Despite hue and cry and staged heavy protest for the ailing cooperative banking system in Telangana, misgovernance and mismanagement plagued the cooperative banking system. As per government reports several solutions find the way but lack of political will and regulatory resolve to put them all in place with a sense of urgency. Still the basic solutions are not addressed.
The Urban Cooperative Banks (UCBs) form an important part of Indian banking and occupy about 7.5% of the financial sector space. Despite the failure of a few UCBs like Krushi, Charminar, and the PMC Bank lately, recognising the need for reforms in them as part of mainstream banking, the Reserve Bank of India (RBI) appointed another Committee with NS Viswanathan, its former Deputy Governor, as the chairperson in July 2021.
Several committees have examined the ills plaguing Cooperative Credit Societies and UCBs.
Misgovernance and mismanagement are the two evils that have plagued the cooperative banking system. We have solutions but need political will and regulatory resolve to put them in place with a sense of urgency. Basically, three objectives come to mind:
- – It is imperative to strengthen cooperative banking for achieving financial stability as their share in the total financial system is 12%
- – Its reach helps in targeting financial inclusion efforts much better than through all other existing channels
- – Improving credit delivery through cooperative banking channels by knitting and netting rural and cooperative banks would help cross-holding the risks as the existing structures have built-in concentration risks, rendering inadequacies in capital, technologies and payment and settlement systems
The rural-urban continuum cannot be ignored. The countryside is getting urbanised, and rural connectivity is improving by the day. UCBs have put the technology in place; going ahead fast in implementing core banking solutions; and building capacities to cope with the technology changes. While they are trying to embrace the new challenges, they should catch up with credit, market and operational risks outlined by the Basel Committee.
UCBs that are growing due to mergers and acquisitions, and diversification of business in India have the potential of causing systemic risks, and they can be contained if they can cross-hold their risks with the rural cooperatives for mutual advantage as both the structures would eventually be member-centric, democratically governed economic entities taking care of the larger societal interests that the commercial and foreign banks can ill afford to.
There is also a push for banking to become a smaller, simpler, less-profitable industry the world over. Even in India, we opened a window for Small Finance Banks. The future of UCBs lies in the vacant space left by large banks guided by profit purposes and not social purposes. They are now member registered credit information companies. They should assign 2.5% additional risk weight towards covering market risk, and also assign a risk weight of 100% against foreign exchange and gold. They should build an investment fluctuation reserve up to a minimum of 5% of the investments held in Held for Trading and Available for Sale categories. These changes require continuing efforts in education, training, research and communication across and within the organisations.
Viswanathan Committee Vision
The Viswanathan Committee developed a vision for the UCBs that cover 67 lakh borrowers and are significant in financial inclusion. It has identified two broad sources of constraints: size, and professional management and committed governance. The committee conceded that smaller UCBs could reduce intermediation costs, but their net-interest margins would be disproportionately high. Hence, their ability to sustain the returns needs to be countenanced. While professional management and governance need to improve substantially, size need not be a constraint as several fintechs, NBFCs of lesser size entities are functioning efficiently drawing clear boundaries for their financial intermediation and introducing technologies.
In the environment of co-lending responsibly with NBFCs/fintechs and for that matter even some of the private sector banks, niche markets can be accessed to the advantage of both institutions and the members of the UCBs, given the fact that UCBs are member-centric, member-led, member-participated democratic institutions.
While professional management and governance need to improve substantially, size need not be a constraint as several fintechs and NBFCs of lesser size are functioning efficiently
The State Cooperative Laws under which these UCBs were set up primarily as societies were framed on the principle of ‘suspect and respect’ while the cooperative principles are based on trust and unity. Accountability, transparency and governance took a backseat. Will the laws of States be re-written to provide for rectifying these deficiencies?
Regulation and Facilitation
UCBs have been brought under the Risk-Based Supervision framework and Basel II guidelines have become mandatory. Know-your-customer (KYC) norms too are mandatory. It is also worthwhile to recall the recent regulatory facilitation and policy changes introduced by the RBI: they can set up ATMs if they maintain a minimum of 10% CRAR (capital-to-risk weighted assets ratio) with no default in CRR (cash reserve ratio) and SLR (statutory liquidity ratio) obligations in the immediately preceding financial year and a net NPA position of less than 5%, earning continuous profit for the last 3 years and having a sound internal control system.
