RBI arranges marriage for failed Global Trust Bank

Continued losses force central bank to pull the plug.

India's central bank has finally stepped in to prevent Global Trust Bank from losing any more money. The bank, which has been embroiled in problems for years, will be recapitalized through a merger with Oriental Bank of Commerce (OBC).

The Reserve Bank of India (RBI) acted at the weekend to stop a run on Global Trust, closing ATMs and capping withrawals at Rs10,000 ($215). The full extent of the bank's problems will remain unclear until the central bank completes its audit, but the size of the losses discovered so far and the suspicion of yet more fraud triggered banking regulations that allowed the central bank to freeze Global Trust's business.

Despite the grim situation, the forced merger with state-owned OBC was by no means a last resort for the government. Private equity investors have shown strong interest in new-generation private banks such as Global Trust, and Newbridge Capital is thought to have tabled a firm offer to buy 40% of the bank for Rs9.5 billion.

But that kind of investment goes against the grain of current thinking at the central bank. A set of draft guidelines issued by RBI recently envisioned a regime whereby individual groups cannot own more than 10% in a bank and stricter minimum capitalization levels of Rs3 billion - Global Trust would fail on both counts as Ramesh Gelli, the bank's founder, controls at least 19% of the stock and capitalization is well below the minimum level.

The new guidelines are designed to prevent exactly the kind of problems that have brought Global Trust to its knees - the RBI, analysts and everyone else qualified to have an opinion agrees the bank's failure was a product of lingering bad management. It is hoped the new rules will make encourage consolidation and make bank ownership more diversified.

Given that the cost of failed banks is invariably borne, at least in part, by the public purse, the central bank understandably wants better standards. "RBI is coming from the perspective that there's no such thing as a private bank if the state has to bear the cost of recapitalization," says a banking analyst in Bombay. "And right now the situation is such that you can't argue with the RBI."

Indeed, some analysts have asked why it took the government so long to act in the first place; the collapse has been brewing for a long time. The bank struggled in the 1990s after reckless involvement in the diamond trade and in 2001 RBI ousted Gelli from day-to-day control of the bank after he became implicated in the Ketan Parekh stock scandal. Last year Gelli and his associates were banned from trading in the company's stock after allegations of price fixing.

Merger with OBC, say analysts, is not a bad outcome anyway. Global Trust is broken, to be sure, but it has good technology and a good customer base. If OBC can leverage that and use its balance sheet to become more aggressive in pursuing the retail wallet it will be an attractive proposition - OBC is reckoned to be one of the most impressive public banks in the country.

One major cause of concern for the central bank was Global Trust's large retail base. Almost three-quarters of its Rs69 billion deposit base comes from 880,000 individual lenders, who were understandably panicked by the situation until RBI assuaged their fears with the announcement of the merger. However, there have been no guarantees that their deposits are safe; details of the plan will probably not be revealed until after the audit of Global Trust is finished.