V Leeladhar: Consolidation in the Indian financial sector
Special address by Mr V Leeladhar, Deputy Governor of the Reserve Bank of India, on the
occasion of the International Banking & Finance Conference 2008, organised by the Indian
Merchants' Chamber, Mumbai, 17 April 2008.
* * *
Dear Friends,
1. It is my pleasure to be here with you this morning on the occasion of International Banking
& Finance Conference 2008 of the Indian Merchants' Chamber. I am grateful to the
organisers for having afforded me this valuable opportunity to address this august audience
and share some of my thoughts on the subject of consolidation in the Indian financial sector.
The Chamber has indeed come a long way since its establishment in the pre-independence
days in September 1907 under the presidentship of late Sir Manmohandas Ramji. In that era,
it performed the role of the nation's watchdog on the economic front under the alien rule. The
Chamber also has the unique distinction of having had the patronage of the Father of the
Nation, Mahatma Gandhi as its honorary member since 1931. The Chamber, during its
functioning of hundred years, has done yeoman service to the country and society at large in
promoting the cause of business community through strengthening the government-business
partnership and representing the business point of view before the public policy authorities
and I hope that it will continue to perform its productive role in the national policy formulation,
in the days to come as well.
2. In my address today, I would like to briefly touch upon the experience in and the emerging
contours of consolidation in the Indian financial sector, that have taken shape over the past
few decades, in the RBI-regulated entities, as a result of a calibrated policy response
designed for the purpose.
Consolidation in the financial sector
3. Consolidation of business entities, through mergers and acquisitions, is a world-wide
phenomenon. The numerous mergers and acquisitions all over the world, including in India,
in the real as well as in the financial services sector, appear to be driven by the objective of
leveraging the synergies arising from the process of merger and acquisition. However, such
structural changes, particularly in the financial system, can also potentially have public policy
implications. With this brief backdrop, I would like to present an overview of consolidation in
the Indian financial sector, particularly amongst the banks, development financial institutions
and the non-banking financial companies.
The Indian scenario
The diversity of statutory frameworks
4. In the context of consolidation in the financial sector in India, let me say a few words about
the unique features of the Indian credit institutions and their operating environment. While
talking about consolidation in the Indian milieu, it is important to bear in mind that there is
diversity of the governing statutes applicable to different entities in the Indian credit system.
Further, they are governed by divergent statutory provisions, depending upon the nature of
their operations and the form of their organisation or ownership.
Thus, while the private sector banks are subject to the provisions of the Banking Regulation
Act, 1949, the public sector banks are governed by their respective founding statutes and by
those provisions of the B R Act which have been made specifically applicable to them. The
urban co-operative banks, on the other hand, are governed by the provisions of the
Cooperative Societies Act of the respective State or by the Multi-State Cooperative Societies
Act, as also by the provisions of the B R Act which are specifically applicable to them.
The development financial institutions (DFIs), which were founded by a statute, attract the
provisions of those statutes while the DFIs structured as limited companies, were subject to
the provisions of the Companies Act, 1956, but both the types of the DFIs are regulated and
supervised by the RBI under the provisions of the R B I Act, 1934.
The Regional Rural Banks (RRBs) were created under the RRBs Act, 1976 and are
regulated by the RBI but supervised by the NABARD, while the non-banking financial
companies are subject to the provisions of the Companies Act, 1956 and are regulated and
supervised by the RBI under the provisions of the RBI Act.
The housing finance companies, which are a sub-set of the NBFC category, are currently
regulated and supervised by the National Housing Bank while the rural co-operative credit
structure falls within the regulatory and supervisory domain of the NABARD.
