R Gandhi: Whither the co-operative banking?
Speech by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the Maharashtra
Urban Co-operative Banks' Conference 2015, Nagpur, 24 October 2015.
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Assistance provided by Shri P K Arora is gratefully acknowledged.
Dear Co-operators,
1. I am thankful to the Maharashtra State Urban Co-operative Banks' Federation for
inviting me to this Seminar. The topic chosen for the Seminar is very contemporary. While I
will certainly make a few points about it later, I would like to first discuss the current status of
the urban co-operative banking in India, how it reached there, what recent initiatives the
Reserve Bank has taken to strengthen the sector and what is the way forward.
2. The organisation of co-operative institutions in India dates back to 19th century
when the first mutual aid society "Anyonya Sahakari Mandali" was formed in Gujarat at
Baroda on February 05, 1889.
3. The Banking Regulation Act, 1949 was extended to co-operative societies on
March 01, 1966 when there were about 1100 UCBs with deposits and advances of ₹ 1.67
billion and ₹ 1.53 billion respectively. As at the end of 1996, the number of UCBs increased
to 1501 and their deposits and advances rose to ₹ 241.61 billion and ₹ 179.27 billion
respectively. With the liberalisation of bank licensing policy, UCBs continued to grow at a fast
pace till 2004 when their numbers increased to 1926 and their deposits and advances to
₹ 1020.74 billion and ₹ 649.74 billion respectively.
Madhavpura crisis
4. Very few regulated entities have the distinction of shaping an entire sector and
generally it is in a positive sense; but sometimes in a negative sense. As destiny would have
it, the Madhavpura Mercantile Co-operative Bank Ltd. has the dubious distinction in that
regard.
5. The entire episode turned to be a watershed event in the history of urban
Co-operative banking sector and the crisis led to decline in public confidence in the UCB
sector as evident from the deceleration of the credit and deposit growth rate from 2003 to
2005 and the existence of large number of weak UCBs. As on March 31, 2004, 732 out of
1926 UCBs i.e. 38% were categorized in Grade III or IV signifying weakness and sickness.
This forced the Reserve Bank to look at the sector differently and new regulations had to be
prescribed.
6. Some of the major changes were compliance with CRAR prescription in phases,
complete prohibition / ban on loans and advances to directors and their relatives, prescription
of Interbank limits, imposition of restrictions on capital market exposure, increase in quantum
of investment in G-Sec for SLR purpose and prescription of limit for single broker exposure.
7. It was also observed that nearly one third of the newly licensed UCBs became
financially unsound within a short period. In view of this it was announced in the monetary
policy statement for 2004-05 that no fresh proposals for setting up of new Urban
Co-operative Bank (UCB) or for conversion of Co-operative Credit Societies into UCBs will
be considered till a comprehensive policy on UCBs, including an appropriate legal and
regulatory framework for the urban co-operative banking sector is put in place and a policy
for improving the financial health of the urban co-operative banking sector is formulated.
Further, embargo was also placed on issuance of new branch licenses for the UCBs.
Vision document
8. A vision document for the UCB sector was drawn up by RBI in 2005 which
envisaged that state specific strategy would be adopted to deal with the UCBs.
Business growth
9. The UCB sector emerged financially stronger ever since RBI conceived the Vision
document for the sector in 2005. The Vision Document envisaged a multi-layered regulatory
and supervisory approach, revival of potentially viable UCBs and non-disruptive exit of
nonviable ones. The sector witnessed a process of rehabilitation and consolidation. There has
been a continued reduction in the number of UCBs from 1872 as at the end of March 2005 to
1579 as at the end of March 2015,inter alia, due to amalgamation of UCBs. The sector
accounted for 3.9% of the deposits of the banking sector and 3.3% of the advances by the
banking sector as on March 31, 2015.
10. During this period, while the number of UCBs were coming down, the business that
all the UCBs recorded went on increasing. The number of UCBs declined in 2006 to 1853
with total deposits of ₹ 1122.37 billion and advances of ₹ 703.79 billion. The number of UCBs
further declined to 1579 as on March 31, 2015 although there is absolute increase in
deposits and advances at ₹ 3551.34 billion and ₹ 2243.08 billion respectively as at March 31,
2015.
11. Asset quality of the sector has steadily improved as reflected in the continuous
decline in the gross NPAs ratio from 21% as on March 2003 to 6.02% as on March 2015.
The gross NPAs are still very high as compared with commercial banks which have Gross
NPAs at 4.62% as on March 31, 2015.
12. The profitability of the UCB sector, too, has shown remarkable improvement as net
profit increased to ₹ 34.89 billion during the financial year 2014-15. Return on Assets (RoA)
has increased to 0.84% in 2015 and Return on Equity (RoE) has increased to 9.85% in 2015.
