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The curious tale of parallel banking and how depositors lose their cash

Tuesday June 4 2013

 

By JAINDI KISERO [email protected]

Mr Ajay Shah, the former executive chairman of the defunct Trust Bank, was in the news last week.

A High Court judge ruled that he and another former director of the bank, Mr Praful Shah, should pay a whopping Sh1.5 billion to former depositors of the bank.

Who is Ajay Shah? One of the most enigmatic Nyayo-era cowboys, his story is an intriguing tale of rags to riches.

He came to Kenya in 1981 at the age of 23 to work for a River Road-based garment manufacturer as a book-keeper, earning a meagre Sh12,000 per month.

In just under five years, he had become a billionaire, rubbing shoulders with the high and mighty of the Nyayo era, running what was then one of the fastest growing commercial banks in Kenya.

I chose to comment on the Sh1.5 billion High Court award to the depositors of Trust Bank because it raises significant policy questions about the state of regulation of our banking system.

Indeed, this case gives a rare insight into the grave injustices and misery which depositors of banks which collapse have to endure in this country. How effective is the deposit protection system?

If your bank suddenly experiences a run today and subsequently collapses, how long do you have to wait before you can get your money back?

The Trust Bank saga is also a statement about performance of our justice system. If I were asked to name the greatest drawback to the administration of justice in this country today, I would say that it is delay.

Were litigation to be included in the next Olympics, Kenya would be certain to win all gold medals in the marathon races.

As one eminent jurist once put it, I know that justice must be blind, but I see no reason why it should also be lame.

Trust Bank’s depositors have been seeking justice in our courts since September 1998.

In my long career in business journalism, and as a regular commentator and observer of developments in the banking sector, I have seen several commercial banks collapse – handed over to statutory managers from the Central Bank of – and eventually liquidated by the Deposit Protection Fund.

But I can say without fear of contradiction that Trust Bank is the most intriguing and complex case of a collapsed bank I have known in my many years.

At the heart of this case is the issue of parallel banking in the Asian community banks. Ajay and company were running a bank within a bank. They operated parallel banking systems known in the Hindi language as chopdi accounts.

What are chopdi accounts? This is a parallel banking facility which offers you more interest than you get in the open market. Its most attractive characteristic is that you are paid your interest in full, without having to pay withholding taxes.

And, because of its secretive nature, a bank with these accounts will not report them to the Central Bank for either cash-ratio or liquidity-ratio compliance.

The problem comes when such a bank collapses. Because they are no records, the directors can easily run away with the money. The depositor cannot prove he was owed money by the bank.

The parallel banking situation at Trust Bank was even more complex because there were individual leaders of the Visha Oshwal community who also kept money in the bank on behalf of other members of the community.

But the largest parallel bank was an account by the name Trust Capital Services Ltd that was run by Ajay and Praful and in which hundreds of millions of shillings were deposited.

Yet whenever the Deposit Protection Fund called meetings of depositors, only a handful would turn out. The chopdi depositor could not shout too loudly about his predicament for fear of prosecution for tax evasion.

In contrast, meetings of depositors called by community leaders in temples and other community meeting places would attract large crowds claiming to be depositors.

How widespread is parallel banking in Kenya and how much does the Central Bank know?

In India, the government dealt with the problem by giving an amnesty to chopdi account holders in exchange for disclosure. Is this the route we must take?