the cause is “severe stress” caused by a suspension of withdrawals.

The autonomous body instituted by the RBI to insure bank deposits in the event of bank failure.

Centrum Capital is a Bombay Stock Exchange-listed entity.

A fintech company.

A unique identification number given to every customer holding an account with a bank.

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Teaching notes

This study explores the importance of business ethics, information sharing and transparency to build an information-driven society by scouting the case of Punjab and Maharashtra Co-operative (PMC) Bank, India, which defaulted on payments to its depositors and was placed under Reserve Bank of India’s directions due to a massive fraud perpetrated by bank officials. The crisis worsened when uninformed and panic-stricken investors advanced their narrative through fake news peddled via social media channels, resulting in alarm that caused deaths of numerous depositors. It exposed several loopholes in information management in India’s deposit insurance system and steered the policy makers to restructure the same, thus driving the country consistent with its emerging market peers. The study further identifies best practices for aligning employees towards ethical behaviour in a virtual workplace and the pedagogical approaches for information management in the new normal.

Target Audience

Educators in the field of banking, business ethics, corporate governance and organizational behaviour; practitioners; various stakeholders of banks; and policy makers.

Learning Objectives

[1] To offer practical suggestions for creating an environment conducive to ethical learning;

[2] To explore the importance of business ethics, information sharing and transparency for building an information-driven society;

[3] To identify best practices for aligning employees toward ethical behaviour in a virtual workplace, and assessing them;

[4] To identify pedagogical approaches for information management and ethics education in the new normal.

Questions for Discussion

[1] What is the overall problem presented in this case?

Answer. The case explores the importance of business ethics, information sharing and transparency to build an information-driven society by scouting the case of Punjab and Maharashtra Co-operative (PMC) Bank, India, which defaulted on payments to its depositors and was placed under Reserve Bank of India’s (RBI) directions due to a massive fraud perpetrated by bank officials.

[2] What are the factors affecting the problem(s) related to this case?

Answer. The case investigates the changing paradigm of business ethics in a dynamic world that is gradually shifting towards virtual technology in the milieu of the global pandemic.

[3] How can an organization align employees in a virtual workplace?

Answer. Organizations must offer fresh prototypes for new ethical circumstances as they arise, and employees must be exposed to such prototypes on a frequent basis. As a case in point, there is growing consensus on previously uncharted ethical territory such as inspection of electronic mail, staff supervision, and genetic screening; employees can consolidate them into their decision-making based on the extent to which organizations impart these norms consistently.

[4] What are the objectives of project premortem?

Answer. The objectives of project premortem are to assess the viability of a project at the start of a project itself, allowing it to be enhanced rather than autopsied.

[5] What are the challenges in the virtual work environment that educators have been facing in the new normal?

Answer. During the pandemic, not only the students, but also the educators began a new era of learning. For educators who had been accustomed to textbook teaching, the enormous technological innovation in the education sector has been both demanding and novel. To make their online classes seamless and compelling, they had to learn far more than their students. During the online classes, educators had to push students to be more engaged and active. They made certain that the lessons were fresh and original enough for pupils to follow and grow from them. Teachers led interactive sessions to ensure that every student in the class was involved. Instead of remaining at home and keeping their beliefs to themselves, they were encouraged to express their views and have healthy discussions. Both students and educators went above and beyond to make online learning a rewarding experience. As a result, the educational sessions turned out participatory and therapeutic in nature.

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Nayak, S., Chandiramani, J. A crisis that changed the banking scenario in India: exploring the role of ethics in business. Asian J Bus Ethics 11 (Suppl 1), 7–32 (2022). https://doi.org/10.1007/s13520-022-00151-4

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Global Financial Crisis, Its Impact on India and the Policy Response

Bajpai, Nirupam

India could not insulate itself from the adverse developments in the international financial markets, despite having a banking and financial system that had little to do with investments in structured financial instruments carved out of subprime mortgages, whose failure had set off the chain of events culminating in a global crisis. Economic growth decelerated in 2008-09 to 6.7 percent. This represented a decline of 2.1 percent from the average growth rate of 8.8 percent in the previous five years. To counter the negative fallout of the global slowdown on the Indian economy, the federal Government responded by providing three focused fiscal stimulus packages in the form of tax relief to boost demand and increased expenditure on public projects to create employment and public assets. India's central Bank — the Reserve Bank of India (RBI) took a number of monetary easing and liquidity enhancing measures to facilitate flow of funds from the financial system to meet the needs of productive sectors. From all accounts, except for the agricultural sector initially as noted above, economic recovery seems to be well underway. Economic growth stood at 8.6 percent during fiscal year 2010-11. GDP growth for 2009-10 was placed at 8 percent. When compared to countries across the world, India stands out as one of the best performing economies. Although there was a clear moderation in growth from 9 percent levels to 7+ percent soon after the crisis hit, in 2010-11, at 8.6 percent, GDP growth in nearing the pre-crisis levels and this pace makes India the fastest growing major economy after China. Considering the current inflationary strains, the as yet excessive pre-emption of the community's savings by the government, the potential for crowding out the requirements of the enterprise sector, and rising interest payments on government debt, it is extremely essential to reduce the fiscal deficit, and more aggressively, mainly by lowering the revenue deficit. Correction of these deficits would, inter alia, require considerable refocusing and reduction of large hidden subsidies associated with under-pricing in crucial areas, such as power, irrigation, and urban transport. Food and fertilizer subsidies are other major areas of expenditure control. Be that as it may, the process of fiscal consolidation needs to be accelerated through more qualitative adjustments to reduce government dissavings and ameliorate price pressures. The step-up in India's growth rate over much of the last two decades was primarily due to the structural changes in industrial, trade and financial areas, among others, over the 1990s as the reforms in these sectors were wide and deep and hence contributed significantly to higher productivity of the economy. Indeed, there is potential for still higher growth on a sustained basis of 9+ percent in the years ahead, but among other things, this would require the following: 1) revival and a vigorous pursuit of economic reforms at the center and in the states; 2) a major effort at raising the rate of domestic savings, especially by reducing government dissavings at the central and state levels through cuts in, and refocusing of, explicit and implicit subsidies, stricter control over non-developmental expenditures, improvements in the tax ratio through stronger tax enforcement, and strengthening incentives for savings; 3) larger investments in, and better performance of, infrastructural services, both in the public and private sectors; and 4) greater attention to, and larger resources for, agriculture, social sectors and rural development programs to increase employment, reduce poverty and for creating a mass base in support of economic reforms.

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Banking Crisis in India – Failure of Governance and Regulation

Now Banking Crisis in India is a hot topic as you know many business men looted bank and escaped to foreign countries. In the 2008 , crisis loomed world over , all major economics effected and growth rated declined , inflation doubled, unemployment increased. However it’s impact was minuscule in India due to strong banking sector in India. In the past also Asian economic crisis happened due to failure of banking sector in Asean countries .

At that time also India immune from crisis due to fortified banking sector. Such a great role banking sector played in India, however recent incidents like vijay malya evasion of bank loans, nirav modi scam, icici loan to Videocon shaken the credentials of banking sector . Is it because of failure of governance or failure of Regulation, to know that issue need detailed analysis.

Table of Contents

Banks contributions in Economy

Banking is lifeline of any economy. It looks like simple thing like collecting money from people and giving credit to people , and retuning the money with interest when depositors wanted it. But banking does many more functions, like financial inclusion, through priority sector lending loans to agriculture, msmes , renewable energy, issuing bonds, facilitator in foreign exchange, and many more . That is why it’s cascading impact is huge on many other sectors, after all everything needs money.

In the history also banking sector role is crucial in industrialization of western counties . Bankers acted like king makers in the past , jagat Seth role in battle of plassey was well studied. Bank of France played phenomenal role in Napoleon campaigns. Great depression was caused when banking sector failed and people queued at banks to withdraw money as they presume bankruptcy of banks. All these examples clearly tell us banks can make economy or break the economy.

India also understood the importance the importance of sector . To make banking more inclusive and secure and safe , nationalization of banking done at early stage. Although some disadvantages are there but helped in making financial inclusion through banks. Later on India implemented narasimhan recommendations and allowed private sector to participate and can hold 74% of stake. These innovative steps increased competition and productivity of banks.

Banking Crisis in India : Challenges and Problems

However at present banking sector in crisis due to many challenges. NPA issue looming , around 8 lakh crore non performing assets, wilfull defaulters like Vijay malya, bank employees collusion with corporates to loot bank, capital to risk adequate ratio dwindling, conflict of interest while sanctioning loans, and many more. But the bigger question is what is the root cause of these problems or symptoms?

• Banking sector has many social obligations but any govt must handle with professionalism. However banking sector does many non banking functions as they are controlled by govt. Demonetization caused great burden on banking sector. Financial inclusion under Jan Dhan yojana, distribution of scholarships, pensions, selling electrical bonds, some institutions applications also available at banks. These extra banking functions increase burden and focus of employees also shifting , not giving full time to banking functions.
• Banks recruitment system also not so effective, except SBI other recruitment tests are not so standard and need to be updated to meet the latest standards and requirement. Training to selected candidates also need to updated with latest frauds.
• To get deposits banks need to offer compatible interest rates, however rates offered by kisan.vikas pages, and other small savings scheme are better banks, so banks are not attracting deposits in large scale, govt keep on recapitalizing banks to meet Basel norms. This is not a good trend. Banks can’t offer market interest rate but it should not be less than postel scheme interest rates.
• Customers face many problems like waiting in queues, cheque bounces, forgetting passwords, failure of netbanking and so on. If banks respond quickly customers show interest to banking, otherwise they simply move to chitti business, or invest in relation estate or gold.
• Lack of accountability, here employees believe it is not their money and collude with corporates, corporates believe they are not looting people as govt recapitalize banks, ultimately tax payers money is using to compensate the scams. If taxpayers money is using for filling scams, will they pay taxes , that is why we have low tax to go ratio 11%.
• At the lower level salaries are good in public banking sector , however to attract professionals at the higher level , salaries must be increased , otherwise public sector employees collude with corporates like pnb scam. Raghuram Rajan said his salary as professor is 10 times more than rbi governor reveal the horrible picture , and SBI chairman salary was hardly below 1 crore, whereas any corporate CEO earns 50 crores minimum.
• Political interference is another major reason for crisis in banking. Major higher level appointments done by govt, and many former rbi governors talked about finance minister interference in rbi functioning. Recent SBI loan to adani group also exposed the same. Nayak committee also written about it , and banks board bureau was established to appoint high level officials, however it was not functioning effectively.
• Banks lend for infrastructure projects , this was one of major reason for npas as these projects gestation period is long , so banks must not fund them, and bond market need to take care of it. And other international mechanisms like world bank, adb, aiib can be given more importance.
• There are some arguments that public sector banking is a major reason for crisis, however combination of public and private sector worked out well in western counties also, so instead of focussing on privatization of banking , reforming the public sector would help to resolve the crisis.
• Npa problem can’t handled by banks alone , because many governance problems like environment clearance, delay in project approvals, export import policies, and destructive technologies like jio also cause npas. So here both banks and govt work together to resolve the npa problem. There are many steps like asset reconstruction companies, sdr, ,s4dr, insolvency and bankruptcy code, joint lending forum, 5/20 scheme, are taken but much more need to done.
• Rbi is the regulatory power and monitor the banks functionality. However there are many functions to rbi and it can’t check each and every transaction so problem raised.
• There are many statutory audits , multiple checks and balances before do any transaction, however in pnb scam , many audits are bypassed.

In the core banking solutions, bank must align with swift , but synchronization not happened, why regulatory failed to check it?

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After the scam RBI simply banned the letter of undertakings, is it a viable step ???

As per bank rules employee need to transfers at regular periods so they can’t abuse the position, however in pnb same employee handled the issue for 5 years, failure of rbi in ensuring complinace.

Recently CBI questioned the former deputy governor over bypassing statutory audits, this also reveal some laxity from rbi.

Internal risk management is crucial while sanctioning loans, here this system failed, but regulatory could not find it, till the scam exposed.

However it is not to blame regulatory because public sector banks have more powers when compared with private sector, and rbi is asking for same powers in public sector also.

Banking Crisis in India :Solutions

So from the above discussion , failure of governance and regulation both are reasons for crisis in banking sector. There are some good steps like amendment in banking Regulation act to give more power to rbi to take decisions to reduce npa, and above 50 crore bad loans are monitored by enforcement agencies, and steps like big private audit firms must audit which public sector banks would not allow now, and independence and autonomy to banks while ensuing compliance, market based salaries to higher professionals, clearing the balance sheets would ensure sustainability of banking sector. Laws like confiscation of property of fugitives , and extradition treaty with nations like UK and western nations help to repatriate those absconders like Malya,Modi.

To.conclude, in India banking is not simply an institution to save money, but a way of life, part of life. Any major activity like marriage, seeding, education, would not start with out withdrawing money from bank. Although banks don’t offer big interest rates , people deposit money out of Nostalgia, safe venture or out of habit. But now this great sector now facing many scandals . Some people are using banks to become richer, willfully not paying bank loans. In that case how banks give loans to start ups? Although rbi reduced repo rate ,banks are not willing to reduce credit rate due to fear of npas, thus credit growth declined. Many bank officials are fear of CBI, Ed and not taking risks to avoid torture. This scenario should be altered. Future belongs to credit availability. Agriculture sector alone need 11 lakh crore loans, how we meet huge demand if banking sector in crisis. So both govt and rbi must implement all steps to regain credibility of banking, and people also should.not lose faith due to one or two scams , and support the sector by reposing unflinching faith, in that case banking sector would easily overcome this crisis, like it did in the past.

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A crisis that changed the banking scenario in India: exploring the role of ethics in business

Sushma nayak.

Symbiosis School of Economics, Faculty of Humanities and Social Sciences, Symbiosis International (Deemed University), Pune, Maharashtra 412115 India

Jyoti Chandiramani

Digital business has marked an era of transformation, but also an unprecedented growth of cyber threats. While digital explosion witnessed by the banking sector since the COVID-19 pandemic has been significant, the level and frequency of cybercrimes have gone up as well. Cybercrime officials attribute it to remote working—people using home computers or laptops with vulnerable online security than office systems; malicious actors relentlessly developing their tactics to find new ways to break into enterprise networks and grasping defence evasion; persons unemployed during the pandemic getting into hacking; cloud and data corruption; digital fatigue causing negligence; etc. This study adopts a case-based approach to explore the importance of business ethics, information sharing and transparency to build an information-driven society by scouting the case of Punjab and Maharashtra Co-operative (PMC) Bank, India. PMC defaulted on payments to its depositors and was placed under Reserve Bank of India’s directions due to financial irregularities and a massive fraud perpetrated by bank officials by orchestrating the bank’s IT systems. The crisis worsened when panic-stricken investors advanced their narrative through fake news peddled via social media channels, resulting in alarm that caused deaths of numerous depositors. It exposed several loopholes in information management in India’s deposit insurance system and steered the policy makers to restructure the same, thus driving the country consistent with its emerging market peers. The study further identifies best practices for aligning employees towards ethical behaviour in a virtual workplace and the pedagogical approaches for information management in the new normal.

