R Gandhi: New-gen urban cooperative banks - some musings
Address by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the Conference
of Urban Co-operative Banks in Gujarat, Ahmedabad, 8 June 2014.
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Assistance by Shri Sushanta Kumar Kar, General Manager is gratefully acknowledged
1. Dear Shri Jyotindra Mehta, Chairman, Gujarat Urban Cooperative Banks Federation, Shri
V S Das, Director, Centre for Banking Research, Development & Excellence, other
dignitaries and delegates. I feel specially privileged to address this Conference of urban
co-operative banks, which is very aptly titled "Sahakar Setu-2014" focusing on the theme of
"Next-Gen Co-operative Banks". I am also happy to note that a Centre for Banking Research,
Development & Excellence is being set up here as a hub for training and capacity building in
the urban banking sector and also to promote research relevant to the functioning of
co-operative banks.
2. Talking to all of you in Gujarat is also of very special significance, not only because of the
origin and proliferation of cooperative banks here but also it is the birth place of M.K. Gandhi,
father of the nation, who propounded the Theory of Trusteeship. Putting it in Gandhiji's words
"Supposing I have come by a fair amount of wealth - either by way of legacy, or by means of
trade and industry - I must know that all that wealth does not belong to me; what belongs to
me is the right to an honourable livelihood, no better than that enjoyed by millions of others.
The rest of my wealth belongs to the community and must be used for the welfare of the
community."
3. If you notice, cooperatives are also based on the same principles of community
camaraderie, - mutual help, democratic decision making and open membership.
Cooperatives represent a new and alternative approach to organisation as against
proprietary firms, partnership firms and joint stock companies, which represent the dominant
form of commercial organisation. As you may be aware, cooperatives around the world
generally operate according to the seven core principles and values, adopted by the
International Co-operative Alliance (ICA) in 1995. Cooperatives trace the roots of these
principles to the first modern cooperative founded in Rochdale, England in 1844. The
principles cover various aspects of cooperatives beginning from its membership to concern
on community.
Evolution of the urban bank sector
4. Urban Cooperative Banks (UCBs) started in India back in 18891 exactly a century and
quarter ago here in Gujarat and India has one of the oldest community-banking movements
in the world. However, the real growth and proliferation began after this sector was brought
under the purview of Banking Regulation Act in 1966. The evolution thereafter may be
broadly divided into three phases, Growth phase, crisis phase and Consolidation phase.
Growth phase (1966-2003)
5. In 1966, there were about 1100 UCBs with deposits and advances of ₹1.67 billion and
₹1.53 billion respectively. Since then there has been phenomenal growth in terms of their
numbers, size and scale of operations. The Reserve Bank pursued a liberal licensing policy
especially pursuant to the recommendations of the Marathe Committee, which had
suggested dispensing the "one-district, one-bank" approach and to shift the stance of the
policy to assess the "need and potential" in an area for mobilizing deposits and purveying of
credit for a new UCB. In the year 1993, before the liberalisation of bank licensing policy,
there were 1311 UCBs having deposits and advances amounting to ₹111.08 billion and
₹87.13 billion, respectively, which increased to 1926 UCBs with deposits and advances of
₹1020.74 billion and ₹649.74 billion, respectively2 by end-March, 2004. This is because after
the liberalisation of licensing norms in May 1993, up to June 2001, 823 bank licences were
issued.
Crisis phase (2003-2008)
6. However, it was observed that nearly one-third of these newly licensed UCBs became
financially unsound within a short period. RBI, therefore, constituted a screening committee
consisting of outside experts in June 2001 to examine the applications for licences. The
Committee recommended that it should be made mandatory for all newly proposed UCBs to
come through a process of graduation from a co-operative credit society on the strength of
demonstrated and verifiable track record.
7. However, in the light of the experience and the prevailing financial health of the UCB
sector after the Madhavpura Mercantile Cooperative Bank episode, it was announced in the
Annual Policy Statement for the year 2004-05 that the Reserve Bank would consider
issuance of fresh licences only after a comprehensive policy on UCBs, including an
appropriate legal and regulatory framework for the sector, is put in place and no fresh
licences have been issued thereafter for organizing new UCBs.