History of consolidation in the Indian banking sector
5. In the context of consolidation in the Indian banking sector, it may be recalled that the
Report of the Committee on Banking Sector Reforms (the Second Narasimham Committee -
1998) had suggested, inter alia, mergers among strong banks, both in the public and private
sectors and even with financial institutions and NBFCs. Indian banking sector is no stranger
to the phenomenon of mergers and acquisition across the banks. Since 1961 till date, under
the provisions of the Banking Regulation Act, 1949, there have been as many as 77 bank
amalgamations in the Indian banking system, of which 46 amalgamations took place before
nationalisation of banks in 1969 while remaining 31 occurred in the post-nationalisation era.
Of the 31 mergers, in 25 cases, the private sector banks were merged with a public sector
bank while in the remaining six cases both the banks were private sector banks.
Since the onset of reforms in 1990, there have been 22 bank amalgamations; brief
particulars of these are furnished in the Annex-I. It would be observed that prior to 1999, the
amalgamations of banks were primarily triggered by the weak financials of the bank being
merged, whereas in the post-1999 period, there have also been mergers between healthy
banks driven by the business and commercial considerations.
Consolidation in the commercial banking segment - recent developments
6. The consolidation efforts in the Indian banking sector can be broadly placed, as per the
nature of the entities involved and of the mergers, into several categories viz., (a) voluntary
amalgamation between private sector banks; (b) compulsory amalgamation of a private
sector bank; (c) merger between public sector banks; (d) merger of a non-banking financial
company (NBFC) with a private sector bank; and (e) merger of a housing finance subsidiary
with the parent public sector bank. Let me present a brief overview of the policy and
processes involved in each type of merger.
(a) Voluntary amalgamation between private sector banks
7. As regards the statutory provisions, the procedure for voluntary amalgamation of two
banking companies is laid down under Section 44-A of the Banking Regulation Act, 1949 (the
Act), which is easy to follow and cost effective. After the two banking companies have
passed the necessary resolution proposing the amalgamation of one bank with another bank,
in their general meetings, by a majority in number representing two-thirds in value of the
shareholding of each of the two banking companies, such resolution containing the scheme
of amalgamation is submitted to the Reserve Bank for its sanction. If the scheme is
sanctioned by the Reserve Bank, by an order in writing, it becomes binding not only on the
banking companies concerned, but also on all their shareholders.
Pursuant to the recommendations of the Joint Parliamentary Committee, the RBI had
constituted a Working Group to evolve the guidelines for voluntary merger between banking
companies. Based on the recommendations of the Group, the RBI had issued guidelines in
May 2005 laying down various requirements for the process of such mergers including
determination of the swap ratio, disclosures, the stages at which Boards will get involved in
the merger process, etc. While amalgamations are normally decided on business
considerations (such as the need for increasing the market share, synergies in the
operations of businesses, acquisition of a business unit or segment, etc.), the policy objective
of the Reserve Bank is to ensure that considerations like sound rationale for the
amalgamation, the systemic benefits and the advantage accruing to the residual entity are
evaluated in detail. While sanctioning the scheme of amalgamation, the Reserve Bank takes
into account the financial health of the two banking companies to ensure, inter alia, that after
the amalgamation, the new entity will emerge as a much stronger bank.
8. The experience of the Reserve Bank has been, by and large, satisfactory in approving the
schemes of amalgamation of the private sector banks in the recent past and it had no
occasion to reject any scheme of amalgamation submitted to it for approval. There have
been five voluntary amalgamations between the private sector banks so far while one
amalgamation between two private sector banks (Ganesh Bank of Kurundwad and the
Federal Bank) was induced by the RBI, in the interest of the depositors of the former. A
majority of these voluntary mergers was between healthy banks, somewhat on the lines
suggested by the First Narasimham Committee. The committee was of the view that the
move towards the restructured organisation of the banking system should be market-driven
and based on profitability considerations and brought about through a process of mergers
and acquisitions.
(b) Compulsory amalgamation of a private sector bank
9. Compulsory amalgamations are induced or forced by the Reserve Bank, under Section 45
of the Act, in public interest, or in the interest of the depositors of a distressed bank, or to
secure proper management of a banking company, or in the interest of the banking system.