Introduction

The importance of information management in the banking sector has gained traction among researchers in recent times. Bank depositors place their savings with banks with an assurance to withdraw their funds on demand, based on the nature of contracts. Likewise, banks grant loans of diverse maturities to different borrowers out of the resources received as deposits (Diamond & Dybvig, 1983 ). In this formal arrangement, banks act as intermediaries vested with the responsibility of ensuring disclosure, operational transparency and ethical compliance as an essential practice of corporate governance. Information sharing is important because it propels ethical compliance and market discipline 1 among banks, and provides all the stakeholders with the information they need to determine if their interests are protected. Retail depositors lack sufficient information about the operational efficiency of their banks and are unable to communicate with fellow depositors, which may impede their ability to collectively guard themselves against potential bank failures.

Before opening an account, banks want possession of copies of various personal documents to know their clients well. However, the depositor never knows how the money mobilised by banks is spent. Bank assets are opaque, illiquid and short of transparency, because most bank loans are typically tailored and confidentially negotiated. Customers are constrained by the information shared by bank managers since financial products are intricate and risky (Tosun, 2020 ). Banks are, thus, at a risk of self-fulfilling panics 2 due to their illiquid assets (loans, which cannot be recovered from borrowers on demand) and liquid liabilities (deposits, which can be withdrawn by depositors on demand) (Bryant, 1980 ; Diamond & Dybvig, 1983 ; Liu, 2010 ). Lastly, it is assumed that the volatility of one bank might cause a contagion effect, distressing a group of banks or perhaps resulting in a systemic failure altogether.

While banks are inherently volatile due to the nature of the functions they perform (Kang, 2020 ; Santos & Nakane, 2021 ), only few have realised the importance of integrating ethics into their operations. In business, the perspective of ethical concerns has shifted dramatically in the past two decades. If a firm wants to be seen as a truthful affiliate and an esteemed member of the industry, it must exhibit a high degree of ethical compliance and upright conduct (Sroka & Szántó, 2018 ). Nevertheless, the situation gets worse when fraudsters abuse loopholes in banking systems to ride on the coat-tails of critical world events such as the COVID-19 pandemic, and its corresponding speedy digital acceleration driven by community guidelines such as “stay home,” “contactless digital payments” and so forth. Cyber-crime and online data breaches (Patil, 2021 ), unethical lending (Pandey et al., 2019 ), under-reporting non-performing assets 3 (Agarwala & Agarwala, 2019 ), frauds (Sharma & Sharma, 2018 ; Sood & Bhushan, 2020 ), poor information sharing (Jayadev & Padma, 2020 ) and floppy corporate governance (Agnihotri & Gupta, 2019 ) have been the factors responsible for most bank runs in Asia in general, and India in particular, in recent years. In 2020, when the Philippines was hit hardest by the virus, phishing was estimated to have surged by 302 percent (Mohan, 2022 ). The same year saw online fraud to be the second most common type of offence reported to police in Indonesia; likewise, investment scams had the greatest impact on victims in Singapore, with about USD 52 million defrauded in over 1100 cases (Bose, 2021 ).

During the period 2009–2021, 69,433 cases of bank fraud were reported in India; in the financial year 2021, the central bank of India confirmed that until mid-September, the value of bank frauds amounted to ₹1.38 trillion (Statista, 2021 ). According to the National Crime Record Bureau, the overall number of incidents of online fraud in India was 2093 in 2019, but it jumped to over 4000 in 2020 after the COVID-19 outbreak. It is interesting to note that five cities such as Ahmedabad, Delhi, Hyderabad, Mumbai and Pune, which had 221 incidences of online frauds in 2017, experienced a massive hike to 1746 cases in 2020 (Dey, 2021 ).

“Organized crime has been quick to respond, mounting large scale orchestrated campaigns to defraud banking customers, preying on fear and anxiety related to COVID-19” (KPMG, 2022 , p. 1). The COVID-19 pandemic has wreaked havoc on the banking industry, increasing fears of online frauds and spiralling bad loans—as consumer and business debt levels soar. In early 2022, while India was staring the Omicron-led third wave of COVID-19, the Central Bureau of Investigation registered four major cases of bank fraud involving Bank of India, Union Bank of India, Bank of Baroda and Punjab National Bank for siphoning of funds that resulted in losses worth ₹ 939 crore for the said banks (Financial Express, 2022 ).

A bank is expected to foster public confidence by providing demand-driven services while adhering to ethical practices such as transparency, honest and timely disclosures for customer retention, security and trust. This is likely to lessen the risk of bank runs, 4 which serves in upholding the security and stability of banks—necessary for consumer protection. Previous studies have rarely investigated how seamless information sharing with the public—by banks, government and regulatory bodies—may moderate the opacity of the bank’s financial performance and inhibit panic runs through informed decisions by the customers. This is particularly important in the current times of risk and uncertainty wherein ethical concerns are perturbing the stakeholders of most businesses, particularly banks.

The present study shall explore the importance of business ethics, information sharing and transparency to build an information-driven society by scouting the case of Punjab and Maharashtra Co-operative (PMC) Bank, India, which defaulted on payments to its depositors and was placed under Reserve Bank of India’s (RBI) 5 directions due to a massive fraud perpetrated by bank officials. The auditors, too, were deemed lacking in their duties because they failed to notice the bank’s serious infractions. Since the depositors were permitted to withdraw only ₹ 1000 from their accounts (suspension of convertibility) and banking operations were stalled until further directions, there was panic among investors. In fact, “PMC was also India’s first crisis related to a bank which played out on social media” (Kaul, 2020 , p. 256). The crisis worsened when uninformed and panic-stricken investors advanced their narrative through fake news peddled via social media channels, WhatsApp and Twitter, resulting in alarm that caused deaths of numerous depositors.

Based on the aforementioned discussion, the authors of this study shall explore answers to the following questions:

• i. What are the gaps in risk-management systems in India’s banking sector, specifically in the slackly regulated cooperative banks?
• ii. What are the best techniques for aligning employees towards ethical behaviour in a virtual workplace, and how should they be assessed?
• iii. What are the pedagogical approaches for information management and ethics education in the new normal?

The rest of the paper is as follows. The next segment explores theoretical background, followed by methodology, case study, discussion, directions for future research and conclusion.

Theoretical background

Evolving paradigm of business ethics.

The impact of the COVID-19 pandemic on global health, organisations, economy and society is intensifying relentlessly (Mahmud et al., 2021 ). The current pandemic has compelled businesses to embrace virtual space to a greater extent than earlier. This needs a comprehensive review of business ethics, among other things. An ethical decision is one that is accepted by a larger community because it adheres to moral guidelines (Reynolds, 2006 ). With the bulk of the personnel working online and maybe indefinitely in the future, a paradigm shift in business ethics, values and social responsibilities seems imminent and looming round the corner. Remote employees are expected to be disciplined with the ability to fulfil their duties with minimal supervision. Remote workers must also comprehend the nature of the task they would be undertaking and what it requires for a business to flourish. Finding solutions to reconcile the demands of work and personal life is the main problem of the new work-life model (Aczel et al., 2021 ).

The idea of an organisation’s social responsibility swings between two extremes: one that limits the organisation’s obligation to maximising profit for its shareholders, and another that broadens the organisation’s responsibility to encompass a wide variety of actors with a “stake” in the business (Argandoña, 1998 ). From an ethical standpoint, the stakeholder notion of social responsibility is more engaging for the common good (Argandoña, 1998 ; Di Carlo, 2019 ). “An individual or group is said to have a stake in a corporation if it possesses an interest in the outcome of that corporation” (Weiss, 2021 , p. 153). Stakeholders are persons or groups with whom the organisation intermingles or works together—any entity capable of influencing or being influenced by the organisation’s activities, preferences, strategies, objectives or practices (Gibson, 2000 ). Therefore, a firm is responsible for value creation for all its stakeholders, not just shareholders (Freeman et al., 2018 ). The importance of stakeholder interactions on corporate performance is particularly highlighted by instrumental stakeholder theory (IST), which calls attention to the effects of high-trust, high-cooperation, and high-information-sharing (Jones et al., 2018 ). Although IST is contested by Weitzner and Deutsch ( 2019 ), Harrison et al. ( 2019 ) claim that few firms have the ability to maintain strong economic performance while also treating their stakeholders ethically at all times. Through communal sharing ties, societal welfare can be improved in a Pareto-optimised manner, meaning that shareholders and some stakeholders benefit without any other stakeholders getting worse. Building strong relationships with stakeholders becomes an appealing strategy even for managers who are fixated on bottom-line results.

The importance of business ethics and moral conduct among leaders is evident in light of the recent high-profile ethical scandals (e.g., Enron) and growing expectations for ethical standards in management. Having a strong self-concept as a leader fosters ethical leadership, which is helpful to organisations as it encourages employees to perform well—both in their roles and outside of them (Ahn et al., 2016 ). Ethical frameworks encourage managers to modify salaries to the “efficiency wage” point, which is the best compromise between the interests of shareholders and employees, and hence the best way to sustain stakeholder relationships (Zhong et al., 2015 ).

Business ethics in banks

Banks and financial institutions are transforming digitally at a rapid pace employing new technologies and developing digital business models that are eventually helping them to create and add more value to their organisations. Given the pace at which workforce skills are being enhanced in the digital reality, these institutions are advancing towards a significant dearth of ethical skills. “The ethical peril of unfair contract terms is evident from the abuse of banks’ dominant position relative to bank consumers in dictating contractual terms and conditions, and asymmetrical information that causes significant imbalance of rights and obligations of bank consumers as the weaker contracting parties, placing them at a detriment” (Bakar et al., 2019 , p. 11). The three pillars of ethics in banking are “integrity”, “responsibility” and “affinity”. Integrity is imperative because it helps build the trust that any banking system needs to thrive. Responsibility necessitates contemporary banks to consider the effects of their lending policies. Affinity refers to fresh approaches to bring depositors and borrowers closer than they are in traditional western banking (Cowton, 2002 ). Herzog ( 2017 ) presents a duty-based explanation of professional ethics in banking. According to this viewpoint, bankers have obligations not just to their clients, who traditionally represent the core of their ethical obligations, but also to prevent systemic harm to entire societies. In order to best address these issues, regulation and ethics must be used in conjunction to align roles, rewards and incentives and produce what Parsons refers to as “integrated situations”.

Collins and Kanashiro ( 2021 ) emphasise the importance of ethics in banks by explaining how they follow a practice of secrecy in maintaining cash vaults by informing the branch manager of the first three digits while the assistant manager informed of the remaining three digits. If the managers violate the policy and collude to know all the six digits, they would be fired. Likewise, studies also suggest that employees are less likely to quit their jobs when they believe their organisation is empathetic and accommodating and provides an ethically supportive setting (Jeon & Kwon, 2020 ). A sustainable job performance can be reached by workers only through strong work ethics (Qayyum et al., 2019 ). It is necessary for employees to encourage ethical practice and prevent unethical deeds that can harm the company’s image and performance, particularly with respect to small organisations (Valentine et al., 2018 ). Work ethics contribute to employees’ job performance depending on how much an individual fosters honesty, prudence, quality, self-control and cooperation while discharging their duties (Osibanjo et al., 2018 ). Even so, the banking business is plagued by a variety of ethical problems, including a lack of adequate ethics training, problems with trust and transparency, increased pressure of competition, the complexity of financial operations and the problem of money laundering, among others (Kour, 2020 ).

Ethically responsive education: challenges and way ahead

Business schools have traditionally assumed that executive education is either delivered online or in-person and that online executive education programmes are substandard than in-person programmes (González-Ramírez et al., 2015 ). This is no longer true. Drawing from their experiences during the pandemic, educators and their institutions are shifting to “omnichannel” programme models, where executive learners have a seamless and engaging learning experience across all channels and platforms through which they participate. While ethical practices are important for an enterprise, business schools face numerous hindrances in their efforts to promote ethical standards in their students (Sholihin et al., 2020 ). Virtual technology allows students to learn practical skills without leaving the classroom. Furthermore, moving from a physical class to a virtual setting can give real-time imagery and interface in a simulated world that is extremely close to the real world, allowing students to gain practical insights without having to leave their homes. Simulations give students room to test out their course knowledge and make leadership decisions through the lens of real-life situations—all in the safety of a virtual class. As a result, virtual technology might be one of the learning media to motivate students studying at home during a pandemic (Chuah et al., 2010 ). However, as pointed out by Bhattacharya et al. ( 2022 ), the support that the institution offers during the transition to online learning, faculty acceptance and adoption of the new technology, and adaptation of the teaching and learning pedagogy to the new medium, are factors that determine whether the abrupt shift to online learning is successful in meeting the needs of students with various learning preferences and abilities. The effectiveness of online learning depends largely on how interesting and dynamic the class sessions are designed by getting students to participate in discussions, role plays, browsing online links, engaging in polls, taking quick quizzes, etc.

Methodology

This study draws upon secondary sources and adopts a case-based approach to explore the role of ethics in business in a dynamic world that is gradually shifting towards virtual technology in the milieu of the global pandemic. The advantage of a case study is that it aims to investigate a current occurrence in its natural setting (Yin, 2017 ). In this study, papers dealing with a wide range of diverse themes relating to business ethics were reviewed. Also, relevant press releases by RBI and Deposit Insurance and Credit Guarantee Corporation (DICGC), newspaper accounts, videos, media narratives, annual reports and recast balance sheet of the PMC Bank were examined. Every fact was cross-checked from two different sources in order to establish the accuracy of the case information. Anything that did not meet this criterion was left out of the analysis. The data was gathered over a period of 2 years to track the changes in the work environment—before and during the pandemic—and to closely examine the multifarious developments that occurred ever since the crisis at PMC Bank came to light. Despite the authors’ attempts to speak with the irate PMC Bank customers to solicit their responses and reactions, the latter declined to do so due to the emotional trauma they had already experienced, and the sense of utter helplessness they felt following numerous unsuccessful attempts to knock at the doors of the relevant authorities. As a result, they denied to participate in the survey, a major limitation of this study.