As regards capital adequacy, it is observed that 1503 UCBs i.e. 95.18% of the total UCBs
have reported a CRAR of 9 per cent or more as on March 2015.
13. The sector, however, continues to be afflicted with the existence of 48 UCBs which
are having negative net worth and 29 UCBs under All Inclusive Directions, as on date.
Expert Committee on licensing of new UCBs
14. Having satisfied with the stability achieved in the sector, an expert committee was
set-up under the chairmanship of Shri Y. H. Malegam in 2010 for studying the advisability of
granting licenses to new co-operative banks. The Committee recommended that new
licenses may be given to UCBs having a good track record in relatively unbanked areas. It
also recommended grant of licence to existing co-operative credit societies with proven track
record. It observed that there is a need for clearly defined control system where co-operative
character of a UCB is controlled by RCS / CRCS and the banking function by RBI for
overcoming the problem of dual control and recommended the creation of a Board of
Management (BoM) in addition to Board of Directors (BoD). It also recommended creation of
Umbrella organization at both national and state level for the urban Co-operative banking
sector.
15. RBI's main objective of regulation and supervision has been to maintain confidence
in the financial system by enhancing its soundness and efficiency. I would now like to
specifically highlight the steps taken by RBI for development of the sector and for
strengthening the regulation and supervision in the recent past.
Recent developments
Steps taken for development of the sector and augmenting the fee based income
16. Introduction of Liquidity Adjustment Facility for scheduled UCBs, permission to offer
internet (view only) facility to all UCBs, enhancement of limit under the scheme of bullet
payment of gold loans from ₹ 1.00 lakh to ₹ 2.00 lakh, permission to offer Demat account
trading facility and liberalization of opening of off-site ATM are some of the steps taken by
RBI to strengthen the sector.
17. More avenues have been provided for UCBs to earn fee based income. Accordingly,
UCBs are now allowed to undertake Point of Presence (PoP) Services under Pension Fund
Regulatory and Development Authority (PFRDA), act as PAN Service Agent (PSA) for
providing PAN Issuance Services to its Customers and issue "Semi-Closed Pre-paid
Payment Instruments" permitting payment of utility bill / essential services up to a limit of
₹ 10,000/-
18. RBI has been conducting seminars / workshops / focused training sessions for
directors / officers / staff of UCBs. This is an on-going exercise and our goal is to ensure that
all Directors are covered under the training programme at the earliest.
19. It was decided to make it mandatory to conduct the statutory audit of UCBs with a
deposit base of above ₹ 250 million by Statutory Auditors (SAs) who will be qualified
Chartered Accountants. However, it was observed that there were large divergences
between the audited financial parameters of UCBs and that assessed by Inspecting Officers.
As statutory audit is one of the important inputs based on which on-site supervision is
conducted, it is imperative to improve and strengthen the quality of reports of SAs. It has
therefore been decided to hold workshops / seminars for SAs to sensitize them with IRAC
norms issued by RBI. Institute of Chartered Accountants of India (ICAI) is also being advised
to prescribe a standard format for statutory audit report of the UCBs.
Steps taken for strengthening the regulation and supervision of the sector
20. RBI moved to CAMELS pattern of rating of UCBs w.e.f. March 31, 2011 in lieu of
earlier system of grading. With the switchover to rating system, there were 697 UCBs in
C & D rating which constituted 42.47% of the total UCBs as on March 31, 2011. The number
of C & D rated UCBs has declined to 339 constituting 21.50% of total number of UCBs as at
the end of March 31, 2015. The number of UCBs in A & B rating increased from 948 in 2011
to 1240 as on March 31, 2015.
21. A new Supervisory Action Framework (SAF) was prescribed by RBI in March, 2012
which replaced the Graded Supervisory Action. As a part of the SAF, RBI specified
regulatory trigger points in terms of five financial parameters viz. CRAR, Gross NPAs,
concentration of deposits, profitability and CD ratio for initiating structured and discretionary
action in respect of banks hitting such trigger points. A revised SAF has been implemented
based on the findings of inspection conducted with reference to March 31, 2014. Under the
revised framework, the individual UCB will be advised of the specific corrective action they
need to take to improve the financial position. With the revision of SAF as above it is
expected that the Board of Directors of UCBs will be proactive in identifying the shortcomings
/ deficiencies in the functioning of the bank and taking timely action to address them.
22. In view of the critical importance of CBS in the banking system, it has now been
decided to include CBS implementation as an additional criterion for a UCB to be classified
as an FSWM bank. With a view to imparting transparency and removing any unintended
element of subjectivity the criterion of "regulatory comfort" has also been redefined.
