Will RBI’s Supervision for Co-operative Banks Benefit Accountholders?

Finally, the government has taken a decisive step to protect the account holders of Urban Co-operative Banks (UCBs). However, the job is still unfinished.

Today, I am going to tell you what has changed fundamentally for UCBs, since they will now be governed entirely by the RBI.

Currently, UCBs are under the dual control of the RBI as well as the State in which they are registered. RBI controls banking areas such as licensing, area of operation, interest rates, maintaining reserves as per the statute, adhering to the capital adequacy requirements, risk control, and lending norms.

On the other hand, the registration, the management, audit, supervision of the board, resolution in case of distress, liquidation, etc. are governed by the respective State Governments (under the Registrar of Co-operative Societies).

The dual control of UCBs is considered to be one of the biggest issues for their atrociously bad corporate governance.

There are 1,482 UCBs and 58 multi-state co-operative banks which collectively hold deposits of Rs 5 trillion and account for nearly 11% of total assets of Scheduled Commercial Banks (SCBs). More than 86 million people trust UCBs with their hard-earned money, and therefore the financial health of UCBs is important. UCBs play a prominent role in India's banking system

One of the main factors that attract people to deposit in co-operative banks is the higher interest rate they offer. These banks typically cater to small depositors and businesses and are important institutions to improve financial inclusion in the highly under-banked areas of the Indian economy.

Historically, undue political interference in such banks, their deteriorating performance and questionable governance practices have been causes for RBI's concern.

According to RBI data, there were 1,926 UCBs in 2004; and over the last 16 years, the RBI was compelled to merge 129 weaker cooperatives with stronger banks. Nearly 246 UCBs collapsed over the last 16 years.

The balance sheets of UCBs at the end of FY18 looked scary. Here's why...

• Average NPA ratio of UCBs and multi-state co-operative banks was 11.1%

• Nearly 13% UCBs and multi-state co-operative banks had the capital adequacy of less than 12%--a critical benchmark to measure bank's risk absorption capacity

• Nearly 40% of primary agriculture societies were loss-making

And in FY19, the combined assets of co-operative banks nearly halved to 10.6% of assets of commercial banks from 19.4% in FY05, cites an RBI report (released in December 2019). Furthermore, the report said that on the financial probability, the Net Profit after Tax (NPAT) noted a decline in FY19.

In my view, ending the dual supervision of UCBs was long overdue to boost depositors' confidence. Failure of Punjab Maharashtra Co-operative (PMC) Bank-one of the top 5 UCBs--was a shocker.

Can you imagine a bank (PMC) with 137 branches and deposits of approximately Rs 11,600 crore wasn't completely under RBI's control?

The RBI, in its Annual Report 2018-19 states that incidents of bank frauds rose by 15% on a year-on-year basis in FY19. India witnessed over 6,800 cases of frauds worth Rs 71,543 crore, mostly relating to cheating and forgery. PSBs accounted for the majority of the frauds. You may imagine how poor the level of corporate governance must have been with UCBs.

Earlier this year, RBI lowered the permissible single borrower exposure and a group borrowing exposure of UCBs to 10% and 25% respectively, from earlier 15% and 40%. And if you know, 73% of PMC Bank's total outstanding loans belonged to just one real estate company, HDIL.

Recently, the RBI suspended CKP Co-operative Bank's license citing its "adverse and unsustainable" financial position. The bank declared massive 97% of its assets as NPAs.

Kapol Co-operative Bank and City Co-operative Bank are other UCBs that have been under the lens of the banking regulator.

With RBI potentially being the sole regulator, the situation on the ground is expected to improve, albeit slowly.

What will change with UCBs coming under RBI's control?

• ✓ Their accounts will be audited according to RBI norms

• ✓ RBI can now carry out on-site inspections which in turn would help curb the malpractices

• ✓ Appointments of CEOs will require RBI's approval

• ✓ The Board will come under the supervision of the RBI

• ✓ RBI can oust the management for any failure in the governance (Just like it did in the case of Yes Bank)

Should you park your money in UCBs?

The governance practices at UCBs might improve once RBI starts overseeing all functions of the UCB's business, but it will be a gradual process. Limit your exposure to UCBs up to Rs 5 lakh (i.e. to the extent of the DICGC cover), including the balance in the current account, savings account and fixed deposits.

Always look at the financial position of the bank before deploying your hard-earned savings. NPA growth, capital adequacy ratio, and return on assets are some of the parameters that can be considered to measure the performance of banks.

And for the better safety of capital, diversify your deposits across different banks instead of parking all your savings in one bank.

Keep in mind not to park your emergency funds with co-operative banks, particularly now when the credit risk has got amplified.

Whenever, co-operative banks have come under the Preventive and Corrective Action (PCA) of the RBI, (take the example of PMC), the depositors have faced difficulties in withdrawing their own hard-earned money, leaving them in hot water.

UCBs may still remain risky...

At present, the Priority Sector Lending (PSL) target of UCBs is 40%. RBI has decided to hike it to 75% by 2024 in a phased manner. Although it's important from the financial inclusion perspective, the higher allocation to the priority sector poses a higher risk for UCBs. You have to be careful when choosing a bank to park your hard-earned money. As far as possible, do not deploy hard-earned savings in a bank fixed deposit of a UCB for more than 2 years.

Unfortunately, numerous senior citizens who had parked their retirement saving in certain UCBs are now finding it tough to meet their retirement needs because of a preventive and corrective action issued against the bank and/or the UCB has gone belly up. So, be extremely wise and prudent in your approach.

For that, you might consider safe public sector banks and leading private sector banks.

Why the job is still unfinished?

Close to 96,000 rural co-operatives are still out of the purview of RBI, but sooner or later they too will have to be brought under the surveillance of RBI.

Rural co-operatives were looked upon institutions that would liberate small farmers from the clutches of usurious moneylenders. In reality, rural credit co-operatives need to be liberated from the tight grip of poor corporate governance and oppressive lending practices.

It remains to be seen how much longer the government will take to include rural cooperatives under RBI's ambit.

Warm Regards,
Rounaq Neroy
Editor, Daily Wealth Letter

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