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Last week, the RBI moved to take charge of PMC Bank, one of the country's top five co-operative lenders, and suspended its managing director Joy Thomas and board after uncovering lending irregularities.
The PMC Bank case comes at a time when the country's financial sector is struggling against more than Rs 10 lakh crore of non-performing assets or bad loans. State-run banks account for the lion's share of this amount.
The Sensex index plunged as much as 737.44 points - or 1.91 per cent - on Tuesday before ending the session with a loss of 0.94 per cent. The broader Nifty benchmark declined 1.97 per cent in intraday trade, before closing down 1.00 per cent.
Analysts say concerns about the financial sector hurt investor sentiment. "Governance issues at a cooperative bank are causing collateral damage in banking space highlighting concerns in the sector," Deven Choksey of KRChoksey Investment Managers told NDTV.
Punjab and Maharashtra Co-operative (PMC) Bank used more than 21,000 fictitious accounts to hide loans it made, news agency Reuters reported citing a police complaint lodged by officials.
The complaint accuses the bank's management of concealing non-performing assets and disbursing loans leading to a loss of at least Rs 4,355 crore, and also names bankrupt realty company Housing Development and Infrastructure Ltd (HDIL), along with its former senior executives Sarang Wadhwan and Rakesh Wadhwan, who were beneficiaries of the loans, according to Reuters.
More than two dozen co-operative banks are now under RBI administration, but PMC Bank - with deposits of Rs 11,620 crore as of March 31 - is by far the largest.
India's financial system has been rocked by a Rs 13,000-crore fraud at Punjab National Bank and the collapse of IL&FS - one of India's biggest non-banking finance companies - last year. IL&FS said on Tuesday it aims to resolve 50 per cent of its debt by March 2020.
On August 30, Finance Minister Nirmala Sitharaman announced a consolidation plan which would result in 12 public sector banks in the system instead of 27, in a bid to strengthen the financial system and push economic growth.