7 PM | Co-operative banks: Is dual regulation the problem? | 4th October, 2019

Context:Cooperative banking in India and the recent Punjab and Maharashtra Cooperative (PMC) Bank crisis.

More in news:

  • In late September, the Reserve Bank of India (RBI) imposed restrictions on withdrawals from the Punjab and Maharashtra Cooperative (PMC) Bank, one of the largest urban cooperative lenders. 
  • The RBI has imposed lending restrictions on PMC Bank, at Rs 10,000 per customer for six months, creating panic among depositors. 

Co-operative Movement in India:

  • The co-operative movement in India is century old which was primarily for dealing with the problem of rural credit.
  • It was aimed at concentrating the efforts in releasing the exploited classes out of the clutches of the money lenders.
  • During British rule, based on the recommendations of Sir Frederick Nicholson (1899) and Sir Edward Law (1901), the Co-operative Credit Societies Act was passed in 1904, paving the way for the establishment of co-operative credit societies in rural and urban areas.
  • Under this Act, only primary credit societies were permitted to register and non-credit and federal organisations of primary co-operative credit societies were left out.
  • The first urban co-operative credit society was registered in October 1904 at Kanjeepuram now in Tamil Nadu State.
  • This Act was amended in 1912 to facilitate the establishment of central co-operative banks at the district level, thereby giving it a three tier federal character.

Co-operative Banks:

  • A co-operative bank is a financial entity which belongs to its members, who are at the same time the owners and the customers of their bank.
  • Co-operative banks are often created by persons belonging to the same local or professional community of sharing a common interest.
  • Cooperative banks generally provide their members with a wide range of banking and financial services (loans, deposits, banking accounts, etc.).
  • Co-operative banks differ from stockholders bank by their organization, their goals, their values and their governance.
  • In most countries, they are supervised and controlled by banking authorities and have to respect prudential banking regulations, which put them at a level playing field with stockholders banks.
  • The co-operative banks in India are regulated by the Reserve Bank of India (RBI) and governed by Banking Regulations Act 1949 and Banking Laws (Co-operative Societies) Act, 1955.

Types of Co-operative Banks: The co-operative banking structure in India is divided into following 5 categories:

  1. Primary Co-operative Credit Society: The primary co-operative credit society is an association of borrowers and non-borrowers residing in a particular locality. The funds of the society are derived from the share capital and deposits of members and loans from central co-operative banks. The borrowing powers of the members as well as of the society are fixed. The loans are given to members for the purchase of cattle, fodder, fertilizers and pesticides.
  2. Central Co-operative Banks: These are the federations of primary credit societies in a district and are of two types-those having a membership of primary societies only and those having a membership of societies as well as individuals. The funds of the bank consist of share capital, deposits, loans and overdrafts from state co-operative banks and joint stocks. These banks provide finance to member societies within the limits of the borrowing capacity of societies.
  3. State Co-operative Banks: The state co-operative bank is a federation of central co-operative bank and acts as a watchdog of the co-operative banking structure in the state. Its funds are obtained from share capital, deposits, loans and overdrafts from the Reserve Bank of India. The state co-operative banks lend money to central co-operative banks and primary societies and not directly to the farmers.
  4. Land Development Banks: The Land development banks are organized in 3 tiers namely; state, central, and primary level and they meet the long term credit requirements of the farmers for developmental purposes. They are governed both by the state government and Reserve Bank of India. Recently, the supervision of land development banks has been assumed by National Bank for Agriculture and Rural development (NABARD). These banks do not accept deposits from the general public.
  5. Urban Co-operative Banks: The term Urban Co-operative Banks (UCBs), though not formally defined, refers to primary co-operative banks located in urban and semiurban areas. These banks, till 1996, were allowed to lend money only for non-agricultural purposes. This distinction does not hold today. These banks were traditionally centered on communities, localities, work place groups. They essentially lend to small borrowers and businesses. Today, their scope of operations has widened considerably.

Functions of Co-operative Banks: Co-operative banks also perform the basic banking functions of banking but they differ from commercial banks in the following ways:

  1. Commercial banks are joint-stock companies under the companies’ act of 1956, or public sector bank under a separate act of a parliament whereas co-operative banks were established under the co-operative societies acts of different states.
  2. Commercial bank structure is branch banking structure whereas Cooperative banks have a three tier setup, with State Co-operative Bank at Apex level, Central / District Co-operative Bank at district level, and Primary Co-operative Societies at rural level.
  3. Only some of the sections of Banking Regulation Act of 1949 (fully applicable to commercial banks), are applicable to co-operative banks, resulting only in partial control by RBI of co-operative banks.
  4. Co-operative banks function on the principle of cooperation and not entirely on commercial parameters.

Regulation of Urban Co-operative Banks:

  • The urban co-operative banks are regulated and supervised by State Registrars of Co-operative Societies, Central Registrar of Co-operative Societies in case of Multi-state co-operative banks and by Reserve Bank.
  • The Registrars of Co-operative Societies of the States exercise powers under the respective Co-operative Societies Act of the States in regard to incorporation, registration, management, amalgamation, reconstruction or liquidation.
  • In case of the urban co-operative banks having multi-state presence, the Central Registrar of Co-operative Societies, New Delhi, exercises such powers.
  • The banking related functions, such as issue of license to start new banks / branches, matters relating to interest rates, loan policies, investments, prudential exposure norms etc. are regulated and supervised by the Reserve Bank of India under the provisions of the Banking Regulation Act, 1949(AACS).

Vision Document for Urban Co-operative Banks:

  • There was a proliferation of licences issued between 1991 and 1998. RBI to deal with the problems of cooperative banks issued a vision document in 2004-05 and stopped all licences of new branches and new bank entities.
  • Under the vision document, a Memorandum of Agreement was entered into by the RBI with each of the States, where the State accepted an audit by professional auditors, and constituted a Task Force for urban cooperative banks which was co-chaired by the RCS and the RBI Regional Director.
  • This worked very well and a number of cooperative banks were delicensed, merged or liquidated. As per the RBI Financial Stability Report (2017-18), there were only four urban cooperative banks with capital adequacy ratios below the regulated threshold.

Is the PMC Bank crisis, a problem of dual regulation?

  • In a sense, urban cooperative banks have been under the radar of the RBI, but because of dual regulation, one always had a feeling that one did not have as much control over these banks in terms of supercession of boards or removal of directors, as the RBI has over private sector banks.
  • In the case of PMC Bank, as per RBI, there are three problems: major financial irregularities, failure of internal control and systems, and underreporting of exposures. 
  • It is well known that PMC Bank has extended 73% of its assets to HDIL, which has created a panicky situation for depositors.
  • The State governments also play a role and politics sometimes enter the space. The management, Board and auditors are responsible.
  • It’s a governance and transparency issue that also affects public sector banks, private banks, and NBFCs.

Steps taken by RBI: The RBI has announced a scheme for voluntary transition of urban cooperative banks into small finance banks, in line with the recommendations of a high-powered committee chaired by former Deputy Governor of the RBI, R. Gandhi.

  • H. Malegam recommended having a board of management in actual control of operations as opposed to elected directors. There must be a push for a fit and proper management, otherwise the elected director can get away with fraud. 
  • RBI has given the choice to urban cooperative banks to convert to small finance banks. That option is there for those players with more than ₹50 crore capital and 15% capital adequacy. This is an incentive as they will then be able to grow their capital by issuing shares at a premium. 
  • RBI has also said that for urban cooperative banks there could be an umbrella organisation promoted by the banks themselves to raise capital as a joint stock company can from the markets.


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