8. The number of UCBs declined from 1926 as at end-March 2004 to 1770 by end-March
2008. The deposits and advances of urban banks increased only marginally during the same
period from ₹1020.74 billion and ₹649.74 billion to ₹1398.71 billion and ₹904.44 billion,3
respectively, posting an average annual growth of 9% in deposits and 10% in advances.4
9. Reserve Bank took several steps to strengthen the sector during this period. Most
important among them is the Memoranda of Understanding (MoU) with all State
Governments and the Central Government. In order to improve the financial soundness of
the UCB sector, Reserve Bank of India entered into Memoranda of Understanding (MoU)
with all State Governments and the Central Government since 2005. The MOUs facilitated
coordination of regulatory policies and actions through the mechanism of TAFCUBs, a
comprehensive set of capacity building initiatives and measures to bring in efficiency through
adoption of technology. This phase also ushered in voluntary consolidation in the sector by
merger of non-viable UCBs with financially sound and well-managed UCBs.
Consolidation phase (2008 onwards)
10. As a result of the new initiatives and sustained efforts by RBI, the number of financially
weak banks in the UCB sector declined and consequently the total number of UCBs declined
from 1770 as end-March 2008 to 1606 by end-March 2013. However, the deposits and
advances of urban banks increased from ₹1398.71 billion and ₹904.44 billion to ₹2769.41
billion and ₹1809.60 billion, respectively, during the same period.5 Thus, there was an
average annual growth of 20 percent6 in deposits and in advances, which is more than
double of the previous phase growth. Further, the number of financially sound7 banks also
increased from 248 as on March 31, 2010 to 684 as on March 31, 2013. Incidentally,
mergers of as many as 116 UCBs have been effected till date after 2005.
11. Against this backdrop, with a view to increasing the coverage of banking services
amongst local communities, the Malegam Committee was set up in 2010 for studying the
advisability of granting new urban co-operative banking licences. After elaborate
deliberations, the Committee recommended that UCBs play a useful role and there is need
for a greater presence of UCBs in unbanked districts and in centers having population of less
than 5 lakh. It is necessary to encourage new entrants to open banks and branches in States
and Districts which are unbanked or inadequately banked. It is equally necessary to
discourage new entrants from opening branches in Districts and population centers which
are already adequately banked. Further, the Committee suggested that the existing
wellmanaged co-operative credit societies meeting certain financial criteria should be given
priority for granting licenses. The Committee's recommendations are under examination by
RBI.
Issues for discussion
12. As we have observed from the trend and pattern of growth in this sector so far, we have
left Madhavpura long behind and moved ahead by fostering organic and inorganic growth.
With higher degree of CRAR8 and less NPAs,9 the system has more or less stabilized, while
the process of consolidation is still on. The first question that rises now is what next. Where
do we go from here? Have we reached a plateau where we need to maintain and strengthen
the healthy consolidation achieved or should we allow further growth? Given the fact that
UCBs are an important segment of the banking system, play a vital role in mobilizing
deposits and purveying credit to the people of small means thereby enhancing financial
inclusion and facilitate payment and settlement, it will only be appropriate to support their
growth and proliferation further.
13. That brings us to the second question. If we allow further growth, in what form should that
be? It again can be addressed in two ways. We either allow them to grow in the existing set
up or UCBs above a certain threshold may assume a new corporate identity.
14. As an implication of this, for large UCBs who have reached certain threshold in the size
and complexity of business, enabling their graduation into commercial banks can be thought
of, so that their further growth is facilitated. It is important to mention here that once
cooperative banks reach a certain threshold level, they are also expected to follow a regimen
like large banks and standardized global practices, which may not be possible within the
existing legal structure of cooperative banks. Thus, before we move forward, the existing
legal and regulatory framework need to be revisited to enable smooth transition. Specifically,
we need to debate the needed legal framework that will facilitate conversion of cooperatives
into joint stock companies, conversion of deposit holders into shareholders etc.
15. The other alternative could be to allow the UCBs to grow and sustain themselves in the
existing set-up. In that event, the obvious question that comes to mind is what are the
existing restrictions that can be liberalised and what further measures can be envisaged for
the smooth non - disruptive growth of the sector? I hope the delegates will deliberate on
these issues and suggest possible measures.
The next phase - next generation cooperative banks
16. Since the theme of the Seminar is "Next-Gen Co-operative Banks" let me now briefly
dwell on the subject. To begin with let us analyse some of the best global practices in
cooperative banking and their implications for next-gen cooperative banks in India, before
moving forward to what is our expectation from these banks.
European co-operative business model
17. As you may be aware, the co-operative banking sector contributes significantly to the
growth, stability and competitiveness of the European banking industry at a local and
regional level. Ordinary citizens can become members / owners of co-operative banks with
relatively small investments. As a result, they have a direct say in the business and are
involved in the governance, strategy and risk management processes. The core business of
co-operative banks is value creation for their members and a long term relationship of trust,
opposed to the profit maximization approach of mainstream banks.