With a certain cap on the capital, the Malegam Committee recommended granting additional licences for setting up UCBs or converting well-functioning societies into UCBs. The Board of Directors and Board of Management are expected to be separate. The CEO will be appointed with the approval of the RBI. The Board of management should consist of persons with professional skills, which shall be entrusted with the responsibility of control and direction of the affairs of the bank.
The RBI, through its regional Task Force of Cooperative Urban Banks (TAFCUB), brought the issues of dual regulation in States under control. These institutions are now able to devote enough attention to business development and growth.
‘UCBs licensed as Authorised Dealers (Category I) were allowed to participate in the exchange traded currency option market of a designated exchange, recognised by Sebi as clients only, subject to RBI guidelines only for the purpose of hedging underlying foreign exchange exposure arising from customer transactions.’ Risks on and off the balance sheet of UCBs, therefore, require dexterous handling.
In addition, the UCBs are short of capital and their ability “to raise capital under the principles of one member, one vote, led to the investment horizon of a shareholder being largely borrower-centric, making it even more difficult to raise capital when a bank is unable to lend”. The committee considers that there is ample space for financial institutions that operate on the principles of cooperation and the inclusivity that they get. It envisions the UCB sector to be powered and driven by a passion for financial inclusion as its core of the business model. It also conceded that financial strength, strong branding, cutting-edge technology driven by processes, and skilled human resources with enabling regulatory environment would alone make such vision turn into reality.
The Vishwanathan Committee envisions the UCB sector to be powered and driven by passion for financial inclusion as its core of the business model
The enabling factors are the recent legislative changes and in-principle approval for the setting up of an Umbrella Organisation (UO). The UO should be seen as a game-changer for the sector and as such the National Federation of Urban Co-operative Banks and Credit Societies Ltd (NAFCUB) should accelerate the steps to setting it up.
While discussing the regulatory architecture for the UCBs, it recognised the need for not following the ‘one-size-fits-all’ approach. It has suggested different benchmarks for different sizes of the banks insofar as regulatory capital is concerned. It emphasises the need for 75% of their lending should be for priority sectors and 50% for entities/activities that do not cross Rs 25 lakh per capita. Although the committee deliberated on the issue of capital, it fell short of recommending a separate Cooperative Exchange.
The Way Forward
Though the UCBs have demonstrated a sense of restraint and better compliance with the regulatory norms, their ability to comply with risk management practices, governance, professionalism in management continues to receive greater attention. It is trust that matters and the growth-driven UCBs must preserve the trust carefully. Ethics count. If they network with their upcoming rural cousins, their ability to provide better services and ring-fence the risks would improve significantly. Unified thinking and approach and cross-selling of products will help.
When milk and juices could build a brand in Indian cooperatives, it should not be difficult for banking to go the same way
Such networking would also enhance trust in cooperative banking. Further, when the LIC and other PSUs are being asked to contribute to the capital and even take over the ailing PSBs, would it not be possible for institutions like the AMUL, KRIBCO and other large-sized cooperatives to contribute to the capital of UCBs and partake in the functioning of the cooperative exchange?
Capital continues to be a matter of concern, and requires some exceptional solutions:
Cooperative Exchanges: The most important question is with the State governments restricting their share to less than 25% in cooperative banking unlike the public sector banks where the GoI is the owner of 51%, how will the member-driven and member-centric cooperative banks find capital?
In fact, one advantage is that unlike in commercial banks, every member enters with a 10% capital contribution. This capital should not get eroded under any circumstances, which would mean that they always have 10% tier-I capital cushion at all points. If the cooperative laws facilitate through appropriate provisions in the bylaws permit the cooperative societies to raise capital additionally from members, it will become imperative that they should promise some minimum return on capital at the end of the year. Can Cooperative Exchanges open only to the members be set up for this purpose?
Even when such exchanges are allowed to come in, the cooperative laws of the State governments should provide for raising the capital from these Exchanges. This is the time to respond to these questions by all those who have the interest to promote and develop cooperatives for alleviating rural poverty and for achieving financial inclusion.
Insurance Mechanisms: Since the Deposit and Credit Guarantee Corporation of India offers a guarantee for deposits up to Rs 5 lakh per individual depositor, all the UCBs and DCCBs have the advantage of offering this security.
The time is ripe for taking up comprehensive reforms to the cooperative banking structure to come into the mainstream.
When milk and juices could build a brand in Indian cooperatives, it should not be difficult for banking to go the same way. Cooperative Banking in India has the potential to build a brand image with adequate understanding and support coming from the regulator. Sustainable cooperative banking is not a distant goal but an achievable prospect in the near term. #KhabarLive #hydnews