The authors selected the case of PMC Bank as it featured among the top bank frauds in India towards the close of the previous decade (Sengupta, 2022 ). The PMC bank failure exposed several loopholes in information management in India’s deposit insurance system (DIS) 6 and steered the policy makers to restructuring the same, thus driving the country consistent with its emerging market peers. In March 2020, the Banking Regulation (Amendment) Bill was introduced in the lower house of the Indian Parliament to avoid a PMC Bank–like crisis in the future. While administrative matters would continue to be governed by the Registrar of Cooperatives, the bill aimed to apply banking regulation principles of the RBI to cooperative banks. Additionally, it suggested that cooperative banks be strengthened by raising professionalism, facilitating capital access, enhancing governance and assuring sound banking through the RBI. Following the failure of PMC Bank, the Union Cabinet amended the DIS in India and addressed an enduring concern of the depositors of troubled banks. In 2020, the deposit insurance (DI) cover was raised from ₹ 1 lakh to ₹ 5 lakhs with the approval of Government of India (RBI, 2020 ), and banks were mandated to disclose this information on their respective websites. Since July 2021, the depositors of distressed banks were permitted to withdraw their holdings from the accounts—up to the highest insured amount—within 3 months since a bank was placed under moratorium by the RBI (Kumar, 2021 ). The RBI also got the ball rolling to prevent scams such as the one perpetrated by PMC by enforcing a set of criteria for the hiring of managing directors and chief risk officers in banks; levying fines (for regulatory lapses); calling for higher reporting standards; developing a big data centre that could access data from banks’ systems; and proposing differential deposit insurance premium for banks, contingent on their risk profile. Likewise, the RBI issued new provisioning norms for primary cooperative banks’ inter-bank exposure as well as valuation of their perpetual non-cumulative preference shares and equity warrants, directing them to continue making provisions of 20% for such exposures, in the aftermath of the PMC Bank’s bankruptcy.

The case of Punjab and Maharashtra Co-operative Bank, India

About pmc bank.

The PMC Bank was functioning as a multi-State scheduled primary co-operative bank in India, with its area of operation extending over seven states viz., Andhra Pradesh, Delhi, Goa, Gujarat, Karnataka, Madhya Pradesh and Maharashtra. With a modest beginning in 1984 as a unit bank, the business later expanded over a vast network of 137 branches in less than four decades. Empowered by a mission “to emerge as a strong, vibrant, most preferred premier co-operative bank, committed to excellence in serving the customers, and augmenting the stakeholders’ value through concern, care and competence”, the bank gradually gained the trust of its customers by reaching numerous milestones such as earning the “Scheduled” 7 status by the RBI and consent to venture into the forex business (PMC Bank, 2021 ). The following years brought laurels to the bank in the form of recognition for “lowest dispute ratio” as well as “work ethics oriented to depositors’ service” by the All-India Bank Depositors’ Association; “Best Bank Award” by diverse State Co-operative Banking Associations; and so forth.

In the early weeks of September 2019, the RBI received information from a whistleblower that the PMC Bank was undertaking fraudulent activities which involved the bank’s board of management (Hafeez, 2019 ). The complaints pointed out that certain loans of PMC should have been classified as non-performing assets (NPAs) but were concealed in the bank’s loan account system. In response to these complaints, the RBI started investigations. On September 23, 2019, RBI placed restrictions on the PMC Bank citing “major financial irregularities, failure of internal control and systems of the bank, and wrong/under-reporting of its exposures under various Off-site Surveillance reports to RBI” (RBI, 2019 ). The RBI acted in quick time and took control of the bank’s operations to assuage any risk of a bank run. To protect the interests of depositors, RBI placed PMC Bank under “Directions” vide Sect. 35-A read with Sect. 56 of the Banking Regulation Act, 1949 (RBI, 2019 ). Subsequently, PMC was refrained from fresh lending, accepting deposits and making investments for six months 8 (Singh, 2021 ). According to a report by BloombergQuint ( 2019a ), at the heart of the PMC Bank crisis stood the fact that several bank officials manipulated their books and their IT system to conceal the loans given to the real estate developer Housing Development and Infrastructure Limited (HDIL). A primary cooperative bank 9 could lend up to 15% of its total capital to a single company—a norm violated by PMC (Kaul, 2020 ). The bank’s then Managing Director, in his confession letter to the RBI, claimed that PMC Bank’s exposure to the large corporate group—HDIL—was just about ₹ 2500 crores (Gadgil, 2019 ). However, PMC’s actual exposure to the HDIL group stood at ₹ 6500 crore, accounting for 73% of the aggregate loan book size of ₹ 8880 crore and nearly four times the regulatory cap as of September 19, 2019 (Rebello, 2020 ). The six board members of PMC had approved loans to HDIL, the largest borrower of the bank, by breaching the RBI’s exposure limit not just to HDIL, but also the Uttam Galva Group and Abchal Group (Rajput & Vyas, 2019 ). PMC had extended loans worth ₹565 crores 10 to Uttam Galva Group—an exposure in excess of the limits set by the RBI (BloombergQuint, 2019b ). There is limited public information on the Abchal Group or its promoters.

Things changed around in 2012–2013 when HDIL started defaulting on the dues owing to cancellation of a slum rehabilitation project near the Mumbai airport—a major setback to the real estate group. Even though the outstanding loans with the group swelled, the bank’s management did not classify them as NPAs, fearing a hit in the balance sheet. They were also apprehensive of reputational loss and facing regulatory action from the RBI. The Economic Offences Wing of Mumbai Police uncovered that the bank’s management had replaced 44 loan accounts of HDIL with over 21,000 fictitious loan accounts—all this in an effort to camouflage defaults by the HDIL group (Ozarkar, 2019 ). PMC bank incurred losses to the tune of ₹ 4355 crores (Seetharaman, 2019 ). Despite these losses, PMC continued to support HDIL owing to the relationship shared between the duo.

The relationship between the PMC Bank and the promoters of HDIL group dated back to the 1980s when the latter had first aided the bank by infusing capital of ₹13 lakh, and also placed a huge sum of deposits for the bank’s revival. Furthermore, when the bank was facing a run on its deposits in 2004, HDIL pumped in ₹ 100 crore to deal with the liquidity crunch that enabled the cash strapped PMC bridge over the crisis. As a result, more than 60% of the bank’s transactions were with the HDIL group. The PMC Bank would charge 18–24% interest from the group accounts and make good profits. Meanwhile, the HDIL group maintained that its banking relations with PMC were clean and the audits presented a true and fair picture (BloombergQuint, 2019b ).

Although HDIL had an impressive record of clearing dues despite certain delays, PMC Bank continued to report the loan accounts as standard assets—albeit they were gradually downgrading to substandard and doubtful categories. All this went unnoticed as statutory auditors were looking at only incremental advances and scrutinised accounts shown by the management (Dalal & Sapkale, 2019 ). Prior to 2015, RBI looked at only the top accounts of the bank. Since loans to HDIL were spread across multiple accounts, they never showed up in the RBI’s inspection. Post 2017, when RBI started looking into the “advances master”, PMC replaced the accounts belonging to the HDIL group with dummy accounts—of small amounts—to escape detection by the regulator (Ozarkar, 2019 ).

The modus operandi

According to a report by BloombergQuint ( 2019a ), experts claim that whenever an auditor or an RBI inspector looks at the books of a bank, they examine the top 50–100 accounts that the bank is exposed to. In the case of PMC Bank, these accounts were masked by holding too many accounts with little funds to avoid any suspicion, by manipulating the bank’s core banking system, officially known as the “core banking solution (CBS) 11 ”. All bank employees have access to the CBS—from a teller to the branch manager, to loan officers and risk managers—but their access and what they can do with the system is limited to their exact area of function. The CBS is essentially a back-end intelligence software. It provides the analytics for decision-making to the bank staff whenever bankers physically input data. So, the CBS has a “rule-engine” which is controlled by an access-control framework, letting only certain people alter the rules. Usually, every bank appoints an IT administrator for managing the CBS, who is the only person allowed to modify the software. According to forensic experts, whenever there is fraud at a bank, the “rule-engine” is compromised. Therefore, by giving limited access to the rule-engine, other employees—such as those in the credit department or risk management division—have little information of the changes made to the CBS. Thus, by creating 21,000 dummy accounts in bogus names to conceal from the auditors and RBI inspectors, other departments of PMC were perhaps in the dark the whole time the bank was exposed to the HDIL group.

The RBI in its investigation established that out of 1800 bank employees, only 25 employees had access to the loan accounts of the bankrupt real estate developer and its group entities (Hakim, 2019 ). These bank officials assigned specific codes to the accounts belonging to the HDIL group in order to disguise the money in the loan accounts. When the suppression of true accounts became too much for the employees, the management decided to come clean to the RBI. PMC was instructed to recast its balance sheet to present an accurate and honest portrayal of the bank’s assets (PMC Bank, 2019 ). Investigating agencies promptly arrested several bank executives including three top officials of the PMC bank, as well as two promoters of the HDIL group.

Depositors’ backlash

The cap on withdrawals came heavily on depositors, particularly those who held all their savings with the PMC Bank. The deposit withdrawal restrictions sparked off a massive public outcry as customers were unable to pay their bills. Ironically, the bank that clients had trusted to keep their money safe had now become the source of their woes. It was difficult to survive on minimal amounts. Businesspersons reported how their business operations had stalled, leaving them to survive on loans from relatives and friends. Several account holders could not access savings, much needed to meet their medical needs. Likewise, deaths due to cardiac ailments and suicide were reported. 12 Distressed depositors held protests outside the PMC Bank and the RBI quarters to permit withdrawals of their lifetime savings. During the same time, numerous WhatsApp videos started circulating among the aggrieved depositors and the news fired up on mainstream and social media (Kaul, 2020 ). Poor lending norms and questionable governance had afflicted the banking system, in part due to professional incompetence to assess project viability, and in part due to the political economy that permits, even nurtures, credit to privileged parties (partisanship). A fake news that went viral on online platforms was the speculation that the government was proposing to close nine public sector banks. This raised qualms about the systemic stability of banking in India, which compelled the RBI to issue a press release that no such plan was in the offing. “PMC Bank is too tiny to pose a systemic threat, but a small, dead canary in a coalmine is still a large warning sign” (Mukherjee, 2019 ).

In response to people’s anxiety and backlash, the RBI raised the withdrawal limits for PMC depositors from time to time, as illustrated in Table ​ Table1. 1 . Deposit withdrawals were permitted to ₹ 1 lakh in exceptional situations such as wedding, education, livelihood, and other adversities. At the same time, in February 2020, the DICGC 13 was authorised to raise the deposit insurance coverage for a bank depositor, from ₹ 1 lakh to ₹ 5 lakh per depositor—an amendment brought into force after 27 years—since the previous one was initiated in 1993 (Nayak, 2020 ).

PMC Bank deposit withdrawals

Source: Based on data from Kaul ( 2020 )

Simultaneously, depositors of insolvent or stressed banks that were placed under a central bank moratorium were entitled to recover their funds (up to ₹ 5 lakh) within 90 days of the commencement of the moratorium. The 90-day span would be split into two periods of 45 days. The RBI mandated: “The stressed bank on whom restriction is placed is expected to collate all information regarding the number of claimants and claim amount and inform DICGC about it within the first 45 days. Within the next 45 days, DICGC is mandated to process the claim and make payment to each eligible depositor” (Motiani, 2021 ). However, customers of PMC Bank were exempted from receiving ₹ 5 lakh in the first lot as the bank was under the resolution process.

Following the PMC debacle, the RBI strengthened its control by necessitating primary cooperative banks to submit quarterly reports of individual loan exposures above ₹ 5 crore to the Central Repository on Information on Large Credits (The Economic Times, 2020 ). The RBI established a big data centre to retrieve data from banks’ systems. The data centre would aid in the prevention of scams such as the one perpetrated by PMC Bank, in which data was camouflaged through the use of phoney accounts (ETBFSI, 2021 ).

The PMC bank takeover

In the second half of 2021, nearly 2 years after the PMC scam had come to light, Centrum Finance Services 14 was given “in-principle” approval by the RBI to establish a small finance bank that would take over the scam-plagued PMC Bank. Two distinct entities—the Centrum and BharatPe 15 syndicate (with 51:49 stake)—were collectively permitted to acquire the PMC Bank. Accordingly, Centrum and Resilient Innovation Private Limited (a BharatPe enterprise) were authorised to set up a small finance bank—which would hold the assets and liabilities of the PMC Bank (Panda & Lele, 2021 ). In October 2021, the Unity Small Finance Bank (USFB) got licence from the RBI and started its operations in record time with an equity capital of ₹ 1100 crore (Banerjea, 2022 ). The RBI came up with a draft plan for the merger of the beleaguered PMC Bank with the new entity, USFB. Depositors could claim up to ₹ 5 lakhs over a 3- to 10-year period, according to the proposal. They could receive up to ₹ 50,000 after 3 years, ₹ 1 lakh after 4 years, ₹ 3 lakh after 5 years, and ₹ 5.50 lakh after 10 years (The Economic Times, 2021 ). On January 25, 2022, the amalgamation of PMC Bank with USFB officially came into force. All the branches of PMC Bank would operate as branches of USFB, ensuring job security and stability to the employees of the merged entity, alongside consistent services to the clients. Since the draft amalgamation plan was opposed by an umbrella body of cooperative societies, the lead bank—USFB—came up with a press release: “96 percent of depositors, have deposits up to Rs 5 lakhs, will be paid upfront (subject to completion of the requirements as per DICGC rules). These depositors can choose to either withdraw or retain this amount with Unity Bank; or make additional deposits, and take advantage of the attractive interest rate up to 7%, being offered on savings accounts” (CNBC, 2022 ). Thus, the long-drawn-out scandal that stretched over 2 years ended up with the PMC takeover by USFB that was enforced in the larger interests of all the stakeholders.

The ethical stance

The PMC Bank failure is a classic case of ethical collapse, wherein the board of management and a few employees took a drastic step of compromising the interests of diverse stakeholders, with little thought to the ramifications it would have on those involved with the bank. This was earlier exemplified by Harris and Bromiley ( 2007 ), as well as Murthy and Gopalkrishnan ( 2022 ), while discussing the behavioural theory of the firm and the factors driving financial misrepresentation in the corporate world. The integrity and ethical commitment of senior management, the ethical policy of an organisation and the external pressure it is exposed to, have an impact on the ethical behaviour in the organisation, which further has an impact on the overall performance of small and mid-size enterprises (Abalala et al., 2021 ). Employees are not recruited on the basis of ethical considerations. Just as they acquire job skills through education, training and practice, they learn to be more or less ethical based on events and individual experiences over a period of time. Companies devote the most resources to environmental policies, but the fewest to actions that promote ethics and deter unethical behaviour (Abidin et al., 2020 ). From the standpoint of human resource development, several organisations consider ethics education as a one-time affair by developing an ethical code of conduct and stating it in their bye-laws. If they do address ethics later, it is mostly by instituting whistleblower laws (Schultz & Harutyunyan, 2015 )—similar to “being wise after the event” instead of “being safe than sorry”. Such practices may check unethical conduct or castigate the outlaws, but they may not help the employees evolve as moral individuals at workplace. Ethical education is a lifetime process and is not a cramming exercise. Employers should create an environment that nudges employees to be morally sound by reflecting moral values. They should make honesty, truth, fairness, sincerity, community service, moral mettle and reverence for others their guiding principles in business dealings (Okpo, 2020 ). The benefits of ethical establishments are manifold. Employees find such businesses more appealing than others as they are seldom involved in scams. They are also favoured by investors, who target good governance and strong cultures as foundations of enduring value creation. Ethical codes have been lauded as a clear path to more sustainable and sound organisational behaviour (Adelstein & Clegg, 2015 ).