Regulatory convergence
23. Pursuant to the amendment to the Banking Regulation Act through the Banking
Laws (Amendment) Act, 2012, the percentage of CRR to be maintained by non-scheduled
co-operative banks and the percentage of SLR to be maintained by co-operative banks were
brought in line with that of commercial banks with effect from the fortnight beginning July 12,
2014. The assets eligible for being reckoned as part of SLR were also brought on par. To
ensure that this is achieved in a non-disruptive manner, banks were allowed to reach the
target in a phased manner. Similarly KYC guidelines for co-operative banks have also been
brought at par with commercial banks.
Way forward
24. RBI had come out with a discussion paper on "Banking Structure in India - The Way
Forward" in August 2013. The paper envisaged four tier banking structure consisting of
International Banks at Tier I, National Banks at Tier II, Regional Banks at Tier III and Local
Banks at Tier IV. The paper has brought to the fore a case for re-orienting the existing
banking structure to make it more dynamic and amenable to meet the needs of the economy
and had suggested basic building blocks of the re-orientation exercise which inter alia
included setting up of specialized/differentiated banks and conversion of Urban Co-operative
Banks which meet the necessary criteria into commercial banks or Local Area Banks/small
finance banks.
25. The Discussion Paper noted that the Urban Co-operative Banks (UCBs) are
organised based on the principles of co-operation. UCBs are perceived as banks for people
of small means. They cater to the financial needs of local communities and serve the lower
and middle strata of population in urban and semi-urban areas, within a limited geographical
boundary.
Conversion of Multi State UCBs into commercial banks
26. As regards the Multi-state co-operative banks, the paper noted that there is a case
for their conversion into commercial banks. As UCBs become larger and spread into more
states, the familiarity and bonding amongst their members diminishes and commercial
interests of the members overshadow the collective welfare objective of the organisation.
The UCBs lose their co-operative character. In the process, some of them become "too big to
be a co-operative". The collective ownership and democratic management no longer suit
their size, and competition and complexities in the business force them to explore alternate
form of ownership and governance structure to grow further. Corporatisation could be the
best alternative for multi-State UCBs. UCBs enjoy arbitrage in terms of both statutory and
prudential regulations. Only some provisions of Banking Regulation Act, 1949 are applicable
to them. UCBs continue to be under Basel I capital framework. Though, these may not cause
serious concerns when UCBs are small and their operations are limited, regulatory arbitrage
may create incentives for large multi-State UCBs to have greater leverage. Their remaining
under lighter regulation is a risk. Larger multi-State UCBs, having presence in more than one
State, dealing in forex and participating in the money market and payment systems, could be
systemically important. Their failure may have contagion effect and unsettle the UCB sector.
The systemic risk could be minimized, by subjecting them to prudential regulations applied to
commercial banks. Another supportive reason would be that larger multi-state UCBs having
more restrictions in some respects in their functioning than commercial banks, may be at a
competitive disadvantage and may lag behind their competitor commercial banks as they are
unable to provide a wider range of facilities to their customers. Conversion into commercial
banks would give more business opportunities to such UCBs.
27. The existing laws governing co-operatives do not specifically provide for conversion
of UCBs into (banking) companies. Therefore, the Paper suggested that necessary
amendments to the Co-operative Societies Acts/Multi-State Co-operative Societies Act and
Companies Act, 1956 may be required for facilitating conversion of UCBs into commercial
banks.
28. On the whole, the Discussion Paper concluded that setting up stronger UCBs, with
good net worth and strong corporate governance, would facilitate extension of banking
services in the regions characterized by poor banking outreach. Some UCBs could convert
into LABs/small finance banks if they meet the required prudential requirements. Such
banks, freed from dual control and with better ability to raise capital, may be able to further
extend the reach of banking services.
Licensing of new UCBs and conversion of UCBs into commercial banks
29. In pursuant of the conclusions of the Discussion Paper and in view of the high
aspirations of UCBs to undertake the business akin to commercial banks despite lack of level
playing field for regulation of UCBs vis-a-vis commercial banks and pursuant to the
deliberations held in the 31st Standing Advisory Committee of UCBs, a High Powered
Committee under my chairmanship was constituted to examine and recommend permissible
business lines and appropriate size, and examine the issues with regard to conversion of
UCBs into commercial banks besides determining whether the time is opportune to issue
new licenses to UCBs as recommended by the Malegam Committee.