18. It is worth mentioning that their performance is a result of their central focus on retail
banking, solid capitalisation and their high-quality credit portfolios. In fact, in Italy, France,
Germany and Netherlands where co-operative banks' market share in loans range between
25% and 45%, SMEs represent between 20% and 50% of the total client portfolio of
co-operative banks. They are able to face the challenges of the new post crisis environment
because their business model responds to the present needs and expectations.
19. Further, across Europe, Cooperative banks exceed the minimum legal capital ratio
requirement of 8%, with an average ratio of about 9%. Credit ratings reflect this very well,
ranging between AA and AAA for the largest co-operative banking groups in Western
Europe.
20. With their roots in the Europe, the Rabobank Group, DZ Bank Group, Credit Agricole
Group, etc have grown in recent decades into an international financial services provider that
has activities in the field of banking, asset management, leasing, insurance and real estate.
The strong points of the cooperative structure became evident during the financial crises of
recent years. They did not have to ask for state aid and were able to keep financial results
well up to standard. Measured according to Tier 1 capital, these Groups are the world's
largest financial institutions. All rating agencies continue to give them high ratings.
21. Their cooperative identity stems back to the early twentieth century. The local member
cooperatives continue to be the collective owner of these groups to this day. The groups
support the member cooperatives and oversee the subsidiaries and affiliated companies.
The members not only benefit from banking and non-banking advantages, they also have the
opportunity to join in the discussion and co-decide on the bank's course. Local member
banks serve millions of retail and wholesale customers with a comprehensive range of
financial services. The groups are leaders in nearly all customer and product segments, from
youth to start-ups and from mortgages to corporate enterprises.
22. I feel Indian cooperative banks can gain from the business matrix of their European
counterparts to cope up with the competition and pressure from bigger commercial banks
and maximize value creation while not undermining the importance of solid capitalization and
high-quality credit portfolio.
Asian cooperative business models
23. If we look eastward, we observe a considerably large presence of co-operatives in Asia
Pacific also. In Asia-Pacific alone there were 22,212 credit unions in 2012 which were more
than double of the 10,051 figure of North America and Europe put together. In terms of the
underlining focus also, it is observed that the co-operatives in Asia were basically formed to
bring about socio-economic development, particularly with respect to agriculture and rural
development.
24. In Asia itself, there have been many success stories to emulate. An exemplary initiative
which the Co-operative Development Authority (CDA) of the Philippines has taken is the
launch of the Co-operative Information System. The CDA in association with the US Agency
for International Development and another technology partner developed this web-based
database of co-operatives, to be accessed in real-time at any of the CDA's extension
counters. The information on each cooperative's annual organizational and financial status
through the Co-operative Annual Performance Report is also integrated with this database,
thereby providing a platform for the co-operatives to exchange information readily. Further
and more importantly, the main aim of the system is to help the Government in creating
performance standards, policies, regulations and development programmes for the overall
benefit of the sector. Perhaps, the creation of such technology information system will also
help our cooperative sector by providing a platform to them to exchange information readily
for performance oriented and integrated development.
Cooperativeness among cooperative banks
25. Cooperatives also need cooperation among themselves to support and promote their
growth and expansion. As you might be aware, the V.S. Das Working Group constituted by
RBI to study these umbrella organization of cooperative banks internationally found that
there are two broad approaches in this regard.
26. In European countries, the Umbrella Organization is generally in the form of a strong
apex level entity. All the local cooperative banks are generally members of the apex entity.
Each member exercises its voting rights under the "one member one vote" principle. The
apex entity supports and advises the individual member banks in areas such as customer
services, ALM, IT, Mutual Funds, product development, etc.
27. In the case of Australia, USA and, Canada, the Umbrella Organization is not part of any
group, but is a distinct entity where the credit unions are its members. In US there is an
"Umbrella" of Umbrella Organizations. The Umbrella Organization in US provides extensive
investment, liquidity, and cash-management products and services; risk-management and
analytic capabilities; settlement, funds transfer and payment services; and safekeeping and
custody services. However, in Australia the emphasis has been on payment clearing
services and emergency liquidity support.
28. These organizations are serving the sector well and have not only resulted in greater
efficiency of operations of their members at the grassroots, but have also contributed
significantly in augmenting financial stability and safeguarding depositors' interests. This has
given comfort to the regulators. Notably, in Australia all credit unions adhere to the Basle II
norms and their average CRAR is 16 percent.
29. It is in this context I will like to touch upon the need for an umbrella organization for the
UCB sector in India that will be the beginning of the next part of my address, viz., our
expectation from the next-gen UCB sector in India.