Cases of cooking the books such as Enron (Arnold & De Lange, 2004 ; Benston & Hartgraves, 2002 ; Reinstein & McMillan, 2004 ), World Com (Wang & Kleiner, 2005 ), Tyco (Sorkin & Berenson, 2002 ), Sub-prime Mortgage Crisis (Adjei, 2010 ), Satyam (Bhasin, 2016 ) and the garment industry disaster in Bangladesh (Taplin, 2014 ) have raised ethical awareness and demonstrated that companies can suffer acute reputational and financial loss when their unethical transactions are discovered (Banerjee, 2015 ). When such incidents come to light, they frequently include a huge scandal that has a significant influence not just on the organisation, but also the entire industry or even the global economy (Halinen & Jokela, 2016 ). The PMC Bank crisis was a signal to the nation of a larger problem in the Indian banking system that needs to be fixed with basic governance reforms (Gupta, 2021 ). The regulatory body should have acted sooner to avoid a situation that caused panic among depositors, some of whom had deposited their entire life savings in the bank. Despite its immense resources and power, the RBI chose to focus on routine checks rather than digging further. According to Dastidar ( 2016 ), despite the fact that appropriate law has been adopted to control banking activities in India and to provide a fairly competitive environment, the regulations and penalties are insufficient to guarantee operations in a disciplined manner. While bankers receive behavioural training, the routine monitoring of staff behaviour is insufficient. Customers are either unaware of how to file a complaint against bank employees with a higher authority or simply disregard the process, believing it to be inconvenient.

Therefore, business ethics and corporate governance should be a part of all accounting and business curriculums (Abdolmohammadi, 2008 ; Acevedo, 2013 ), particularly in the current times, when the line between our personal and professional life has gotten increasingly blurry. Work and life are more linked than they have ever been (a trend invigorated by the COVID-19 pandemic). This is partly because Millennials and Generation Z spend a large time at work and are far more connected through video-communication and social media platforms such as Google, Facebook, LinkedIn, Twitter and WhatsApp. There are rules to follow, clients to serve, contracts to honour and communities to interact with, at jobs. Eventually, exposure to each can help enhance the understanding about ethics. A significant question that begs to be answered is “How can companies assist their employees in using the workplace as a character-developing laboratory?”.

One of the ways is experiential learning. For instance, in January 2002, social media went gaga after a video of a farmer being mistreated at a Mahindra car dealership went viral. The Chairman of the Mahindra Group was also informed of the occurrence. He stated that the key value is to protect an individual’s dignity, and that if someone violates the policy, it would be dealt with quickly. The Chief Executive Officer of the Mahindra Group was quick to respond too: “Dealers are an integral part of delivering a customer centric experience & we ensure the respect & dignity of all our customers. We are investigating the incident & will take appropriate action, in the case of any transgression, including counselling & training of frontline staff” (Khatri, 2022 ). Thus, learning by doing is hands-on and engaging, with the instructor acting as a guide. Nevertheless, experiential learning has been sluggish to take off as a technique for business ethics training (Meisel, 2008 ), although it has been popular in academic circles and management development programmes.

Professor Scott Reynolds proposes “a neurocognitive model of the ethical decision-making” (Reynolds, 2006 ) by initially pointing out his findings to the four-step process first theorised by Rest ( 1979 , 1986 ). The recognition of the ethical dilemma, according to Rest, is the first step in making ethical decisions. The individual then takes an ethical decision, declares an intention to act ethically and ultimately acts ethically. Ethics education, however, is a contentious topic. Some people argue that ethics cannot be learned (McKenzie & Machan, 2003 ). Others feel that ethics can be imparted, although they differ with respect to the method of delivery (Gautschi & Jones, 1998 ; Pfeffer, 2003 ).

According to the neurocognitive paradigm (Reynolds, 2006 ), ethics education is feasible—ethical decision-making can be enhanced through a variety of methods. However, the model recommends that methods of instruction should be tailored to the situation at hand. Ethics education should concentrate on the “mental structures of prototypes” (Reynolds, 2006 , p. 745) and moral standards in order to be effective, but it should be accomplished through a variety of methods. Employees may join an organisation with strongly ingrained preconceptions about managerial challenges such as corruption, scam, deception and harassment, which, regrettably, may not reflect what the organisation considers to be the morally suitable outcome in some situations. This is not to say that these prototypes cannot be changed. Ethics education must confront deep-rooted stereotypes and dig them out of unconscious processing of the employees so that they can be reviewed and modified accordingly. Role-playing and small-scale group discussions are examples of activities that can help achieve these goals (Gioia, 1992 ).

Likewise, the organisation must offer fresh prototypes for new ethical circumstances as they arise, and employees must be exposed to such prototypes on a frequent basis (Reynolds, 2006 ). As a case in point, there is growing consensus on previously uncharted ethical territory such as inspection of electronic mail, staff supervision and genetic screening (Beauchamp & Bowie, 2004 ); employees can consolidate them into their decision-making based on the extent to which organisations impart these norms consistently. The intense, yet gradual, indoctrination of ethically sound prototypes will spontaneously result in ethical outcomes by employees. Regardless of the significance of prototypes, the neurocognitive model supports an age-old pedagogical belief that ethics education should offer broad principles or benchmarks for decision-making (Sims, 2002 ). The corporate environment is always changing, and in the virtual workspace, employees are frequently working in new environments where conventions have yet to be formed and prototypes are limited. Therefore, employees frequently count on their higher-order cognitive skills (Stenmark et al., 2020 ), and, as any skilled tradesman, they require the tricks of the trade to do so effectively (Stenmark et al., 2019 ). The more an organisation can equip employees with moral norms to apply in diverse circumstances (as well as opportunities to apply them), the more likely they will utilise them to effectively solve their issues. To effectively mould ethical behaviour, organisations must offer tools for innovative ethical decision-making and a steady stream of pre-set paradigms with built-in moral implications (Reynolds, 2006 ).

Organisations can also adopt “Performing a Project Premortem” which, in a corporate setting, occurs at the start of a project, allowing it to be enhanced rather than autopsied (Klein, 2007 ). For instance, in the virtual space, a bank conducted a session to identify the best possible practices of serving the customers seeking financial statements by contacting customer care via phone. In this session, the bank manager sought responses from customer care executives, asking them how would they prevent unauthorised access and confirm the authenticity of a customer—establishing contact through phone—before releasing a financial statement via email. One of the executives responded that he would ask the account number, branch address, date of birth, registered mobile number and email credentials before releasing the statement to the customer. Another executive stated that apart from seeking the aforementioned details, he would also encrypt the financial statement with the account holder’s Customer ID 16 so that only the legitimate person could access it. The premortem allowed the customer care executives to adopt best practices while rendering services in the new normal so that third parties might not use confidential data in ways that were inconsistent with the bank’s ethical values. Such exercises can be undertaken from time to time to assess the employees’ ethical compliance and elicit a paradigm shift in the way people think about character development in the virtual workplace.

Information management

In this age of widespread digitalisation, an individual intending to open a bank account is expected to submit numerous personal documents to confirm their domicile. While this information is expected to remain confidential, the bank assumes control over the shared data, and indicates a possibility of using it for internal purposes if it so chooses. Likewise, if an individual avails credit from a bank, the latter may seek myriad information, considering itself to be a majority stakeholder in the transaction. However, if a depositor enquires about how the bank uses their funds and who it lends to, the bank is likely to respond with a frigid silence (Bakar et al., 2019 ). The average person rarely has the opportunity to question the bank, which is a biased practice given that deposits are the lifeblood of the Indian banking industry. They hold more than half of the nation’s savings and greater than 80% of a bank’s liabilities. In comparison to China, Hong Kong and Singapore, India’s reliance on deposits is the highest among emerging economies (Karthik, 2021 ). However, depositors have few options to safeguard their deposits. Simply said, deposits are critical to the banking system, but banks rarely go to the same lengths to safeguard depositors’ interests and privacy as they do for major firms. The failure of PMC Bank in India, along with many others from the private and the cooperative sector, makes for a compelling reason for transparency and fair disclosures on the part of banks as well as regulatory authorities. In each of these circumstances, several rules had to be relaxed in order to prevent the bank’s failure from affecting the country’s financial system. The PMC Bank case raises important concerns about the monetary authority’s efficacy as a regulator. Additionally, it draws attention to the critical flaws in Indian banking industry’s risk-management procedures (Hafsal et al., 2020 ), particularly in the loosely regulated cooperative banks.

Public awareness of deposit insurance is abysmally low in India, which limits informed decisions by depositors (Nayak et al., 2018 ; Singh, 2015 ). Moreover, India follows a partial deposit insurance system; in the event of a bank failure, only a capped amount is received by the depositors of a single bank. However, people believe their money is safe the moment they deposit it with a bank, ignoring the fact that banking is just another business (Kaul, 2020 ). Quantitative statistics are frequently included in the banks’ annual reports. They include information on deposits, loans and advances, capital adequacy, income recognition, asset quality, provisioning against bad debts, etc. Nonetheless, when it comes to loans and advances, it is generally the qualitative part that causes a bank to fail. PMC Bank was one of the several banks in India where blanket lending practices resulted in capital erosion. The case right now is a call for more transparency in India’s banking system, particularly in a virtual world marked by extensive digitalisation.

Future research directions

Studies so far have examined the role of ethics in diverse situations and sectors. However, there is limited research on whether ethics education should be conducted differently for stakeholders in remote workplace as against on-site work. Also, if organisations are attentive to goodwill and brand name, what are the causes that deter them from ethical conduct? Furthermore, if performance-linked incentives can motivate employees to achieve promising outcomes, can an organisation introduce ethics-linked incentives to boost employee productivity? Previous studies have rarely investigated how seamless information sharing with the public may moderate the opacity of an organisation’s performance and reinforce informed decisions by the customers. This is particularly important in the current times of risk and uncertainty wherein ethical concerns are perturbing the stakeholders of most businesses, particularly banks. In the banking industry, assessing behavioural characteristics for risk mitigation is still unexplored. The personality factor can aid in understanding the mental aspects as well as the reasons for the association of dark triads with economic crimes. Researchers can explore these uncharted areas.

Conclusion and recommendations

The PMC Bank crisis is only the most recent manifestation of deeper, unresolved issues in India’s banking industry. The persistent concern of non-performing assets (NPAs), which was exacerbated in the case of cooperative banks in India due to poor governance and a risky business strategy, lies at the core of the crisis. Regulators have, sadly, just responded to symptoms thus far; there is little indication that they have a thorough knowledge of the underlying condition. In order to prevent crises like the one that has befallen PMC—where an astonishing 73% of the loan book was represented by one corporate group with close relationships to the bank—cooperative banks need substantial restructuring in their governance. The direct appeal made by numerous irate depositors, which was widely shared on social media, is another intriguing aspect of how the public has responded to the PMC Bank situation. Some of the viral videos show utterly upset, destitute depositors literally screaming and begging for aid. Such a response is difficult to envisage in developed economies, where the unsatisfied public’s response would more likely be indignation at the incompetence of politicians and regulators, than one of entreaty.

While the COVID-19 pandemic has compelled businesses to embrace virtual space to a greater extent than earlier, this calls for a comprehensive review of business ethics, among other things. Ethics education is feasible, and ethical decision-making can be enhanced through a variety of methods. The corporate environment is ever changing, and in the virtual workspace, employees are frequently working in new environments where conventions have yet to be formed and prototypes are limited. Organisations must offer fresh prototypes for new ethical circumstances as they arise, and employees must be exposed to such prototypes on a frequent basis. To effectively mould ethical behaviour, organisations must offer a steady stream of pre-set paradigms with built-in moral implications.

At the same time, bankers must be transparent for customers to receive the pertinent information they need to make sound financial decisions. Customers frequently lack the resources and financial language expertise necessary to grasp the complex financial products and services. As a result, they are unable to comprehend or obtain accurate, understandable and/or thorough information regarding a variety of products, thus leading them to choose poorly or inadvertently. There are inherent information asymmetries in the financial sector, with bankers having more information than customers, which burdens the latter due to low financial literacy and complexity of financial products. Therefore, thorough disclosures regarding the product and its features become a crucial component to close this gap. At the same time, these disclosures should not result in information overload, which could reduce the value of the advice given. Fair and forthright disclosures give clients the ability to compare various products from different service providers, enabling them to make an informed choice. An enhanced customer knowledge would also encourage competition, which would improve the standard of services provided by the digital platforms. Fair customer treatment typically entails moral behaviour, appropriate sales tactics and handling of client information. Even though fair treatment concepts are well understood, it is challenging to hard-code these in regulations. However, the fundamental idea that the consumer should always be treated fairly and with respect persists. This takes on increased significance in digital banking, because the target clients may comprise typically small customers with little access to or knowledge of grievance redressal mechanisms. Banks can set up cyber security awareness initiatives to inform clients of the risks associated with phishing, malware, wire fraud, and more when using online banking. Customers can have access to a distinctive online library of learning aids, which includes newsletters, email campaigns, movies, posters and articles on information security awareness. The first essential step towards effectively managing risks, reducing fraud and ensuring compliance is to educate the board of directors and customers about social engineering risks and best practices in information security.

Declarations

Relevant dataset citations in the reference list are provided and verified.

The authors declare no competing interests.

1 Market discipline refers to a practice by which market actors, such as depositors and shareholders, oversee bank risks and take steps to minimise unwarranted risk-taking.

2 In fractional reserve banking systems, banks hold limited amounts of cash hoping that all depositors will not withdraw at the same time. Nonetheless, banks are exposed to the risk of self-fulfilling panics caused by mass hysteria that leads their customers to withdraw the funds at the same time for fear that the institution may go kaput.

3 A loan for which the principal or interest payment is more than 90 days past due.

4 Depositors who attempt to withdraw their money from a bank in a coordinated effort because they believe the bank will fail.

5 Central Bank (Monetary Authority) of India.

6 A deposit insurance policy that protects against losses on bank deposits if a bank goes bankrupt and has no funds to pay its depositors, forcing it to liquidate.

7 Banks registered in the second schedule of the Reserve Bank of India Act, 1934.

8 The “Directions” were later extended up to June 30, 2021.

9 Urban Co-operative Bank.

10 Since it is a classic case of cooking the books, diverse sources have claimed different figures.

11 Core banking system is the core ledger and account management system for banks. It collects relevant financial as well as non-financial information, data and documents for all the depositors and borrowers. It also automatically prepares daily accounts for a bank as a whole, which are used for regulatory and compliance purposes. “As on March 31, 2019, of the 1542 primary cooperative banks in the country, over 1436 banks had implemented CBS”.

