Co-operative banks: Is dual regulation the problem? (The Hindu)

Mains Paper 3: Economy
Prelims level: Not much
Mains level: Reforms in Banking system

Context

•  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.
•  Over the past week, bank customers have been in a state of panic and the central bank has sought to assuage concerns about the banking sector’s health.

What are cooperative banks and it features?

•  Co-Operative Banks are small financial institutions that offer the lending facility to the small businesses in both urban and non-urban regions. It is characterised as member’s bank where they are both the owners and customers. It focuses on thrift.
•  These are monitored and regulated by the Reserve Bank of India (RBI) and come under the Banking Regulations Act, 1949 as well as the banking laws act, 1965. In a cooperative bank, one shareholder has one vote whatever the number of shares he may hold.
•  Cooperative banks issue shares of unlimited liability.
•  Cooperative credit societies were set up under The Cooperative Societies Act, 1912 recognized the need for establishing new organisations for supervision, auditing and supply of cooperative credit. These organisations were (a) A union, consisting of primary societies; (b) the central banks; and (c) provincial banks.

The cooperative banks regulations

•  The Registrar of Cooperative Societies (RCS) is in control of management elections and many administrative issues as well as auditing.
•  Cooperative banks came directly under the RBI’s radar in 1966 but faced the problem of dual regulation. The RBI brought them under the Banking Regulation Act as applicable to cooperative societies, which included all the regulatory aspects, namely, the granting of the license, maintaining cash reserve, statutory liquidity and capital adequacy ratios, and inspection of these banks.
•  Urban cooperative banks have been under the radar of the RBI, but because of dual regulation, it is perceived as less controlled.
•  RBI issued a vision document in 2004-05 and stopped all licences of new branches and new bank entities because there was a proliferation of licences issued between 1991 and 1998.
•  By 2017-18, as stated in the RBI Financial Stability Report, there were only four urban cooperative banks with capital adequacy ratios below the regulated threshold.

Cooperative banks scenario

•  Cooperative institutions play a significant role in credit delivery to unbanked segments and financial inclusion.
•  But their role has declined with the expansion of scheduled commercial banks and adoption of technology.
•  Urban cooperative lenders are facing competition from payment banks, small finance banks, and NBFCs (non-banking finance companies).
•  We have about 1,500 urban cooperatives, but there are nearly 96,000 rural banks, including primary agriculture credit societies.
•  Long-term credit extended by them is declining, but there is still a role in agriculture for rural cooperative societies.

PMC Bank crisis: As per RBI, there are three problems

•  Major financial irregularities, failure of internal control and systems, underreporting of exposures.
•  The problem is the dual control by the RBI and the RCS, with the State government also playing a role.
•  The management, Board and auditors, governance and transparency issue also affects public sector banks, private banks, and NBFCs.

Suggestion for improvement:

•  Merging and converting some of the cooperative banks to small finance banks.
•  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.
•  This would enable them to have most of the products available with commercial banks, and help get a pan-India presence.
•  Challenges to this are there are many conditions on share capital, loan sizes and loans to priority sector.

Effectiveness of Small Finance Banks:

•  RBI set up a committee under H. Malegam which recommended a board of management other than the board of directors. Depositors are not really represented as these banks accept deposits from non-members. Therefore a board of management in actual control of operations as opposed to elected directors. This could prevent the sling of recently witnessed bank frauds where the board of directors flees.
•  A majority of the cooperative banks have been meeting the needs of small businesses and even rural credit as inclusive finance. Just about 50 or 60 of these 1,500 banks are large. So the RBI’s supervisory resources have to be really focused on these larger banks mostly operating across the country like commercial banks.
•  The 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 Rs. 50 crore capitals 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. The supervision system should be able to catch much more underreporting or false reporting and ensure accountability of the Board and the auditors.
•  The frequency and intensity of supervision has to be clearly based on the size of the bank and the assessment made of the governance standards in the banks.
•  All banks — small finance banks, cooperative banks and leveraged institutions like NBFCs — are open to the risk of poor governance. Hence corporate governance is the ultimate tool.

Way forward

•  Many depositors opt for cooperative banks because they give a higher interest rate. The confidence comes from governance and regulation. We need confidence building for all banks, not just for cooperatives, but even NBFCs.
•  A recent study showed that small cooperatives are doing better in terms of non-performing assets and other aspects, while large urban cooperatives are not doing well. So, we have to look at how to supervise large cooperatives better.

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Prelims Questions:

Q.1) With respect to the change in name of any State in India, consider the following statements:

(1) A Bill contemplating the change can be introduced in the Parliament only with the prior recommendation of the President.
(2) Before recommending the Bill, the President has to refer the same to the State Legislature concerned for expressing its views within a specified period.

Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2

Answer: C
Mains Questions:
Q.1) What are cooperative banks and it features?