In the case of a banking company in financial distress, which has been placed under the
order of moratorium, under Section 45(2) of the Act, on an application made by the Reserve
Bank to the Central Government, the Reserve Bank can, for the foregoing reasons, frame a
scheme of amalgamation for transferring the assets and liabilities of such distressed bank to
a much better and stronger bank. Such a scheme framed by the RBI is required to be sent to
the banking companies concerned, for their suggestions or objections, including those from
the depositors, shareholders and others. After consideration the same, the RBI sends the
final scheme of amalgamation to the Central Government for sanction and notification in the
official gazette. The notification issued for compulsory amalgamation under Section 45 of the
Act is also required to be placed before the two Houses of Parliament.
10. Most of the amalgamations of the private sector banks in the post-nationalisation era
were induced by the Reserve Bank in the larger public interest, under Section 45 of the Act.
In all these cases, the weak or financially distressed banks were amalgamated with the
healthy public sector banks. The over-riding principles governing the consideration of the
amalgamation proposals were: (a) protection of the depositors' interest; (b) expeditious
resolution; and (c) avoidance of regulatory forbearance. The amalgamations of the erstwhile
Global Trust Bank and the erstwhile United Western Bank with public sector banks are
recent examples. Even in such cases, commercial interests of the transferee bank and the
impact of the amalgamation on its profitability were duly considered.
The mergers of many weak private sector banks with the healthy ones, have brought us to a
creditable stage today when not a single private sector bank in the country has the capital
adequacy ratio of less than the minimum regulatory requirement of nine per cent. This now
paves the way for effective implementation of the Prompt Corrective Action (PCA)
Framework by the RBI, which could not be invoked earlier when the banking system was
populated by many weak banks, without creating confidentiality issues.
(c) Merger of public sector banks
11. The statutory framework for the amalgamation of the public sector banks, viz., the
nationalised banks, State Bank of India and its subsidiary banks, is, however, quite different
since the foregoing provisions of the B R Act do not apply to them. As regards the
nationalised banks, the Banking Companies (Acquisition and Transfer of Undertakings) Act,
1970 and 1980, or the Bank Nationalisation Acts authorise the Central Government, under
Section 9(1)(c), to prepare or make, after consultation with the Reserve Bank, a scheme,
inter alia, for transfer of undertaking of a "corresponding new bank" (i.e., a nationalised bank)
to another "corresponding new bank" or for transfer of whole or part of any banking institution
to a corresponding new bank. Unlike the sanction of the schemes by the Reserve Bank
under Section 44-A of the B R Act, the scheme framed by the Central Government is
required, under Section 9(6) of the Bank Nationalisation Acts, to be placed before both
Houses of Parliament. Under this procedure, the lone merger that has happened so far was
the amalgamation of the erstwhile New Bank of India with the Punjab National Bank,
occasioned by the weak financials of the former. However, the post-merger experience was
considered to be not altogether satisfactory on account of the problems in effective
integration of the two entities.
12. As regards the State Bank of India (SBI), the SBI Act, 1955, empowers the State Bank to
acquire, with the consent of the management of any banking institution (which would also
include a banking company), the business, including the assets and liabilities of any bank.
Under this provision, what is required is the consent of the bank sought to be acquired, the
approval of the Reserve Bank and the sanction of such acquisition by the Central
Government. Several private sector banks were acquired by the State Bank of India following
this route. However, so far, no acquisition of a public sector bank has materialised under this
procedure. Similar provisions also exist in respect of the subsidiary banks of the SBI.
13. It would thus be seen that there are sufficient enabling statutory provisions in the existing
statutes governing the public sector banks to encourage and promote consolidation even
within the public sector banks through the merger and amalgamation route, and the
procedure to be followed for the purpose has also been statutorily prescribed.