12 The exact number of deaths is still unknown, although the cause is “severe stress” caused by a suspension of withdrawals.

13 The autonomous body instituted by the RBI to insure bank deposits in the event of bank failure.

14 Centrum Capital is a Bombay Stock Exchange-listed entity.

15 A fintech company.

16 A unique identification number given to every customer holding an account with a bank.

Publisher's note

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Teaching notes

This study explores the importance of business ethics, information sharing and transparency to build an information-driven society by scouting the case of Punjab and Maharashtra Co-operative (PMC) Bank, India, which defaulted on payments to its depositors and was placed under Reserve Bank of India’s directions due to a massive fraud perpetrated by bank officials. The crisis worsened when uninformed and panic-stricken investors advanced their narrative through fake news peddled via social media channels, resulting in alarm that caused deaths of numerous depositors. It exposed several loopholes in information management in India’s deposit insurance system and steered the policy makers to restructure the same, thus driving the country consistent with its emerging market peers. The study further identifies best practices for aligning employees towards ethical behaviour in a virtual workplace and the pedagogical approaches for information management in the new normal.

Target Audience

Educators in the field of banking, business ethics, corporate governance and organizational behaviour; practitioners; various stakeholders of banks; and policy makers.

Learning Objectives

[1] To offer practical suggestions for creating an environment conducive to ethical learning;

[2] To explore the importance of business ethics, information sharing and transparency for building an information-driven society;

[3] To identify best practices for aligning employees toward ethical behaviour in a virtual workplace, and assessing them;

[4] To identify pedagogical approaches for information management and ethics education in the new normal.

Questions for Discussion

[1] What is the overall problem presented in this case?

Answer. The case explores the importance of business ethics, information sharing and transparency to build an information-driven society by scouting the case of Punjab and Maharashtra Co-operative (PMC) Bank, India, which defaulted on payments to its depositors and was placed under Reserve Bank of India’s (RBI) directions due to a massive fraud perpetrated by bank officials.

[2] What are the factors affecting the problem(s) related to this case?

Answer. The case investigates the changing paradigm of business ethics in a dynamic world that is gradually shifting towards virtual technology in the milieu of the global pandemic.

[3] How can an organization align employees in a virtual workplace?

Answer. Organizations must offer fresh prototypes for new ethical circumstances as they arise, and employees must be exposed to such prototypes on a frequent basis. As a case in point, there is growing consensus on previously uncharted ethical territory such as inspection of electronic mail, staff supervision, and genetic screening; employees can consolidate them into their decision-making based on the extent to which organizations impart these norms consistently.

[4] What are the objectives of project premortem?

Answer. The objectives of project premortem are to assess the viability of a project at the start of a project itself, allowing it to be enhanced rather than autopsied.

[5] What are the challenges in the virtual work environment that educators have been facing in the new normal?

Answer. During the pandemic, not only the students, but also the educators began a new era of learning. For educators who had been accustomed to textbook teaching, the enormous technological innovation in the education sector has been both demanding and novel. To make their online classes seamless and compelling, they had to learn far more than their students. During the online classes, educators had to push students to be more engaged and active. They made certain that the lessons were fresh and original enough for pupils to follow and grow from them. Teachers led interactive sessions to ensure that every student in the class was involved. Instead of remaining at home and keeping their beliefs to themselves, they were encouraged to express their views and have healthy discussions. Both students and educators went above and beyond to make online learning a rewarding experience. As a result, the educational sessions turned out participatory and therapeutic in nature.

List of Additional Sources.

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Grace, D., & Cohen, S. (1995). Business ethics . Australia: Oxford University Press.

Gupta, A. D. (2016). Ethics, profession, and rational choice. Asian Journal of Business Ethics, 5 (1-2), 53-60. https://doi.org/10.1007/s13520-016-0054-6 .

Lütge, C., & Uhl, M. (2021). An economically informed approach to business ethics. Business Ethics, 1-2. https://doi.org/10.1093/oso/9780198864776.003.0001 .

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McManus Warnell, J., & Umeda, T. (2019). Perspectives on Business Ethics in the Japanese tradition: Implications for global understanding of the role of business in society. Asian Journal of Business Ethics, 8 (1), 25-51. https://doi.org/10.1007/s13520-019-00087-2 .

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Venkatadurai, J., Dhyani, U., & Sharma, M. (2013). Ethics and morality beyond normative theories. Asian Journal of Business Ethics, 3 (1), 35-39. https://doi.org/10.1007/s13520-013-0029-9 .

Contributor Information

Sushma Nayak, Email: moc.liamg@28kayanamhsus .

Jyoti Chandiramani, Email: [email protected] .

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Does credit risk persist in the Indian banking industry? Recent evidence

Asian Journal of Economics and Banking

ISSN : 2615-9821

Article publication date: 2 August 2021

Issue publication date: 4 August 2022

This study aims to capture the “persistence effect” of credit risk in Indian banking industry using the bank-level data spanning over the period of 19 years from 1998/1999 to 2016/17. Alongside, the study explored how the bank-specific, industry-specific, macroeconomic variables alongside regulatory reforms, ownership changes and financial crisis affect the bank's asset quality in India.

Design/methodology/approach

Using two-step system generalized method of moment (GMM) approach, the study derives key factors that affect the bank's asset quality in India.

The empirical results confirm the time persistence of credit risk among Indian banks during study period. This reflects that bank defaults are expected to increase in the current year, if it had increased past year due to time lag involved in the process of recovery of past dues. Further, higher profitability, better managerial efficiency, more diversified income from nontraditional activities, optimal size of banks, proper credit screening and monitoring and adherence regulatory norms would help in improving the credit quality of Indian banks.

Practical implications

The practical implication drawn from the study is that nonaccumulation of nonperforming loans (NPLs), higher profitability, better managerial efficiency, more diversified income from nontraditional activities, optimal size of banks, proper credit screening and monitoring and adherence regulatory norms would help in improving the credit quality of Indian banks.

Originality/value

This study is probably the first one that identifies in addition to the current year, whether lag of bank industry-macroeconomic affects the level of NPLs of Indian banks. So far, such an analysis has received less attention with respect to Indian banking industry, especially immediate aftermath of the global financial crisis.

• Credit risk
• Persistence effect
• Dynamic estimation
• Indian banks

Goswami, A. (2022), "Does credit risk persist in the Indian banking industry? Recent evidence", Asian Journal of Economics and Banking , Vol. 6 No. 2, pp. 178-197. https://doi.org/10.1108/AJEB-01-2021-0006

Emerald Publishing Limited

Copyright © 2021, Anju Goswami

Published in Asian Journal of Economics and Banking . Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http://creativecommons.org/licences/by/4.0/legalcode

1. Introduction

The recent global financial crisis of 2007–08 has stimulated the interest of academicians, policymakers and researchers to the key consequences that banking crisis can have on to the nation's economy. The situations of financial crisis intensify the banking distress, and in the process, become one of the main obstacles to the stability of the financial system, in general, and banking system, in particular. More specifically, a rapid increases in asset prices, high leverage of borrowers and lenders, a decline in lending standards, coupled with liquidity and/or insolvency problems caused by the increase in nonperforming loans (NPL) and regulation and supervision failures may pace up the risk of an occurrence of such financial crises ( Laeven and Valencia, 2008 ; Castro, 2013 ; Claessens et al. , 2014 ). Caprio and Klingebiel (1996) concluded that such crises in the past have resulted in severe bank losses or public sector resolution costs, especially in developing countries [1] . Such a consequences of banking crises has raised the concern as to the reasons why such crises occur? The credit risk, which arises due to bubbling up of NPLs in the bank's balance sheets, generally overlays the other causes for the occurrences of banking crisis since it can seriously undermine the financial soundness of the banking sector.

The level of NPLs or impaired loans is generally used as a critical indicator to quantify the credit risk burden, which represent the risk of loss due to nonpayment by the borrower ( RBI, 2007 ) [2] . Currently, the high level of NPLs in banks has been a matter of grave concern for all nations' policymakers since it creates bottlenecks in the smooth flow of credit in the economy. This underlines the procyclical behavior of the banking system, wherein asset quality get compromised during periods of high credit growth and results in the creation of default risk for banks in the later years. In the Indian context too, the gross and net NPLs as a percentage of advances stood at 15.7 and 8.1% in 1996–1997, which later declined to 2.3 and 1.1% in 2007–08, reflecting an improvement in asset quality in post-reforms period. But, during the crisis year 2008–09, the gross NPLs ratio remained stable for Indian banks, reflecting the success of financial sector deregulation and reforms, regulatory and supervisory process. In particular, banks have made substantial progress in cleaning up the NPLs from their balance sheets during the pre-crisis period ( Reserve Bank of India, 2004 ).

However, the robust credit growth (of more than 30%), followed by economic expansion (of around 10%), in the Indian economy during 2006–2011, has further raised concern with regard to the credit risk. As of March 2015, gross and net NPLs for the Indian banking system as a whole rose at 4.4 and 2.4% of total advances, respectively, doubled from the 2007–08 level. Thus, due to an excessive credit lending to troubled borrowers and mismanaged information regarding borrowers, reduced the likelihood of them to repay their debts and increased the probability of defaults ( Reserve Bank of India, 2011 ). Now, the distressed asset crisis weighed heavily on credit growth in India, which stood at only 4% for public sector banks, compared with 25% for private banks as at end March 2016. The public sector banks now have no ability to take on additional credit risk which poses a serious issue for the economy. From the above discussion, it is clear that the rising NPLs cause a serious concern for the policymakers, regulators, government and the central bank. For minimization of the credit risk, the bank regulators need to undergo deeper investigation of its underlying determinants. The present study is an attempt in this direction.

Against this backdrop, the key objective of this paper is to examine the determinants of credit risk in Indian banking industry for more recent time period, i.e. 1999–2014, covering the period following the global financial crisis. This study intends to provide evidence on the factors determining the credit risk structure in the emerging nation with special reference to Indian banking industry. The contribution of our study to the existing literature on credit risk determinants is threefold. First, this study provides new and most recent evidence on the time persistence in accumulation of NPLs in the Indian banking industry. For the estimation of “persistence effect”, the study employs a two-step system generalized method of moment (GMM) estimation method on an unbalanced panel of bank-level data spanning over the period of 19 years from 1998/1999 to 2016/17. The study further provides the pooled OLS, PCSE, within group fixed effects and two-step difference GMM estimates for robustness check.

Second, this study is probably the first one that identifies in addition to the current year, whether lag of bank-industry-macroeconomic also generates a burden of credit risk in Indian banking industry. This study would perhaps be the first one to consider the role of prudential norms, crisis and ownership structure as additional factors, along with size, profitability, credit growth, diversification, market concentration, bank solvency, among others, underlying the dramatic changes in credit risk structure of Indian banking industry. I believe this study has potential to provide a clear and lag-wise scenario of bank-macro and industry-specific factors for credit risk to regulators and stakeholders of Indian banks. So that they can form the necessary strategy against those factors, which are fully responsible for the generation of NPLs in the banking industry in India.

Finally, our study provides an evidence for a single country with particular reference to the Indian banking industry. Such an analysis bear a great significance due to the fact that the Indian economy has bank-based financial system like Indonesia and Pakistan, where banks play an important role in their financial system, and any shock to banks ultimately impact the entire economy ( Demirgüç-Kunt and Levine, 1999 ). This study seems to have relevance in the current scenario due to surging bad loans in the balance sheets of Indian banks in the recent years. Furthermore, bank's NPLs in India as a percentage of gross loans has been found to be consistently far above the levels seen in other Asian economies [3] . Ahmad and Ariff (2007) concluded that the credit risk in emerging economy banks is higher than that in developed economies, and that risk is formed largely by bank-specific factors in emerging economies compared to their counterparts. In this regard, this study would try to help the bank managers in identifying the factors that may lead to deterioration in credit quality and increase the burden of default risk. So far, such an analysis has received less attention with respect to Indian banking industry, especially in the aftermath of global financial crisis.

The rest of the paper is organized as follows. Section 2 discusses credit risk scenario in in the Indian banking industry. Section 3 presents a relevant literature review on the subject matter. Section 4 encompasses description of databases, methodology and discussion on conceptual framework. Section 5 focuses on results and discussion, while Section 6 concludes the findings of the study.

2. Review of the literature

A significant body of the literature has evolved in the past which explored the determinants of credit risk in the banking sector. In particular, there exit two strands of the literature on the determinants of bank credit risk ( Castro, 2013 ; Aver, 2008 ; Ahmad and Ariff, 2007 ). The first volume of the literature focused primarily on the factors affecting systematic credit risk (e.g. macroeconomic factors, economic policies, political changes, etc.). The studies that only examined the macroeconomic factors affecting the credit risk include Baboucak and Jancar (2005) , which provide the systematic assessment of the links between loan quality and macroeconomic shocks in the Czech banking industry. They found a direct relation between NPLs, rate of unemployment and consumer inflation rate, while an inverse relation with GDP growth in the Czech economy. On the similar grounds, Nkusu (2011) analyzed the credit risk determinants across 26 advanced economies during the period spanning from 1998 to 2009. They found that NPLs were positively explained by macroeconomic variables such as the unemployment rate, policy rate of interest and lagged NPLs, while negatively explained in GDP growth rate, housing price index and equity price index. Beck et al. (2013) examined the role of macroeconomic indicators in 75 advanced and emerging economies during the period 2000–2010 and concluded that the bank asset quality significantly affected by a drop in real GDP growth, share prices, the exchange rate and the lending interest rate. Further, exchange rate depreciations have also lead to an increase of NPLs in sampled countries. Similarly, Castro (2013) analyzed the link between the macroeconomic factors and credit risk in the Greece, Italy, Portugal, Spain and Ireland by employing dynamic panel data approaches over the period 1997q1–2011q3. They conclude that the credit risk increases when GDP growth, share price indices and housing prices decrease and rises when the unemployment rate, interest rate and credit growth increase.

In contrast, the second strand of the literature has also considered the role of unsystematic risk factors (e.g. bank-specific, industry-specific, regulatory and institutional, etc.) in generating the default risk. Considering the relationship between bank's efficiency and bad loans, Berger and DeYoung (1997) performed Granger causality analysis for the period 1984–1995 and found that less cost efficient banks wind up having more problem loans. They also concluded with the importance of four hypotheses explaining the relationship between efficiency and NPLs – bad management, bad luck, moral hazard and skimping hypotheses. Ahmad and Ariff (2007) explored a sample of four advanced and five developing nations and concluded that regulatory capital, management quality and loan loss provisions were significant determinants of potential credit risk. Louzis et al. (2012) explored the factors that affect NPLs from three categories of loans mortgage, business and consumer separately. The results show that, for all loan categories, NPLs in the Greek banking system have been explained mainly by GDP, unemployment, interest rates, public debt and management quality. The similar findings have been revealed by Abid et al. (2014) for Tunisian banking industry. Using the panel dataset of 80 banks in the GCC region, Espinoza and Prasad (2010) found that lower non-oil real GDP growth and higher interest rates increased the level of NPLs during the period of 1995–2008. Further, a positive relationship has been found between lagged credit growth and NPLs. Khemraj and Pasha (2009) found that real effective exchange rate and real interest rate to have a positive significant impact on NPLs, while GDP growth, loan to assets ratio and loan growth had a negative impact. Makri et al. (2014) also found strong correlations between NPL and various macroeconomic (annual GDP growth rate, public debt to GDP ratio and unemployment rate) and bank-specific factors (return on equity and capital adequacy ratio).

