Cooperative banking

Source: By Madan Sabnavis: The Financial Express

The recent ordinance relating to cooperative banks, barring those which lend to farmers, has brought in a certain amount of euphoria. The ordinance gives regulatory oversight of these banks, essentially urban cooperative banks and multi-state cooperative banks, a push by putting in place a stronger RBI supervisory structure for them. The objective, as stated by the government, was to provide protection to the deposit-holders.

Two things must be remembered. The first is that the Registrar of Cooperatives and RBI were both the regulators of these cooperative banks, and hence, the former does not lose its power which remains unchanged. Therefore, the two regulator model still holds. Second, even earlier, there was RBI oversight though not to the extent that is being spoken of today. Hence, it is not a case of saying that there was no oversight earlier that has been brought in today.

The PMC fiasco laid bare the problems with the cooperative structure. These banks had a different kind of regulation from that of the commercial banks. Hence, while the PMC problem became an RBI problem, which had to be addressed, the fact remains that co-op banks have very opaque structures. Given the large number of such banks (urban and multi-state) — around 1,500—the regulatory pressure on RBI would be immense.

If one were to look at the structure of UCBs, in 2019, 1,544 of them, according to RBI, accounted for a balance sheet size of Rs 6 lakh crore compared to the Rs 166 lakh crore of commercial banks. Of this Rs 4.8 lakh crore were deposits (Rs 129 lakh crore for commercial banks) and net worth of around Rs 0.5 lakh crore (Rs 13.3 lakh crore). On the assets side, loans were at Rs 3 lakh crore (Rs 97 lakh crore) and investments Rs 1.57 lakh crore (Rs 43 lakh crore for commercial banks).

Since 2015, the SLR requirements of UCBs have been reduced progressively in line with the prescription applicable to SCBs. Furthermore, since UCBs are governed by Basel 1 regulatory norms, the liquidity coverage ratio (LCR) requirement is not applicable to them. In terms of soundness based on CAMELS, RBI has classified 78% of them in the A and B categories.

The capital adequacy ratio for them was 9% as they are not supposed to be included under Basel 3 with any capital conservation buffers or higher tier-1 capital; 96% of them had a CAR of over 9%. Gross NPA ratio was 7.1% in 2019, but was up to 10.5% in H1FY20 due to the large failures. As of 2019, return on assets was 0.74%, and the return on net worth was 8.66%. Hence, the overall picture is not bad, but for the fact that there have been failures. There have also been 132 mergers of UCBs in the last decade and a half.

How will things be different now? The deposits of UCBs have always been covered under the deposit guarantee scheme, and hence, nothing much will change as deposits upto Rs 5 lakh would be covered under the same. These banks can, however, now have access to capital in the form of both debt and equity after taking permission from RBI. Hence, the due diligence process that has to be followed for raising either equity capital or bond will automatically ensure that they work towards maintaining a very good track record of performance, and, more importantly, governance. The ordinance also gives RBI the power to allow for mergers or amalgamations, and hence, if it is observed that some of them are too weak to survive on their own, action can be taken.

The cooperative banks have a wide scope to expand their business, which is good for the financial system because this large pie of players has remained at the periphery for too long. They have a strong focus on the SME sector, which can benefit a lot. In 2019, 44% of their lending was for priority sector, and the two leading segments were MSMEs, with a share of 26.9%, and housing, with 7.5%.

From the point of view of RBI, the challenge would be to regulate and supervise these 1,500-odd banks with the same rigour as is accorded to the commercial banks. It will also have a say in the appointment of key management positions just as it has for commercial banks, and it can seek changes in case the performance is not up to the mark. RBI can, in the public interest, supersede the management of a multi-state cooperative bank for up to five years and appoint an administrator. If the bank is registered with the Registrar of Cooperative Societies of a state, the regulator will have to consult the state government concerned before issuing an order to supersede the board.

This will require expansion in staff to meet the requirement of maintaining high standards of governance that are adhered to in the larger banking space. Less than 30% of the banks have total advances of above Rs 500 crore. Over half have a credit size of less than Rs 50 crore, which will make the job of supervision even more challenging. It can be expected that a certain degree of segregation would be called for initially where the bigger ones would be taken up on priority.

Also, looking at the future of the cooperative banking system, one can visualise a change coming in over a period of time. This large number of banks may not be sustainable, especially as the larger ones do take on the expansion path and are able to further diversify their asset portfolio and get into new spaces. This possibility cannot be ruled out and can lead to a wave of M&A activity as these banks seek to leverage synergies and grow their books. Presently, the approach has been to remain niche players, and there has been limited incentive to grow as the perimeter of activity has been defined, and the players work within these lines drawn.

It has often also been alleged that some of these cooperative banks have political clout, and it would be interesting to see how this new regulatory and supervisory structures change the way in which these banks conduct business. Logically, given the way some of the expansion and M&A activity takes place, it can only be expected that better governance practices would percolate into their functioning. But, getting this done could be one of the tougher challenges for the new regulatory architecture.