Expectation from next-gen UCBs
Umbrella organisation for UCBs in India
30. UCB sector in India needs to have the benefit of an Umbrella Organization of its own
customized to the legal framework in India and the challenges of the sector. In India only
scheduled UCBs have direct access to liquidity support from RBI in the form of refinance.
Other UCBs are dependent on District Cooperative Banks / State Cooperative Banks for their
liquidity needs. Some District Cooperative Banks / State Cooperative Banks are themselves
financially not well. There is also a need to provide the management, IT and training and
other services which the UCB sector needs.
31. For our UCB sector, the V S Das Group had recommended the requirements of the
provision of payment and settlement services; the provision of other services, which are
mainly in the region of management or outsourced services; the provision of liquidity support
through state level schemes; and the provision of solvency support through state level
schemes. The Group further recommended that there should be two separate Umbrella
Organizations. First one is a national level organization which provides payment and
settlement services and other services as also liquidity support to its members. The second
could be state level organizations or outside agencies, which provide the management, IT
and training and other services.
32. The proposals are being examined by RBI in consultation with urban bank federations
and other stake holders. In this context, I feel that the Centre for Banking Research,
Development & Excellence that is being set up here as a hub for training and capacity
building in the UCB sector is a good initiative in that direction.
Technology-savvy UCBs
33. It is heartening to note that leveraging on technology is being taken up for discussion in
this Conference. In today's technology driven world, one cannot ignore the role of technology
in providing competitive banking services and all UCBs must exhibit the keenness to adopt
technology in a time-bound framework. Presently, only 32% (510 out of 1589 as on March,
2014) of UCBs have adopted Core Banking Solution (CBS). Delay in adopting technology
has resulted in UCBs losing their customers to commercial banks. They also become
vulnerable to frauds due to use of applications that are outdated or lacking security features,
etc. Also manual book-keeping system has led to arrears in reconciliation of accounts and
made them vulnerable to frauds.
34. RBI has advised UCBs to adopt CBS in a graduated framework: large UCBs by Dec 31,
2013, tier I banks by June 30, 2014 and unit banks by Dec 31, 2014. In future, Reserve Bank
will definitely look forward to more technology-savvy UCBs competing with commercial banks
for customer spaces.
Cooperative character of UCBs
35. Apart from the cooperativeness among cooperative banks, the next issue to ponder over
is the cooperativeness inside a cooperative bank. We observe that over the years, many
UCBs have lost their cooperative character and have been reduced to almost family run
institutions. To ensure cooperative membership, RBI has prescribed that the proportion of
borrowing nominal members should be limited to 20% of regular members. Some large
multistate UCBs have aligned their business models and goals with those of commercial banks
while availing the concessions to the sector.
36. In this context, a study was undertaken by the RBI on cooperativeness of cooperative
banks. The study found that the cooperative business model has withstood the test of times
in several countries in the world and also weathered the recent financial crisis in the most
non-disruptive manner while commercial entities have struggled to stay afloat. What has
seen them through is the cooperativeness in their character, which is somehow getting
diluted in the Indian UCBs. The assessment of the study establishes that "Cooperativeness
of Cooperative banks" in India is on the decline.
37. RBI, therefore, conducted a Seminar on this subject in September last year to sensitize
the cooperative banks on this crucial issue. Some of the steps to enhance the
cooperativeness in UCBs in India could be increasing member awareness to strengthen the
democratic character, focus on member education and rekindle members' interest in the
principles of cooperation. Steps can be also taken to increase in the quorum requirement for
Annual General Body meetings, make provision of electronic and secure remote voting
facility and cap the tenure/term of the Directors of UCBs in the Board.
Strengthening capital standards
38. In today's globalised world it is difficult to insulate our institutions from the best global
regulatory practices.
39. In India UCBs can raise capital only from their members. Recognising this limitation, RBI
has prescribed share-linking to borrowing. The matter was further examined by a Working
Group appointed by RBI and based on their recommendations. UCBs were permitted in 2008
to raise capital through innovative instruments like Perpetual Non-Cumulative/Cumulative
and Redeemable Preference Shares as also Long Term (Subordinated) Deposits. RBI has
issued several guidelines for financial restructuring of less capitalised UCBs such as
conversion of deposits into equity, guidelines for merger including that with DICGC support,
guidelines for transfer of asset & liabilities of weak UCBs to commercial Banks with DICGC
support, etc.
40. Reserve Bank of India has adopted a calibrated and gradual approach towards
application of Basel standards for various regulated entities keeping in view their systemic
importance and availability of skill sets. As of now, UCBs have been subjected to Basel I
requirements for computation of capital. Certain elements of market risk management have
been made applicable for bigger UCBs conducting forex transactions.