Using a dynamic panel analysis, Chaibi and Ftiti (2015) compared the determinants of NPLs of commercial banks in France (a market-based economy), with Germany (a bank-based economy) during 2005–2011. The empirical results reveal that credit risk in France is more susceptible to bank-specific determinants compared to Germany. Klein (2013) observed the persistence of NPLs in 16 Central, Eastern and South Eastern Europe countries during 1998–2011. Further, unemployment, inflation, exchange rate, VIX and loan growth has been found to positively explain the NPLs, while the solvency ratio, ROE and GDP growth rate had a negative association. The similar findings have been reported by Skarica (2013) . Alhassan et al. (2014) also found the persistence of NPLs in Ghanaian banking sector, with loan growth, bank market structure, bank size, inflation, real exchange rate and GDP growth to have a significant effect on banks' asset quality. Finally, Ghosh (2015) analyzed the persistence effect of credit risk in US banking sector during the period 1984–2013 using dynamic panel estimation method. The results reveal that greater capitalization, liquidity risks, poor credit quality, greater cost inefficiency and banking industry size to significantly increase NPLs, while greater bank profitability lowers NPLs.

In Indian context, Rajaraman and Vashishtha (2002) were the first one to examine the factors influencing the NPLs in the public sector banks during the period 1996–2000. They found that operating profit to working funds has a significant negative impact on asset quality of public sector banks in India. Later, Ranjan and Dhal (2003) also considered a sample of public sector banks and found that bank size in terms of assets has the negative, while in terms of capital has positive impact on gross NPLs. Das and Ghosh (2007) empirically reported the high persistence of credit risk across state-owned banks in India during the period 1994–2005. Using the balanced panel data of 19 private and 26 public sector banks operating in India during 2005–2013, Satpathy et al. (2015) found that operating inefficiency, restructured debt and inflation rate have a positive impact on NPLs, while credit growth, priority sector advances, fiscal deficit, GDP growth rate, lending rate, trade balance and advanced to sensitive sector seems to have a negative effect. Bardhan and Mukherjee (2016) find the persistence effect of NPAs in the Indian banking industry. A higher level of capitalization, profitability and GDP growth lowers NPAs level in the following years, while the lagged size of banks and inflation leads to a higher level of NPAs in the Indian banking industry. Bawa et al . (2019) find that lagged NPAs level is positively associated with the current NPAs level in the Indian banking industry during the period 2007–2014. In addition, they reveal that a higher intermediation cost and return on assets tend to reduce the level of NPAs, while aggressive asset growth and solvency induce a rise in the level of NPAs. Using a two-step system GMM approach, Gulati et al . (2019) explore the key determinants of credit risk for the period 1998/99 to 2013/14. They find a persistence effect of credit risk in the Indian banking industry.

From the above survey of literature, following observations have been made. First, it is clear that most existing studies on credit risk determinants in the banking industry relates to either those of developed nations or were conducted in cross-country settings, especially in the aftermath of global crisis. No doubt, the research efforts have also been made to investigate the factors contributing to credit risk in single-country settings, but large majority of studies have focused on European nations. Thus, among the existing studies, there exist only few one whose attention is directed to developing countries. Second, the contemporary literature proves that, in the past, most of the studies concentrated on macroeconomic linkage of credit risk, while few other studies incorporate the role of bank-specific and other factors which may be responsible for the rise in NPL levels. The large majority of studies mainly focused on the macroeconomic and bank-specific factors, but the changes in credit worthiness of borrowers, depth of information sharing, regulatory policies, governance structure which are difficult to examine and left out of consideration. Third, only a handful of studies have accounted for the persistence of credit risk in the banking sector. The large majority of research efforts were only after the global crisis of 2007–08, and that too for US and European banks. However, none of the existing studies tried to identify that whether accumulation of credit risk, bank-macro and industry-specific factors may impact the NPLs level over the last 3 decades in the Indian banking industry or not. The present study aims to attempt in this direction. I believe this study has potential to provide a clear and lag-wise scenario of bank-macro and industry-specific factors for credit risk to regulators and stakeholders of Indian banks. So that they can form the necessary strategy against those factors, which are fully responsible for the generation of NPLs in the banking industry in India.

It is obvious that there is a gap in the contemporary literature, regarding the determinants of NPLs in the developing and emerging nations, particularly India. The studies pertaining to Indian banking sector have mainly looked at the determinants of credit risk in the public sector banks only (see, Das and Ghosh, 2007 ), which currently forms only 75% of the business operations in terms of total assets in India. This study is perhaps an effort to consider full range of sample of Indian banks (including public, private and foreign banks) operating in India from 1998–99 to 2016–17. Further, it has been observed that credit risk in emerging economy banks has been found to be higher than that in developed economies ( Ahmad and Ariff, 2007 ). So, considering the above notion, our study tries to fill this gap for emerging nations by empirically investigating the determinants of credit risk across a bank-based economy like India. The study would not only analyze all the possible factors that may deteriorate the asset quality but also account for the persistence of credit risk in Indian banks.

3. Database and methodology

3.1 database.

Our study considers all the banks operating in the industry during the period from 1998/99 to 2016/17. The bank-level data pertaining to all the variables have been obtained from the various issues of “Statistical Table Relating to Banks in India”, an “ annual publication of Reserve Bank of India (RBI) ” and “ Performance Highlights of Public Sector Banks ” , “ Performance Highlights of Private Banks' and Performance Highlights of Foreign Banks' ”, an “ annual publications of Indian Banks' Association” (IBA). The real GDP growth rate (%) and inflation rate (%) for each sample year has been obtained from the World Bank database. Finally, the mergers and acquisitions, and exit of some banks from the industry have left us with the unbalanced panel of banks for the above mentioned period.

3.2 Dynamic panel model estimation

This study adopts the two-step system generalized method of moments (GMMs) technique of Blundell and Bond (1998) to test the time persistence in credit risk structure in the Indian banking industry for the following reasons: (1) in the presence of the lagged dependent variable, Y i , t − 1 , the traditional panel estimators are seriously biased (see, Baltagi, Econometric Analysis of Panel Data , 5th edition, 2013 and Roodman, D., through the looking glass, and what OLS found there: on growth, foreign aid and reverse causality. Unpublished working paper, Center for Global Development, 2008); (2) fixed effects model's accuracy deteriorates when the panels are unbalanced. Therefore, the use of system GMM method appears to outperform than the fixed effects model in the presence of endogeneity and lagged dependent variable in unbalanced panels (see, Arellano and Bond, 1991 ; Blundell and Bond, 1998 ) and (3) one-step GMM estimation can produces consistent estimates under the assumption of independent and homoscedastic residuals (both cross-sectional and over time). However, its standard error is largely downward biased in small samples. Therefore, Windemeijer's (2005) correction for small sample is applied to rectify the standard error bias. Consequently, the two-step GMM estimator is used which provides more accurate estimates than the robust one-step GMM estimator, especially for the system GMM ( Roodman, 2006 ). In addition, the study uses the Arellano and Bover (1995) forward orthogonalization procedure and collapsing method of Holtz-Eakin et al. (1988) to limit the number of instruments (for more details, see Roodman, 2009 ).

The factors that determine credit risk have been examined based on the generalized method of moments. The dynamic panel data specification used is given by: (1) Y i t = α + δ Y i , t − 1 + ∑ j = 1 J β j X i t − s j + ∑ z = 1 Z γ z X i t − s z + ∑ k = 1 K θ k X i t − s k + ∑ d = 1 D η d X i t d + μ i t where  | δ | < 1 , i = 1 , ... N , t = 1 , ... , T , s = 0,1 , ... , L where the subscripts i and t denote the cross-sectional and time-dimensions of the panel, respectively. The dependent variable, Y i t , used is the logit transformation of the net nonperforming loans to total advances, a proxy for credit risk for i th bank in the t th year. As suggested by Espinoza and Prasad (2010) , Klein (2013) , Wenzel et al. (2014) and Ghosh (2015) , such transformation ensures the dependent variable to span over the interval [+∞, −∞] and is distributed symmetrically. Further, it allows the assumption of normality in the error term and accounts for nonlinearities in a way that larger shocks to the explanatory variables may cause a large, nonlinear response in the transformed dependent variable. The value of δ lies between 0 and 1 implies persistence of credit risk. β j X i t − s j denotes bank-specific variables in t - s period, β z X i t − s z , β k X i t − s k and β d X i t − s d macroeconomic, industry-specific and dummy variables (see, section 4 for more details). Further, μ i t = η i + ν i t , where η i represents the unobserved bank-specific effects, and ν i t is the error term.

The overall validity of the instruments has been tested by using the Hansen J specification test, which under the null hypothesis of joint validity of the moment conditions (the presence of over-identification) is asymptotically distributed as chi-square ( Arellano and Bond, 1991 ; Arellano and Bover, 1995 ; Blundell and Bond, 1998 ). Furthermore, we assess the fundamental assumption of serially uncorrelated errors, i.e. ν i t using Arellano–Bond tests for Autoregression AR(1) and AR(2) by testing the hypothesis that Δ ν i t is not second order autocorrelated. The rejection of the null hypothesis of no second order autocorrelation of the differenced errors implies serial correlation for the level error term and thus, inconsistency of the GMM estimates.

4. Variable(s) specification

4.1 dependent variable.

In the present study, we use the ratios of net nonperforming loans (NNPLs) to total advances as proxies for credit risk. Much of the literature on credit risk (see, for example, Salas and Saurina, 2002 ; Das and Ghosh, 2007 ; Espinoza and Prasad, 2010 ; Klein, 2013 ) has considered the dependent variable in dynamic panel data regression using logit transformation of either GNPLs or NNPLs. Similarly, we define the dependent variable as of the following: ln   [ NNPLs i , t / ( 1 − NNPLs i , t ) ] in case of net NPLs specification. It is important to note that this transformation ensures the dependent variable to span over the interval [ − ∞ , + ∞ ] (as opposed to between 0 and 1 in case of NPLs ratio) and is distributed symmetrically.

The rest of systematic (macroeconomic) and unsystematic factors that are expected to form credit risk in the Indian banking industry are listed in Table 1 . However, the brief description of each independent variable(s) is given below.

4.2 Systematic (macroeconomic) variables

4.2.1 real gdp growth rate (rgdp).

The real GDP growth rate (RGDP) is used to control the effect of macroeconomic business activity. The literature suggest that during the periods of expansion, growth in real GDP usually increase the income which ultimately enhances the loan payment capacity of the individual and corporate borrowers which in turn contribute to lower default. As the expansion period continues, credit is then extended to lower quality debtors and subsequently results in increase in NPLs in the recession period. Thus, considering the above notion, the literature suggest that a negative relationship between economic activity and NPLs (see for, e.g. Ranjan and Dhal, 2003 ; Khemraj and Pasha, 2009 ; Nkusu, 2011 ; Beck et al. , 2013 ; Castro, 2013 ; Chaibi and Ftiti, 2015 ).

4.2.2 Inflation rate (INF)

The literature spells an ambiguity in the relationship between NPLs and inflation. The studies by Baboucek and Jancar (2005) , Klein (2013) and Alhassan et al. (2014) have found that an increase in inflation rate (INF) characterized by uncertain business conditions worsens the loan payment capacity by eroding the purchasing power of consumers and reducing the real income of borrowers, and thus reduces the debt servicing capacity resulting in increased risk of nonpayment of loans. On the contrary, a rise in inflation rate in the current period could see a reduction in the level of NPLs. This is because it can enhance the loan repayment capacity of borrower by reducing the real value of outstanding debt ( Shu, 2002 ; Khemraj and Pasha, 2009 ).

4.3 Unsystematic (bank-specific) variables

Return on assets (ROAs) is expressed as a proxy for bank's profitability. It is expected that better bank's performance in terms of profitability lowers the level of NPLs. Louzis et al. (2012) , Castro (2013) and Chaibi and Ftiti (2015) found that more profitable bank reflect better management quality in terms of efficiency in borrower's application screening and credit granting procedures, which may likely to lower the risk of defaults as supported by the “bad management” hypothesis. Thus, ROA is hypothesized to have a negative relationship with the level of NPLs. On the contrary, Rajan (1994) model suggests that higher profits may also lead to rise in NPLs. This may be due to “ liberal credit policy ” adopted by banks' management to maximize banks' earnings to maintain the short-term reputation. This view has been empirically tested by Ghosh (2015) .

4.3.1 Non-interest income (NONIT)

The ratio of non-interest income (NONIT) to total assets is used as a measure of income diversification which may expect to lower the risk from traditional lending. Banks earnings not only depend on loans and advances but also rely on NONIT like fee-paying and commission paying services, investment banking, assets management, etc. It leads to reduction in the bank credit risk from loans due to bank's diversified sources of income. Following Alhassan et al. (2014) , Chaibi and Ftiti (2015) and Louzis et al. (2012) , a negative association is hypothesized between NONIT and credit risk.

4.3.2 Credit growth (CGROWTH)

The literature suggests that growth in advances of a bank also helps in determining the credit risk. It is expected that higher loan growth leads to higher NPLs. It is argued that increase in supply of loans may reduce the credit standards, thereby increase the chances of loan defaults by borrowers ( Keeton, 1999 ). Following, Espinoza and Prasad (2010) , Messai and Jouini (2013) and Alhassan et al. (2014) , the study proxied credit growth by total loan growth, i.e. percent change in the current year loans and advances with previous year's by an individual bank.

4.3.3 Bank size (SIZE)

This variable is proxied by natural logarithm of bank's total assets. Empirical evidences on the relationship between NPLs and bank size (SIZE) is ambiguous. The large banks are assumed to have better risk management techniques, which ensure proper screening of loan applicants and lower default rate and better diversification opportunities. In this line of research, Salas and Saurina (2002) , Ranjan and Dhal (2003) and Alhassan et al. (2014) reported a negative impact of SIZE on asset quality. Some of the empirical studies that have argued that as banks become too large, monitoring and evaluation become difficult as they take on increased risk and may lead to “too big to fail” ( Louzis et al. , 2012 ).