Consolidation and its impact on the branch network
14. It may be mentioned here that one of the likely effects of consolidation in the banking
sector may be the rationalisation of the branch network of the banks concerned, resulting in
the likely closure of certain branches of the merging banks, where there might be an overlap
in their catchment area. Generally, as part of consolidation process, the emerging bank
would be more inclined to shift its branches and focus of operations from the rural to the
urban and semi-urban areas, which are usually more remunerative. However, the current
regulatory regime for branch authorisation does not generally permit closure of the rural
branches of the banks. Such a requirement is in tune with the philosophy of financial
inclusion which emphasises increasing penetration of the banking services in the unbanked
and under-banked areas of the country. For instance, under the new Branch Authorisation
Policy of the RBI announced in September 2005, during the year 2007-08 (April-March), of
the 4117 branch authorisations issued 1979 were for the under-banked centres. In
aggregate, 627 authorisations were issued during the year for opening of rural branches and
1471 branches in the semi-urban areas. I would like to emphasise that the new branch
authorisation policy does not preclude the possibility of any urgent proposals for opening
bank branches being considered by the RBI even outside the annual plan, specially in the
rural / under-banked areas, anytime during the year.
15. In brief, RBI has been discharging the mandate given to it for branch licensing as
required by law, public policy and regulatory comforts. Let me add that under the new policy,
all the branch-authorisation requests of the banks were granted by RBI, subject to the banks
fulfilling the criteria laid down for opening of branches in under-banked areas, except in the
case of a few banks where there were serious regulatory discomfort on account of their
indiscretions and contravention of the regulatory norms. It is interesting to note in this context
that in the USA, for instance, for lesser regulatory violations, the banks are subjected to
"cease and desist" order from the regulator, severely restricting their activities during the
currency of the order.
(d) Merger between a private sector bank and an NBFC
16. As I mentioned earlier, the Reserve Bank is vested with the discretionary powers to
approve the voluntary amalgamation of two banking companies under the provisions of
Section 44-A of the Banking Regulation Act, 1949. However, these powers do not extend to
the voluntary amalgamation of a non-banking company with a banking company where
amalgamations were governed by sections 391 to 394 of the Companies Act, 1956 in terms
of which, the scheme of amalgamation has to be approved by the High Court. Hence, the
banks were advised in June 2004 that where an NBFC is proposed to be amalgamated with
a banking company, the banking company should obtain the approval of the Reserve Bank
after the scheme of amalgamation is approved by its Board but before it is submitted to the
High Court for approval.
17. Subsequently, in pursuance of the recommendations of the Joint Parliamentary
Committee (JPC), a Working Group was constituted by RBI to evolve guidelines for voluntary
merger of banking companies. Based on the recommendations of the Group and in
consultation with the Government, it was proposed in the Annual Policy Statement of April
2005 to issue guidelines on merger and amalgamation between private sector banks and
with NBFCs. The guidelines were to cover: process of merger proposal, determination of
swap ratios, disclosures, norms for buying / selling of shares by promoters before and during
the process of merger and the Board's involvement in the merger process. The principles
underlying these guidelines were also to be applicable, as appropriate, to public sector
banks, subject to relevant legislation. Accordingly, the guidelines were issued in May 2005.
18. There have been a few instances of mergers of the NBFCs with the private sector banks.
The first such merger occurred in May 1999 when the RBI approved the merger of Twentieth
Century Finance Corporation Ltd., an NBFC, with Centurion Bank Ltd. Subsequently, in
2003, the merger of IndusInd Enterprises & Finance Ltd. (IEFL), one of the promoters of the
IndusInd Bank Ltd., with the bank was also approved. Further, the Kotak Mahindra Finance
Ltd., an NBFC, was converted into Kotak Mahindra Bank Limited, by amending its
Memorandum and Articles of Association, and was granted a banking licence by the RBI in
February 2003. In June 2004, the merger of Ashok Leyland Finance Ltd., an NBFC, with the
IndusInd Bank Ltd. was approved by the RBI. Besides, certain banks also have significant
stakes in some of the NBFCs. For instance, the Development Bank of Singapore (DBS) has
a major stake in Cholamandalam Investment & Finance Ltd. while the Barclays Bank has a
major holding in Rank Investments Ltd.
