Palai Central Bank - Banking Crisis

Banking Crisis

In 1960 February, a new ministry assumed office in Kerala with Pattom Thanu Pillai as Chief Minister. In August that year, the Governor of RBI succeeded in persuading Desai for the closure of Palai Central Bank which, he told him, had too much of doubtful advances. That RBI gave misleading and false data to convince him is something which Desai himself would come to know only much later. The fact that all the doubtful advances were more than a decade old, and related to the period before the introduction of the Banking Regulation Act was not conveyed to him.

RBI moved the application in Kerala High Court for the winding up of the Bank under Section 38(3)(b)(iii) of the Banking Regulation Act, 1949. It may be noted that the Banking Regulation Act does not allow the High Court to go into the merits of RBI's application but specifies that the Court "shall order the winding up" if an application is made by RBI. Also, RBI can move an application if in the opinion of the RBI "the continuance of the banking company is prejudicial to the interests of its depositors", which is a rather vague provision. Justice P T Raman Nair, the presiding Judge of the Kerala High Court ordered the winding up on 8 August 1960.

After the winding up, Desai vehemently defended his action in Parliament. He, however, had to admit later that the reasons earlier stated were not correct.

The liquidation of the Bank was followed by a banking crisis. Most of the Banks in the State faced 'run' on their deposits. Even some of the Banks outside Kerala were affected. The total deposits of all the 339 commercial banks in India stood at Rs. 2021.84 crores in 1960. Out of the 339 commercial banks, 94 were Scheduled Banks and 245 were Non-Scheduled banks. The total deposits of all the 94 scheduled commercial banks, which was Rs. 1971.97 crores before the crisis, fell by more than 10% to Rs. 1741.80 crores in the 6 months following the crisis. RBI had a tough time proving that all is well with its running of the country's banking system. Punjab National Bank, the worst affected among the northern Banks, received special support. But the affected Kerala banks were less lucky. They were amalgamated with other banks in the State or outside.

When the closure of the State's largest Bank also led to a crisis in the entire banking system, there was a hue and cry in all quarters, including the press. But out of sheer obstinacy, Desai refused to reconsider the matter. When a group of Kerala MPs met Nehru requesting that the Bank be revived, he told them that he would like to, but his insistence will lead to the resignation of Desai. He said there is a feeling that Finance Ministers did not thrive under him and so he did not want another resignation. In the larger interests of the nation, he asked the Kerala MPs to put up with the whole thing. When Chief Minister Pattom Thanu Pillai met Desai to make a personal appeal, he cut him out by asking as to how much money he had lost. A furious Pattom Thanu Pillai told him that like Desai he was also a true Gandhian and he has never had a bank account in his life. He then angrily walked out. With that, all doors for a revival from Government side were closed.

A legal battle was then fought. But the delay of the legal process made a revival impossible. In the Supreme Court, the Bank's case was argued among others by Gopal Swarup Pathak, who later became Vice-President of India. The Court ruled in a 3-2 judgement that with the delay, a revival has been rendered infructuous.

After the closure of the Bank the first impression of the public was that the Bank had gone bust. They assumed foul play. When the Finance Minister of the country states in Parliament that the Bank's deposits had hardly 15% asset backing, the people had no reason to disbelieve. They had to wait for years to know that even after bearing several years of liquidation expenses, the depositors got more than 90% of their money – but in petty instalments. The people knew only then that as a going concern, the Bank could very well have repaid its depositors fully.

About 30 years later, in the early 1990s when banks in India faced a crisis of mounting losses and high levels of non-performing assets, an interviewer asked a now-retired Justice P T Raman Nair about his thoughts on the winding-up order of Palai Central Bank three decades ago. He then remarked that today's banks were in much worse condition and that if the current yard stick were applied Palai Central Bank would not have been ordered to be closed.

In Volume II of the History of RBI covering the years 1951-1967, a 27-page appendix viz. "Appendix C: The Palai Central Bank" extensively covers the history of the Bank. The following is an extract:

"While defending the Reserve Bank as 'one of the best central banks in the world' maintaining a 'high level of efficiency', the Prime Minister, Jawaharlal Nehru, was reported to have acknowledged that it may have made a 'mistake' in closing down the Palai Central Bank.

"Defending the (Reserve) Bank's action, the (RBI) Governor recalled the representations received from the Kerala Bankers' Association and the Travancore-Cochin Banking Inquiry Commission to 'go slow' on refusing licences to banks in Kerala and pointed out that if the (Reserve) Bank had taken the action it had now taken in any of the previous three years, it would have been subject to even greater criticism. 'This has been the considered judgement of my colleagues and myself in the Bank.' However, (Governor) Iengar conceded, 'someone else could have exercised his judgement differently'."

The crisis that shook the banking sector of the country led to some changes in that sector. The demand for protecting the interests of depositors in the event of similar crises led to the passing of the Deposit Insurance Act by Parliament in 1961 and the eventual formation of the Deposit Insurance & Credit Guarantee Corporation (DICGC). Another demand arose from the allegation that RBI is a bureaucratic institution insensitive to the needs of the banking sector. Its advocates called for the formation of a Superintendent of Banking like that in the US to carry out the function of supervision of banking in the country. This demand was partially met years later when Government introduced a policy to appoint a career banker as one of the Deputy Governors of RBI.