4.3.4 Inefficiency (INEFF)

The credit risk may also be determined by bank's inefficiency (INEFF) defined by a ratio of total operating expenses to total assets, i.e. intermediation cost of bank. The empirical literature suggests an ambiguity in the relationship between INEFF and NPLs. Berger and DeYoung (1997) argued that problem loans may arise either due to the events beyond the bank's control (“bad luck”) or management's INEFF to control lending risk (“ bad management ”). Either of the two situations will lead to increase future NPLs, implying a negative effect of INEFF on NPLs (see for, e.g. Chaibi and Ftiti, 2015 for French banks, Ghosh, 2015 ; Louzis et al. , 2012 ; Podpiera and Weill, 2008 ). On the contrary, the “skimping hypothesis” of Berger and DeYoung (1997) suggest that defaults are likely to increase with cost efficiency. This may be due to the fact that banks decide not to spend sufficient resources to ensure higher loan quality would appear to be efficient. This view has been empirically supported by Chaibi and Ftiti (2015) for German banks. Thus, the effect of inefficiency on NPLs may be expected to be negative or positive.

4.3.5 Bank solvency (SOLVENCY)

Following the Louzis et al. (2012) , Klein (2013) , Makri et al. (2014) , Chaibi and Ftiti (2015) and Ghosh (2015) , this study determines the effect of bank's solvency on asset quality by using a ratio of bank's equity to total assets. The literature suggests that managers of thinly capitalized banks have moral hazard incentives to engage in risky lending practices, along with poor credit screening and monitoring of borrowers ( Keeton and Morris, 1987 ). The inverse relation between solvency and NPLs validates the existence of “ moral hazard ” hypothesis in the Indian banking industry.

4.4 Industry-specific variable

4.4.1 concentration ratio (cr 10 ).

Only few studies have determined the impact of bank concentration on the credit risk. This variable measures a concentration of top ten banks in terms of advances in the industry during a particular year. The literature suggests that a higher concentration in lending by top ten banks increases the likelihood of credit risk. It is argued that banks with high degree of concentration may aggressive lend to specific sectors (such as agriculture and commerce) as a strategic choice to gain market power and earn higher profits which lead to high level of NPLs in future. Following Louzis et al. (2012) , we hypothesized the concentration to have a positive impact on credit risk.

4.5 Dummy variables

4.5.1 prudential norms (pnorms).

This variable is included in the econometric model as a dummy variable for a policy change. It represents a role of prudential norms in the improving the assets quality across Indian banks. The Reserve Bank of India has implemented a reform measure pertaining to classification of an asset as nonperforming and defined an asset to be a nonperforming when it remained not paid for 90 days, as on end of 2004. It is hypothesized that regulatory reforms has led to the improvement in the asset quality of Indian banks.

4.5.2 Ownership dummy (PUBLIC or PRIVATE)

The study estimates the differences in level of credit risk across distinct ownership groups using two ownership dummies – PUBLIC and PRIVATE. Higher coefficient value of PUBLIC relative to PRIVATE reflects greater credit risk among public sector banks.

4.5.3 Financial crisis (FINCRISIS)

In addition, we also incorporated the dummy to capture the influence of global financial crisis of 2007–09 on the credit risk structure of Indian banks.

5. Empirical results

5.1 descriptive statistics and preliminary evidences.

Table 2 reports the descriptive statistics of the sample data set. For the estimation purpose, the study used net NPLs to net advances as a proxy for credit risk. The dependent variable, the logit transformed ratio of net nonperforming loans to net loans (NNPLs), reports a mean value of −1.83, respectively. The negative mean values indicate that there has been a decline in impaired loans after write-offs over time. The average equity to total assets ratio is about −1.06, and log of total assets is about 4.89, respectively. The mean NONIT to total assets is approximate at 0.0085, and average ROA is 0.004 with SD 0.009. Broadly similar mean values have been observed for all the macroeconomic and industry-specific variables. The SWILK and SFRANCIA tests of normality indicate that all the variables are not normally distributed at the 1% level of significance.

Table 3 shows the cross-correlations between all the independent variables which are used in the study for estimation purpose. The results indicate that, except inflation and CR10, no significant indication of multicollinearity is observed among the independent variables [4] . Following the empirical literature, we also performed unit root tests for individual variables using the Fisher Augmented Dickey-Fuller (ADF) and the Phillips-Peron (PP) tests to establish the degree of data integration. Assuming the individual unit root process, the results reported in Table 4 reveals that all the individual variables are stationary at level.

5.2 Dynamic estimation

As noted above in Section 3 , the study employs dynamic panel estimation method to account for “persistence effect” in credit risk along with the set of potential systematic and unsystematic factors responsible in the formation of credit risk in Indian banking industry. For the estimation purpose, we employed two-step system GMM approach and presented the empirical findings in Table 5 .

5.2.1 Persistence effect

In order to account the persistence of credit risk in Indian banking industry, we included the first lag of NNPLs in the econometric model. The empirical findings, as reported in Table 5 , reveals the existence of “persistence effect” in credit risk among Indian banks with persistence coefficient ( δ ) to vary from 0.15 to 0.18% across different model specifications. This confirms that bank defaults are expected to increase in the current year, if it had increased past year due to time lag involved in the process of recovery of past dues. The results thus clearly provide an evidence of time persistence in accumulation of bad loans in the Indian banking industry. Further, the effect on NPLs has prolonged in the aftermath of the financial crisis of 2007, and it would take time to reduce at a significant level. The plausible reason for this may be that the Indian bank has followed a procyclical pattern of credit growth (during 2004–2007), in which they gave aggressive loans to stressed sectors (namely, infrastructure, coal mining and aviation, etc.), which grossly compromised their credit quality in 2011 due to economy slowdown and ultimately contributed to higher defaulters. The significant positive effects of lagged NNPLs in all the estimated models in Table 5 are similar to the findings of Louzis et al. (2012) , Ghosh (2015) and Bardhan and Mukherjee (2016) .

5.2.2 Bank-specific effects

Bank's profitability (ROA) : On discussing the effect of profitability on bank's asset quality, we note that current year rise in ROA by 1% leads to decline in risk of future accumulation of NPLs by (−) 0.0079 to (−) 0.0120%. This suggests that if the profitability of Indian bank(s) increases, they engage themselves in more prudent lending, with more careful screen and monitors the borrowers, which may lead a reduction in the risk of defaults. This empirical finding is consistent with Ghosh (2015) and validates the existence of “ moral hazard ” hypothesis in Indian banking industry. If one period lag of ROA is considered, the sign of the coefficient changes significantly. It indicates that past year's profitability of Indian banks on an average generate 0.0018–0.028% higher level of NPLs, signifying the fact that Indian banks have not followed prudent lending practices in the past years. This may be due to “ liberal credit policy ” adopted by banks' management to increase the credit supply and maximize banks' earnings, thus supporting “ bad management ” hypothesis. This finding of our study is consistent with Makri et al. (2014) , Messai and Jouini (2013) , Abid et al . (2014) , Chaibi and Ftiti (2015) and Klein (2013) . Further, it has been noted that in many developing countries, accounting standards have not been rigorous enough to prevent banks and their borrowers from concealing the true size of their NPAs portfolio. Most often, bad loans were made to look good by additional lending to troubled borrowers (“ ever-greening ”) ( Reserve Bank of India, 1999 ).

Surprisingly, the current year's 1% rise in NONIT to total assets ( NONINs ), increases the default risk by 0.0032–0.0047%, indicating that a higher the share of NONIT of banks, higher the risk for banks. This reflects risk-taking behavior of banks where they rely more on other risky investment portfolios with a view to diversify source of income rather to still depend upon the interest income incurred from loan repayment. This is also found by Ghosh (2015) . As expected, the previous year coefficient of NONIT has been found to be negative, implying that if past years' investment portfolio of banks generate good source of income from nontraditional activities then banks rely less on the interest income from loan repayment, which ultimately leads to reduction in the bank credit risk ( Louzis et al. , 2012 ; Ghosh, 2015 ; Alhassan et al. , 2014 ; Chaibi and Ftiti, 2015 ).

The large sized banks, on an average, generate higher NPLs by 0.753–1.186% in Indian banking industry. The other studies suggesting the positive relation between size and risk are Khemraj and Pasha (2009) , Louzis et al. (2012) and Chaibi and Ftiti (2015) . This reflects that large banks take excessive risk and extend their credit without proper screening and monitoring of the borrower's creditworthiness. This is also supported by an incident happened in the year 2010–11, where State Bank of India, the India's biggest lender bank, extended loans to troubled corporate borrower(s) which in turn led to deterioration in the asset quality of this bank. The lagged size effect has been found to be significantly negative in all the models (similar to Alhassan et al. , 2014 ; Ghosh, 2015 ). This shows that the smaller bank may have greater managerial efficiency than larger banks in terms of screening and monitoring of loans, leading to lower defaults.

The intermediation cost found to have expected negative sign for gross NPLs (see, Table 5 ), suggesting that Indian Banks had been very economical in making expenses on credit screening and monitoring to remain cost efficient, but it led to rise in gross NPLs in future. However, the inefficiency does not seem to have any significant impact on net NPLs adjusted for provisions.

5.2.2.1 Industry-specific effects

The impact of bank's concentration in terms of advances (CR10) in terms of market power is positively significant positive on asset quality. This is in contrast with the prediction of “ tight control ” hypotheses ( Louzis et al. , 2012 ). As the market concentration increases, the market power of top ten concentrated banks will also increase and they make more lending mainly to the stressed sector may be due to political or regulatory pressures. This is evident from the fact that Indian banks had high levels of stressed assets from five stressed sub-sectors including infrastructure, iron and steel, textiles, mining (including coal) and aviation, resulting in increased chances of future defaults ( Reserve Bank of India, 2014 ).

5.2.2.2 Macroeconomic effects

Our results suggest that lower probability of risk of default during the periods of inflation in Indian banking industry. This may be due to adjustments in policy rates by the central bank as a step to contain inflation which reduces the real value of outstanding loans and make debt servicing easier for the borrowers. This is line with Chaibi and Ftiti (2015) , Khemraj and Pasha (2009) , and Makri et al. (2014) . Finally, the coefficient estimate of RGDP has not shown any significant impact of economic activity during the analyzed period.

5.2.2.3 Dummies effect

The implementation of prudential regulatory reforms in 2004–05 has revealed a significant decline in nonperforming loans. On an average, net NPLs have lowered by (−)0.6866% annually during the sample period. Further, the study also examined the time-specific effects by including yearly dummies on NPLs in the model 5. We note a significant decline in NPLs due to implementation of prudential norms. An attempt has also been made to ascertain the diversify behavior of NPLs across distinct ownership groups. This ownership effect is captured by including PUBLIC and PRIVATE dummies in the model. It was found that risk of defaults is significantly lower in case of private banks and foreign banks as compared with public sector banks due to effective write-off (see, Table 5 ).

This study has empirically tested the overall validity of the instruments using the Hansen J specification test, i.e. to test the null hypothesis of joint validity of the moment conditions (the presence of over-identification), is asymptotically distributed as chi-square ( Arellano and Bond, 1991 ; Arellano and Bover, 1995 ; Blundell and Bond, 1998 ). The test is based on null hypothesis, i.e. whether all the instruments are valid in the panel data model or not?, which is consistent with the empirical findings of Table 5 and confirmed the acceptability of two-step system GMM model in the dynamic panel framework.

Furthermore, we also assess the fundamental assumption of serially uncorrelated errors ν i t in Table 5 , using Arellano–Bond tests for Autoregression. The test statistics are reported of AR(1) and AR(2) in Table 5 , test the null assumption that Δ ν i t are not first and second order autocorrelated. The rejection of the null hypothesis in first and second order autocorrelation in the differenced errors, implying no serial correlation for the level error term and thus again support the consistency of the GMM estimates.

5.3 Robustness check

To test the sensitivity of two-step system GMM estimates, we have also obtained pooled OLS (POLS), panel corrected standard error (PCSE) and fixed effects (FE) estimates. The results are reported in Table 6 . We note that the empirical results obtained using POLS, PCSE and FE confirms the findings of the two-step system GMM estimation. It has been restated that larger the size of bank, more engagement of bank in nontraditional activities, lower profitability and higher concentration of banks' in lending in the current year seems to increase the risk of defaults in future. Some additional findings of POLS, PCSE and FE estimates include (1) equity to total assets ratio exhibits a negative and significant impact on NPLs, especially in case of pooled OLS and fixed effects estimations which are in parallel to the findings of Chaibi and Ftiti (2015) , Klein (2013) and Louzis et al. (2012) . This suggest that low capitalized bank face increased credit risk and validates the “solvency” hypothesis in Indian banking industry and (2) previous year credit growth seems to have a significant positive impact on asset quality (as consistent with Ghosh, 2015 ; Espinoza and Prasad, 2010 ; Klien, 2013 ). It supports the “pro-cyclical” [5] nature, wherein credit quality can get compromised during the periods of high credit growth which lead to the creation of NPLs for banks in the future years. The macroeconomic variable INFLATION too exhibits the same sign and significance in case of POLS, PCSE and FE estimation as the system GMM. However, surprisingly current year's RGDP shows positive significant impact on NPLs. It may be due to poor credit standards adopted by Indian banks during the boom period (as supported by Beck et al. , 2013 ). Finally, a clear comparison of the expected sign between different estimation methods used in the present study are reported in Table 6 . It is observed that the results are similar for different estimation methods. The results thus provide strong justification for the use of two-step system GMM estimation as the results are over estimated when OLS is applied and underestimated for fixed effects estimation.

6. Conclusion and policy implications

In order to enhance the banking stability, it is vital to monitor the deterioration in credit quality which may increase the risk of defaults in the economy. With this, the present study is an effort to capture the “persistence effect” of credit risk and assess the factors that influence the asset quality in the Indian banking industry. In particular, we test for the persistence effect of credit risk in Indian banking industry during the period 1999–2014. To achieve this objective, the study employs two-step system GMM estimation approach and explored how the bank-specific, industry-specific, macroeconomic variables alongside regulatory reforms, ownership changes and financial crisis affects the bank's asset quality in India. Such an analysis would help the policymakers to clearly quantify the degree of credit risk persistence and identify the key factors which might be responsible in the formation of credit risk in Indian banks.

Following observations have been made from the empirical results. First, the study found the persistence in credit risk among Indian banks during 1999–2014. This confirms that bank defaults are expected to increase in the current year, if it had increased past year due to time lag involved in the process of recovery of past dues. Second, higher the profitability of Indian bank(s), lower is a risk of defaults in the current year. However, the past year's lower profitability, on an average, generate higher level of NPLs, signifying the fact that Indian banks may have not followed prudent lending practices in the past years. This may be due to “liberal credit policy” adopted by banks' management to increase the credit supply and maximize banks' earnings, thus supporting “ bad management ” hypothesis. Third, with the higher share of income from nontraditional activities in the past year, the probability of default risk gets lowered for Indian banks. This is due to the fact that if past years' investment portfolio of banks generate good source of income from diversified sources then banks rely less on the interest income from loan repayment. Fourth, large banks found to have taken excessive risk and extended their credit without proper screening and monitoring of the borrower's creditworthiness. This finding is also supported by the concentration effect. As the market concentration increases, the market power of concentrated banks will also increase, and they make more lending mainly to the stressed sector may be due to political or regulatory pressures which increases the risk of default. Fifth, probability of risk of default declines during the periods of inflation in Indian banking industry. Sixth, regulatory reforms in terms of prudential norms found to have improved the asset quality in Indian banks. However, the financial crisis of 2007–08 had no significant impact on credit quality of Indian banks. This might have been due to effective write-off done by the banks under distinct ownership groups, especially new private and foreign banks.