In view of the recent global developments, the current policy of merger of NBFCs with banks
will require a comprehensive review.
(e) Merger of a housing finance subsidiary with the parent public sector bank
19. There have also been a few instances where the housing finance subsidiaries of the
public sector banks were merged with the parent bank. During April 2002 and March 2007,
the merger of the housing finance subsidiaries of Andhra Bank, Vijaya Bank, Corporation
Bank and Bank of Baroda with the respective parent banks was approved by the RBI. The
mergers were triggered primarily by the rising cost of funds of the housing finance entities,
which adversely impacted the viability of their business models. The approvals for mergers
from the RBI became necessary as there was a change in the structure of the banks'
subsidiaries, which had been established under Section 19(1) of the B R Act, 1949 with the
regulatory approval of the RBI.
(f) Attempted mergers that did not materialise
20. Let me also take this opportunity to point out that all the attempts made for merger of
banks do not necessarily result in a successful outcome. There has been an instance where
despite the process of merger having progressed quite a bit, it did not eventually fructify. The
case of the attempted merger of the then UTI Bank and the erstwhile Global trust Bank can
be cited in this regard. While the scheme of voluntary amalgamation of the two banks had
been submitted to the RBI for approval, the approval was kept on hold pending the
completion of the SEBI investigations. It may be recalled that, in the run up to the proposed
merger, the SEBI had initiated certain investigations into the share-price manipulation of the
GTB shares. While the approval from the RBI was yet to be granted, the proposed merger
was called off by the parties concerned. Thus, the merger did not materialise.
Consolidation of the Development Financial Institutions (DFIs)
21. It may be recalled that the DFIs were set up in the country in the post-independence era
for providing long-term finance to the industrial projects to facilitate industrial development, in
the absence of alternative sources of long-term funds. Hence, to enable the DFIs to play this
role, they were also provided access to certain concessional sources of funds by way of
allocation of SLR Bonds and lending from the Long Term Operation Funds of the RBI.
However, with the onset of financial sector reforms, and pursuant to the recommendations of
the First Narasimham Committee, the access by the DFIs to the traditional concessional
sources of funds was gradually phased out. Consequently, the raising of resources at
market-related rates, increased their cost of funds, thereby, affecting the very viability of their
business model, coupled with increasing competition from the banks. The DFIs came within
the regulatory purview of the RBI in 1991 for the first time, and the regulatory domain of the
RBI, till recently, extended to the seven Term-Lending Institutions (TLIs - EXIM Bank, ICICI
Limited, IDBI, IDFC Limited, IFCI Limited, IIBI Limited, and TFCI Limited) and three
ReFinancing Institutions (RFIs - NABARD, NHB and SIDBI).
22. The Committee on Banking Sector Reforms (Second Narasimham Committee) had
recommended in 1998 that the DFIs over a period of time should convert themselves into
banks and there should be only two forms of intermediaries - banking companies and
nonbanking finance companies, and if a DFI does not intend to become a bank with a banking
licence, it should be categorised as an NBFC. The Working Group for Harmonising the Role
and operations of DFIs and Banks (Khan Working Group - KWG), was also of the view that a
full banking licence be eventually granted to the DFIs. Based on these recommendations, the
RBI had released a "Discussion Paper" (DP) in January 1999 soliciting wider public debate
on the issue. The DP had, inter alia, envisaged a transition path for the DFIs for becoming
either a full-fledged NBFC or a bank. Based on the feedback received on the DP, the
Monetary and Credit Policy for the year 2000-2001, outlined the broad approach proposed to
be adopted for considering the proposals in the area of Universal Banking. The Policy stated
that the principle of "Universal Banking" was a desirable goal and any DFI, which wished to
transform into a bank, should have the option to do so, provided it was able to fully satisfy the
prudential norm applicable to the banks. For the purpose, such a DFI was expected to
prepare a transition path for consideration of the Reserve Bank. Thus, in due course, the
recommendation of the Narasimham Committee to have only banks and the restructured
NBFCs in the system, could be operationalised. Accordingly, in April 2001, the FIs were
advised several operational and regulatory issues relevant in evolving their transition path to
a universal bank and for formulating a road map for the purpose.