41. However, it may be worth mentioning in this context that keeping in view the risk
management structure of cooperative banks, internationally Basel II norms are applicable for
Co-operative banks in many of the advanced countries. Although in view of the heterogeneity
in size and sophistication of Indian UCBs RBI has taken a considered view, the next-gen
banks must gear up for adopting global best practices in prudential regulations.
Role of financial inclusion by UCBs
42. Our next issue for deliberation could be the important expectation from Government, RBI
and people in general from the banks, i.e. promoting financial inclusion. I am happy to note
that this issue is also included for discussion in this Conference. The organizational structure,
local clientele and easy access are UCBs' strengths in this regard. RBI has taken a number
of measures in this direction for UCBs by prescribing introduction of No-frills account with nil
or low minimum balance, relaxation of Know Your Customer (KYC) requirements for small
accounts, liberalising norms for opening of new branches and off-site ATMs and permitting
use of Business Correspondents (BCs) and Business Facilitators (BFs), etc.
43. UCBs are, to some extent, already into financial inclusion as their client profile mainly
consists of priority sector segments viz. small business establishments, SSI, retail traders,
self-employed etc., who do not get easy access to commercial banks. There still remains,
however, a huge hidden potential to be tapped, given the large number of small urban
co-operative banks.10 UCBs need to capitalise on their advantage and reap the business
opportunity. In semi-urban and rural areas, there are a number of unbanked and
underbanked districts inhabited by people like artisans, migrant labour, small businessmen and
retailers, etc. These people find it difficult to join the formal financial sector. UCBs can take a
lead in bringing these people into the ambit of banking.
44. UCBs should re-design their business model in this regard and integrate their financial
inclusion plan into their annual business plans. UCBs should give wide publicity to their
services to connect with large population segments. It is also important that the service
provided should be at an affordable cost and here technology will play a big role.
Corporate governance and management structure
45. Before I conclude let me touch on the final issue of importance in the next-gen UCBs that
is corporate governance. The concept of corporate governance is not much different than the
internationally accepted principles of co-operation. One of the cardinal principles of
co-operation as accepted by International Co-operative Alliance (ICA) is "member economic
participation" indicating contributing equitably to, and controlling democratically, the capital of
co-operative by the members.
46. Many of the problems faced by the UCBs are due to governance issues and lack of
professionalism.
47. RBI has also prescribed that at least two directors with suitable banking experience or
with relevant professional qualification in the fields of law, accountancy or finance are
co-opted on the Board. The Malegam Committee has even recommended creation of a
professional Board of Management structure in between the Board of Directors and the CEO
as a pre-condition for licensing of new urban co-operative banks. However, there are still
many governance gaps that need to be addressed for the UCBs of future. There can hardly
be a debate on the desirability of a higher degree of professionalism in the governance
structure of co-operative institutions. We will like to look forward to having a highly efficient
and professional management structure in next-gen cooperative banks.
48. Another issue with regard to governance is that today it is typical of our cooperative
banks where the creditors have a big say in the governance; depositors have very little stake
and they need to be empowered appropriately. This will ensure that they have a direct
bearing on how well their moneys are managed.
Conclusion
49. I am sure all these issues are being addressed by the distinguished panelists and
participants during this two-day conference which has technical sessions in the form of panel
discussions on important topics relevant to this theme and other important issues. I sincerely
thank the Conference organizers for their efforts and wish this Conference all success.
50. I thank all of you for your patient attention.
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Sources:
i. Annual Report (2012-13) - European Association of Co-operative Banks
ii. Cosma, S. - The impact of Basel II on Co-operative Banking
iii. Chakrabarty, K.C. (2011), "Financial Inclusion - A road India needs to travel", Article
published in www.livemint.com on Oct 22, 2011
iv. Malegam Committee Report on Licensing of New UCBs
v. Sinha, Anand (2012) - Perspectives on Co-operation: Address at the International
Conference on Cooperatives - College for Agriculture Banking, Pune
vi. http://www.icba.org
vii. http://www.globalcommunities.org
viii. Gandhi, M.K. - Trusteeship, compiled by Ravindra Kelkar, Navajivan Mudranalaya,
Ahmedabad
ix. Statistical Report - World Council of Credit Unions (2012) - http://www.woccu.org
x. Mellore, John W. (2009) - New Challenges and Opportunities in Low and
MiddleIncome Countries, Measurements for Tracking Indicators of Co-operative Success
(METRICS), United States Overseas Co-operative Development Council, United
States Agency for International Development
xi. Reports on Trends and Progress of Banking in India