In all, the empirical results suggest that both systematic (macroeconomic) and unsystematic (bank-specific and regulatory factors) have been found to be crucial in monitoring the level of credit risk and preventing the deterioration in the asset quality. Further, higher profitability, better managerial efficiency, more diversified income from nontraditional activities, optimal size of banks, proper credit screening and monitoring, and adherence regulatory norms would help in improving the credit quality and minimizing the likelihood of default risk. The study found significant time persistence in the accumulation of NPLs, so adequate attention is required to these bank-specific factors to solve the problem of rising future NPLs. Further, to combat the impact of inflation on NPLs, regulatory authorities need to adjust the real value of outstanding loans, so that borrowers can easily repay back their dues on time.

Specification of variable(s)

Note(s): (1) Figures in parentheses are robust standard errors, (2) AR(1) and AR(2) are the Arellano-Bond test for first and second order autocorrelation of the residuals, (3) in case of AR(1), AR(2) and BP-CW Hettest, we reported the p -values and (4) ***, ** and * denotes significance levels at 10, 5 and 1%, respectively

Source(s): Author's calculations

It has been observed that such costs amounted to 10 percent or more of GDP in more than a dozen of developing country episodes during the past 15 years ( Reserve Bank of India, 1999 ).

Reserve Bank of India (2015) defined non-performing loans as a loan or an advance where interest and/or installment of principal remain overdue for a period of more than 90 days in respect of a term loan.

The information has been reported based on the ratio of non-performing loans to gross loans of banks across Asian countries. According to the IMF data as of 2015, NPLs in India are around 6% of gross loans followed by Thailand (under 3%) and Indonesia (a little over 2%).

According to Kennedy (2008) and Alhassan et al. (2014) , correlation coefficients of below 0.70 represents weaker relationship associated among variables.

It is noteworthy that in the year 2009–10, the growth in NPAs of Indian banks has largely followed a lagged cyclical pattern with regard to credit growth.

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Corresponding author

About the author.

Anju Goswami is currently working as an Assistant Professor at the Depertment of Economics and International Business, University of Petroleum and Energy Studies, Dehradun, India. She received the MHRD Assistantship to pursue her doctoral research. During her doctoral research, she is trained with the skills in constructing models using mathematical programming approaches to benchmark the performance of decision-making units. Currently, her key research interest includes efficiency and productivity analysis and banking institutions.

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INSIDE THE NPA CRISIS IN INDIA

By Shivani Khanna

A developing country is on the track of a successful trajectory when it’s banking system is strong and reliable. Banking sector recently is proving itself to be the backbone of a successful economy. With the monetized economies on the rise it happens to be a prerequisite demand that is worthy of attention.

Lately Indian banking system has been flouting the very aspect of safe keeping of public asset with it’s soring NPA crisis in history. Moreover, Indian government’s sheepishly reluctant attitude to handle the crises only digs the grave of the mighty Indian banking system. On 9 may 2017, the news press in India screamed about Vijay Mallya’s felony to 17 banks owing them 90 billion which sent a wave of shock throughout the market.

Similarly CBI received two complaints from PNB against billionaire diamantine Nirav Modi and a jewellery company alleging fraudulent transactions worth about 11,400 crore. State Bank of India recently posted a staggering loss of 6968 crore in FY-19.

NPA stands for Non-Performing Asset, a loan or advance for which the principal or interest payment remains overdue for a period of 90 days. In other words a dead asset for the bank which no longer will generate any revenue. Indian Public Sector banks collectively owed approximately 6.8 trillion Indian rupees as non-performing assets at the end of the fiscal year 2020.

With such humongous revenue losses especially in the public sectors which are usually offset due to various faulty and pretentious socialistic schemes of the government like MUDRA which gives out loans to less creditworthy or the needy people, banks file for bankruptcy.

NPA crisis reasons also include lack of intermediate contact between the bank and the government, state control of the banks with red tapism and inefficiency due to shorter tenures of executives and usually wage discrepancies. With loss of revenue the credit worthiness of a bank dies or rather even a speculation about it leads to it’s slow death. As the consumer confidence is shaken, an individual instinct orders him or her to withdraw his or her money from the banks, which ultimately leads to bankruptcy.

NPA crisis also takes place when top banks are not transparent about their npa crisis and also ill coordination due to dual control by RBI and centre through finance industry. Instead of tending to the grievances of the banking system, government usually resorts to recapitalization, a short term ineffective strategy through taxpayers money.

2019 budget announced a 70,000 crore bank recapitalisation programme to help public Sector banks shore up their capital reserves. With recapitalization of the banking sectors, inefficiency creeps into the system leading to another npa crisis followed by another recapitalization. Thus an unending vicious cycle seals the fate of not only the banking sector but also the economy as a whole. With banking system weakened and wreaked, lower finances are available for investment, a key driver of the economy.

State run banks account for 70 percent of the overall market share in terms of asset size of Indian banking system. India ranks 5th in list of countries with highest NPA levels. It’s non performing ratio stood at 9.1 % in September 2019 which came down from 11.2% in FY18, as a recognition that bad loans neared completion. Thus what is the need of the hour is to reform the banking system for a ‘ATMANIRBHAR BHARAT’.

Privatisation for efficiency sounds a reliable way out as per Mr. Raghuram Rajan. Recently banks have relied on Asset Reconstruction Companies (ARC). Basically, ARC buys bad loans at a steep discounted rate and take measures themselves for recovery. This leads to private owned ARCs to make profit and get good returns.

This method usually leads bank to be in loss but helps them to keep their loan books clean. But recently, this system is proving to be faulty as ARCs are demanding steeper discounts.

Therefore, Government has come up with “bad Banks” scheme, which will be owned by the  government or the private shareholders or the bank themselves and it can act as a temporary solution. These Bad Banks are to buy bank’s bad loans at the market price and then recover them using various arduous methods. This idea suggests that it will keep bank books clean until a permanent solution is crafted.

But this method requires buying, selling and recovery of bank’s stressed assets which turns out to be a tedious and an exhaustive task.

So, when will a probable solution to the bad loan crises be crafted, is still a mystery.

A woman who believes in equal rights and aspires to inspire people through her writings. I aspire to contribute to the economic world and society with diligence and thus being an economic advisor tops my career ambitions . I currently am pursuing Economic honours ( at undergrad level) from delhi university.

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Insights into Editorial: Resolving India’s banking crisis

Non-performing assets (NPAs) at commercial banks amounted to Rs.10.3 trillion, or 11.2% of advances , in March 2018.

Public sector banks (PSBs) accounted for Rs.8.9 trillion, or 86%, of the total NPAs . The ratio of gross NPA to advances in PSBs was 14.6%.

These are levels typically associated with a banking crisis. In 2007-08 , NPAs totalled Rs.566 billion (a little over half a trillion), or 2.26% of gross advances.

The financial stability report released by the Reserve Bank of India has warned that the gross non-performing assets (GNPAs) of scheduled commercial banks in the country could rise from 11.6% in March 2018 to the GNPA ratio for public sector banks (PSBs) is posited to only inch lower to 14.6% by March, from 14.8% in September.

The Reserve Bank of India (RBI), acting in the belief that NPAs were being under-stated, introduced tougher norms for NPA recognition under an Asset Quality Review .

This puts at rest the hope of a bottoming out of the NPA crisis that has affected the banking system and impeded credit growth in the economy.

Origin of the present NPA crisis:

The origin of the crisis lies partly in the credit boom of the years 2004-05 to 2008-09 . In that period, commercial credit (‘non-food credit’) doubled.

It was a period in which the world economy as well as the Indian economy were booming. Indian firms borrowed furiously in order to avail of the growth opportunities they saw coming.

Most of the investment went into infrastructure and related areas : telecom, power, roads, aviation, steel. Businessmen were overcome with exuberance, partly rational and partly irrational. They believed, as many others did, that India had entered an era of 9% growth.

Thereafter, as the Economic Survey of 2016-17 notes:

Many things began to go wrong. Thanks to problems in acquiring land and getting environmental clearances , several projects got stalled. Their costs soared.

At the same time, with the onset of the global financial crisis in 2007-08 and the slowdown in growth after 2011-12, revenues fell well short of forecasts.

Financing costs rose as policy rates were tightened in India in response to the crisis. The depreciation of the rupee meant higher outflows for companies that had borrowed in foreign currency.

This combination of adverse factors made it difficult for companies to service their loans to Indian banks.

Tightening norms made us clear in finding Exact Problem:

For every loan given out, the banks to keep aside some extra funds to cover up losses if something goes wrong with those loans. This is called provisioning.

Provisioning Coverage Ratio (PCR) refers to the funds to be set aside by the banks as fraction to the loans.

Provisioning basically means that the banks estimate that a particular borrower may not be able to pay back the loan in full and hence make a provision of the amount they could lose (as in that won’t be paid back to banks).

Banks start creating provisions on a loan given when the borrower starts defaulting on his repayment instalments.

Higher NPAs mean higher provisions on the part of banks. Provisions rose to a level where banks, especially PSBs, started making losses . Their capital got eroded as a result.

Capital from the government was slow in coming and it was barely adequate to meet regulatory norms for minimum capital.

Without adequate capital, bank credit cannot grow. Even as the numerator in the ratio of gross NPAs/advances rose sharply, growth in the denominator fell.

Both these movements caused the ratio to shoot up to a crisis level . Once NPAs happen, it is important to effect to resolve them quickly. Otherwise, the interest on dues causes NPAs to rise relentlessly.

Plans to Prevent such crises in Future:

We need a broad set of actions, some immediate and others over the medium-term and aimed at preventing the recurrence of such crises.

Wholesale privatisation of PSBs is thus not the answer to a complex problem.

One immediate action that is required is resolving the NPAs. Banks have to accept losses on loans (or ‘haircuts’).

They should be able to do so without any fear of harassment by the investigative agencies. The Indian Banks Association has set up a six-member panel to oversee resolution plans of lead lenders.

To expedite resolution, more such panels may be required. An alternative is to set up a Loan Resolution Authority, if necessary, through an Act of Parliament.

Second, the government must infuse at one go whatever additional capital is needed to recapitalise banks providing such capital in multiple instalments is not helpful.

Medium-term to Long-term Solutions:

PCA helps in increase profitability of banks through reduction of NPA. Unless, now they earn profit of it and also risky to lend to big borrowers as their liquidity is less because of high NPA.

So Prompt Corrective Actions helps to bank to improve their business for the foreseeable future instead of hurting their operations.

Over the medium term, the RBI needs to develop better mechanisms for monitoring macro-prudential indicators . It especially needs to look out for credit bubbles.

True, it’s not easy to tell a bubble when one is building up. Perhaps, a simple indicator would be a rate of credit growth that is way out of line with the trend rate of growth of credit or with the broad growth rate of the economy.

Actions needs to be taken to strengthen the functioning of banks in general and, more particularly, PSBs.

Governance at PSBs, meaning the functioning of PSB boards , can certainly improve.

One important lesson from the past decades experience with NPAs is that management of concentration risk that is, excessive exposure to any business group, sector, geography, etc. is too important to be left entirely to bank boards.

Conclusion:

The task of accelerating economic growth is urgent. This is not possible without finding a solution to the problems that confront the banking system.

Succession planning at PSBs also needs to improve. Despite the constitution of the Banks Board Bureau to advise on selection of top management, the appointment of Managing Directors and Executive Directors continues to be plagued by long delays .

There is ample scope for improving performance within the framework of public ownership. It can be done. What is needed is a steely focus on the part of the government.

Overall risk management at PSBs needs to be taken to a higher level . This certainly requires strengthening of PSB boards. We need to induct more high-quality professionals on PSB boards and compensate them better.

India needs a safe and efficient banking system to service the needs of a growing economy. The RBI as well in addition to government part would do well to use the current opportunity to strengthen the banking system .

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Bank holidays in April 2024: Banks to remain shut for 14 days. Check full list

Bank holidays in April 2024: Banks in India will be closed for 14 days in April. Know full list of holidays here

Banks in India will remain shut for 14 days in April in different states as per the Reserve Bank of India's calendar. The banks will remain shut due to public holidays, regional holidays, Saturdays, and Sundays. The holiday calendar is decided by the RBI and the corresponding state governments. The regional holidays of the banks vary depending on the local customs of different states.

Bank holiday in April 2024:

While April has no national holiday, there are several regional holidays in a different state when banks' offline operations will remain suspended.

Are banks open today? These banks will be open on 30 and 31 March. Details here

Notably, banks will remain shut on 1 April for annual account closing except in Chandigarh, Sikkim, Mizoram, West Bengal, Himachal Pradesh, and Meghalaya.

Other bank holidays in April:

• April 5 bank holiday: On account of Babu Jagjivan Ram’s Birthday/Jumat-ul-Vida, banks will remain shut in Telangana and Jammu
• April 9 bank holiday: Banks in Maharashtra, Karnataka, Tamil Nadu, Andhra Pradesh, Telangana, Manipur, Goa, Jammu and Srinagar will be closed for Gudhi Padwa/Ugadi Festival/Telugu New Year's Day/Sajibu Nongmapanba (Cheiraoba)/1st Navratra.
• April 10 bank holiday: Banks will be closed in Tripura, Assam, Manipur, Jammu, and Srinagar because of the Bohag Bihu/Cheiraoba/Baisakhi/Biju festivals.

Central govt employees may get pay hike salaries, arrears on March 30: Report

• April 15 bank holiday: On this day, banks will suspend offline operations for customers in Assam and Himachal Pradesh due to Bohag Bihu and Himachal Day.
• April 16 bank holiday: On the occasion of Ram Navami, banks will be closed in Gujarat, Maharashtra, Madhya Pradesh, Orissa, Chandigarh, Andhra Pradesh, Telangana, Rajasthan, Uttar Pradesh, Bihar, Jharkhand, Himachal Pradesh.
• April 20 bank holiday: Banks' branches in Tripura will be shut for Garia Puja festival.

After a year of exuberance, markets bid adieu to FY24

Regular Bank Closures in April 2024:

• Bank will be closed on the second Saturday- 13 April
• Bank will be closed on the fourth Saturday- 27 April
• Bank holiday on Sunday- 7,14,21 and 28 April

Despite bank holidays, access to online banking services will persist for customers.

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