23. In the light of the RBI guidance, two leading term lending institutions viz., the erstwhile
IDBI and ICICI Limited got converted into a commercial bank, each. The four term-lending
institutions (IDFC Ltd., IFCI Ltd., IIBI Ltd. - since wound up, TFCI Limited) which were in the
category of NBFCs, are now regulated as per the norms applicable to the NBFCs. However,
the EXIM Bank and the three RFIs (NABARD, NHB and SIDBI) continue to be under the
regulatory domain of the RBI and are regulated as per the norms applicable to the financial
institutions.
Consolidation of the Regional Rural Banks (RRBs)
24. The RRBs were established under the RRBs Act, 1976 with a view to create an
institutional mechanism for delivery of rural credit through an entity which would have the
local feel but the expertise of the commercial banks for catering to the rural credit needs. The
RRBs are owned jointly by Government of India, sponsor banks and State governments of
50, 35 and 15 per cent, respectively, and were expected to have region-specific limited area
of operation. Over the years, their number had increased to 196, operating in 26 States of
the country, being sponsored by 27 scheduled commercial banks and one State
Cooperative Bank. However, with their limited size, scope and area of operations, competition
from the rural branches of the commercial banks and the rising cost of operations due to
upgraded wage structure on par with the commercial banks, their profitability and viability
was adversely affected. This triggered the move towards their consolidation. The
consolidation of the RRBs was first suggested by the Working Group to Suggest
Amendments to the RRBs Act, 1976 (Chalapathy Rao Committee) in 2001. It had suggested
that while retaining the regional character of these institutions, the number of sponsor banks
may be reduced. Subsequently, the Advisory Committee on Flow of Credit to Agriculture and
related Activities (Vyas Committee) had suggested in 2004 that in the first stage, all RRBs of
a sponsor bank in a State should be amalgamated into a single unit in that State and at the
second stage, there should be a State-level consolidation of RRBs. Subsequently, the
Internal Working Group on RRBs, constituted by the RBI (Sardesai Committee) in June
2005, also suggested two options for strengthening RRBs, namely, merger between RRBs of
the same sponsor bank in the same State or the merger of RRBs sponsored by different
banks in the same state.
25. The main triggers for these recommendations were the small size of the RRBs which had
made their operations unviable leading to significant amount of accumulated losses - which
was not considered desirable. In order to improve the operational viability of RRBs and to
take advantage of the economies of scale by reducing transaction cost, Government of India
initiated, in September 2005, a process of amalgamation of RRBs sponsor bank-wise. The
first set of amalgamations took place on September 12, 2005 when 28 RRBs were
amalgamated to form 9 new RRBs. The amalgamations were carried out under Section 23-A
of the RRBs Act, 1976, which provides that the Central Government, after consultation with
the National Bank, the concerned State Government and the Sponsor Bank may
amalgamate two or more RRBs. The process of amalgamation is still continuing.
26. As a result of such amalgamations, the number of RRBs has come down to 91 as on
March 31, 2008 as against 133 and 196 RRBs as on March 31, 2006 and 2005, respectively.