30. UCBs have high aspirations of competing with commercial banks despite their
restricted ability to raise capital and they expect RBI to provide relaxation in various
regulatory restrictions. However due to weak resolution regime and non-availability of powers
to RBI to regulate and supervise UCBs at par with commercial banks, RBI faces constraints
in making such relaxations. No powers are available with RBI for constituting Boards of
UCBs, removal of directors, supersession of Board of Directors, auditing of UCBs, winding
up and liquidation. The resolution regime for UCBs exists in a rudimentary form. The growth
of the sector, therefore, has to be in a carefully calibrated manner, consistent with legal
framework and regulatory parameters and their limitations. It is in the above background that
the High Powered Committee had as one of its terms of reference to determine whether
unbridled growth of UCBs can be allowed and if so, in what form it should take keeping in
view the restricted ability to raise capital, lack of level playing field in regulation and
supervision and the absence of a resolution mechanism at least on par with commercial
banks.
31. The important recommendations of the HPC inter alia include UCBs having a
business size of ₹ 200.00 billion or more may be expected to convert itself into a commercial
bank. The conversion need not be de jure compulsory. Smaller UCBs can apply for
conversion to Small Finance Banks provided they fulfil the eligibility criteria for such
conversion and the licensing window is open.
32. Licenses to set up new UCBs may be issued to financially sound and well-managed
co-operative credit societies having a minimum track record of 5 years which satisfy the
regulatory prescriptions set by RBI as licensing conditions and putting in place a BoM in
addition to BoD as suggested by Malegam Committee has to be one of the mandatory
licensing conditions for licensing of new UCBs and expansion of existing ones. The report
has also suggested amendment of Section 56 of the B.R. Act, 1949 so as to empower RBI to
bring in regulation of UCBs at par with commercial banks.
33. The report is already placed on the website of RBI for soliciting public comments; I
am glad that this Seminar today also has been arranged to discuss the recommendations of
the Committee. Debate, in any case, is always welcome and differing or different views will
certainly augment final decision which will be taken by RBI after duly considering the views of
all the stakeholders.
Co-operative character in co-operative banking
34. While the likely loss of co-operative character of the large Multi-State Co-operative
Banks was vividly deliberated in the Discussion Paper as mentioned above, and so have
become "too big to be co-operatives", it is unfortunate that the co-operative character is
increasingly being undermined even in the uni-state co-operative banks. A study conducted a
couple of years ago by the College of Agricultural Banking pointed to low attendance in
AGMs, restrictive practices in admitting new members, low voting turnout for election of new
management, re-election of the same management or their family members, unanimous
elections, lack of meaningful discussions in AGMs, etc. Thus, it was observed that the
cooperatives especially UCBs are losing their co-operative character.
35. We need to reflect on certain soul searching questions. It may cause certain shock
to several of you, the veterans of co-operative movement, to undertake this search. Because,
you need to find answers to some inconvenient questions. They are as follows:
a. Has the co-operative movement retained its relevance after its 130 years existence
in India?
b. Has the Indian psyche grown beyond the need for "one person one vote for mutual
benefit" idiom?
c. Has the co-operative movement captured the imagination of younger generation?
d. Has it produced enough qualified and energetic young leaders to carry forward the
movement?
e. How the movement can insulate itself from the trends that as the CAB study pointed
out reduce the cooperativeness of co-operatives?
36. I would strongly urge the sector, if not in this Seminar, to find answers to these
questions.
37. Another area where the cooperativeness of co-operatives is missing relates to the
Federations' role. Several Committees have suggested that the co-operative banking sector
need umbrella organisations to facilitate, among others, funds management, IT services,
capacity building and strategic guidance. I hear about only one serious attempt has been
made by the Gujarat Federation so far in that direction. It is a matter of regret that
Federations could not so far come forward to activise such umbrella organisations. I look
forward to the Federations moving ahead on this very useful, self-helping initiative.
Conclusion
38. To conclude, let me say that we do recognize that co-operative banks are unique in
terms of their structure, clientele and credit delivery. The resilience shown by these banks
during their long existence can be leveraged. Despite their inherent weaknesses in terms of
low capital, poor management and intrusive policies of State, co-operative banks in India
have successfully weathered several challenges during their century old existence and
continued to grow in the competitive environment which emerged following the Economic
and Financial Sector Reforms initiated in 1991. RBI has been continuously taking policy
measures to strengthen the co-operative banking sector. It is heartening to see that
supportive regulatory environment, adoption of technology and re-orientation of business
strategy can act as enablers for co-operative banks to contribute more meaningfully. Yet,
looking into the future, some hard questions relating to maintaining the cooperativeness in
co-operatives need to be answered. And Federations have to deliver on Umbrella
Organisations.
39. Thanking you all for your patient attention.