It needs to be noted here that this consolidation has occurred only amongst the RRBs, and
not with the sponsor banks, and has been achieved without amendment to the governing
statute of the RRBs. The structural consolidation of the RRBs has resulted in formation of
new RRBs, which are financially stronger and bigger in size in terms of business volume and
outreach. Thus, the emerging RRBs will be able to take advantages of the economies of
scale and reduce their operational costs. With the advantages of local feel and familiarity
acquired by the RRBs, they would now be better placed to achieve the objectives of rural
development and financial inclusion.
Urban Co-operative Banks (UCBs)
27. The UCBs probably pose the most complex issues for a regulator since their governance
is subject to the provisions of the Cooperative Societies Act, which is administered by the
State governments while their banking operations are governed by the B R Act, administered
by the RBI, leading to a duality of control. Hence, any move towards consolidation in this
sector, required a very special and collaborative approach involving all the stakeholders. The
constitution of the Taskforce for Cooperative Urban Banks (TAFCUB), for each State, at the
initiative of the RBI, with representation from all the stakeholders was, therefore, a step in
this direction and has proved effective in resolving the intractable issues of the UCBs.
28. The spectacular growth of UCBs in the late nineties and up to 2003, which had resulted
in increasing their penetration, ironically, also led to certain weaknesses in the sector that
adversely affected public perception and thereby, their competitiveness. A major reason for
the decline in public confidence was the crisis faced in 2001 by a large multi-state
cooperative bank in the State of Gujarat, when the bank witnessed a sudden "run" on its
branches, following rumours of its large exposure to a leading stock broker who had suffered
huge losses in the share market. The large-scale withdrawal of deposits within a short time
resulted in severe liquidity problems for the bank. The bank was also holding about rupees
800 crore of inter-bank deposits from a large number of UCBs within and outside the State,
which posed a systemic risk. In order to protect the interests of the general public and also
that of the other co-operative banks, RBI issued directions to the bank restricting certain
operations (acceptance of fresh deposits, restricting payments to any single depositor to
Rs.1000 and ban on fresh lending) and requisitioned the Central Registrar of Co-operative
Societies, New Delhi to supersede the Board of Directors and appoint an Administrator. An
order of moratorium was also enforced on the bank by the Central Government for a short
period. The bank was subsequently placed under a scheme of reconstruction with the
approval of Reserve Bank of India.
29. The Gujarat episode was followed by another major crisis in the state of Andhra Pradesh
in 2002, when one of the largest co-operative banks in the State faced a run, following a
newspaper report regarding an inquiry instituted into the affairs of the bank by the State
Registrar of Cooperative Societies. The bank was in a weak position, and ultimately, after
attempts for its revival failed, its licence was cancelled by the Reserve Bank in 2004.
30. The decline in public confidence in the UCB sector, deepened in the aftermath of the
crisis in Gujarat and Andhra Pradesh and concomitantly, the position of UCBs generally
deteriorated. As on June 30, 2004, 732 out of 1919 UCBs were categorised In Grade III or IV
signifying weakness and sickness. With a view to facilitating consolidation and emergence of
strong entities and providing an avenue for non-disruptive exit of weak/unviable entities in the
co-operative banking sector, RBI had also issued guidelines in February 2005 to the UCBs to
encourage merger/amalgamation in the UCB sector. Although the Banking Regulation Act,
1949 (As Applicable to the Cooperative Societies) does not empower Reserve Bank to
formulate a scheme with regard to merger and amalgamation of co-operative banks, the
State Governments have incorporated in their respective Co-operative Societies Acts a
provision for obtaining prior sanction in writing, of the RBI for an order, inter alia, for
sanctioning a scheme of amalgamation or reconstruction. The Reserve Bank's role in the
merger of the cooperative banks is, thus, confined to the examination of only the financial
aspects of the scheme of merger and to protect the interests of depositors of the banks
concerned as well as ensuring the stability of the financial system while considering such
proposals. Subsequently, recognising that the UCBs are an important part of the financial
system in India, it was also considered necessary for them to emerge as