When urban cooperative banks (UCBs) — built on community trust — enter the public discourse, unfortunately, the first image to surface is that of Madhavpura Mercantile Cooperative Bank (MMCB) and Punjab and Maharashtra Cooperative (PMC) Bank.
Poor governance, political interference, dual regulation, concentrated lending, weak capital structure and technology deficiency sum up for the failure of several UCBs, forcing the Reserve Bank of India (RBI) to cancel licenses and also stop issuing fresh ones from 2004.
Lessons learned from the past, together with its belief that expansion without sound governance could multiply risks, led the banking regulator to rethink UCBs, and the RBI recently decided to resume issuing licenses to them after more than two decades.
The RBI’s renewed licensing policy gives a new lease of life to the UCBs, which were set up with the specific purpose of acting as a bridge between informal community finance and formal banking, with the guiding principle of localisation reducing information asymmetry.
In the early 1990s, there were as many as 1,100 UCBs, growing with a cautious approach, but after economic liberalisation, the RBI adopted a more liberal approach following recommendations of the Marathe Committee.
As of March 31, 2003, there were 2,104 UCBs of which 56 were scheduled banks. About 79% of these are in five States — Andhra Pradesh, Gujarat, Karnataka, Maharashtra and Tamil Nadu.
After which, it shrank to around 1,500 due to cancellations, mergers, voluntary conversions or liquidations as governance foibles translated in to systemic risks for the failed entities .
Birth of UCBs
Conceived as entities of financial democracy, akin to Self Help Groups in modern parlance, UCBs were established on the cooperative principle of mutual assistance by mobilising savings from members and extending affordable credit to those overlooked by mainstream banks, a classic example of financial inclusion.
Owing its origins to the 1904 Cooperative Credit Societies Act, the UCBs played an important role in financing neighbourhood commerce, retail trade, housing, education and small businesses, especially after independence.
Interestingly, the first urban cooperative credit society was registered in Kanjivaram in Madras province in October, 1904.
Misgovernance
As the cooperative banking ecosystem began to grow exponentially, making the hot seats mighty, the structural vulnerabilities began to emerge, but addressing them was difficult due to regulatory duality. The RBI supervised banking functions, while the management and governance remained under the jurisdiction of State Registrars of Cooperative Societies.
Governance failures became endemic as weak internal controls, connected lending, inadequate risk management and politicised board elections led to institutional breakdown, finally making many fall apart due to the weight of crony capitalism.
The UCBs experienced a severe capital crunch as the cooperative board structure “one member, one vote”, irrespective of shareholding, reduced incentives for capital infusion, denting public confidence and leaving depositors in lurch.
Failure bandwagon
One of India’s earliest major UCB failures was MMCB, which had excessive exposure to stock market operator Ketan Parekh-linked entities; another prominent one was PMC, which concealed large stressed loans, particularly exposure to HDIL, through fraudulent accounting practices.
Kapol Cooperative Bank suffered from high non-performing assets (NPAs), inadequate capital and weak governance; CKP Cooperative Bank had negative net worth, huge NPAs, insufficient capital and poor recovery prospects; Lucknow Urban Cooperative Urban Bank’s license was cancelled on inadequate capital, poor earning prospects and failure to comply with banking regulations; United Cooperative Bank, which failed to meet statutory requirements under the Banking Regulation Act; The City Cooperative Bank’s license was cancelled due to inadequate capital, lack of earning prospects, regulatory violations and inability to safeguard depositors’ interests; and Benares Mercantile Cooperative Bank for inadequate capital, poor financial position and failure to comply with regulatory requirements.
Reignition
India’s banking industry is increasingly centred around large universal banks with a larger capital base and technological infrastructure, majorly catering to the formal sector.
So, reigniting the cooperative banking sector, which went through a painful course correction and once had as much as a 4% share in total banking credit and now less than 2%, is a logical step to deepen financial inclusion as micro, medium and small enterprises continue to face credit gaps despite digital lenders’ growth.
With the regulatory architecture undergoing significant strengthening through amendments to enhance supervisory powers over cooperative banks, the RBI, which came out with a four-tier regulatory structure for UCBs in 2022, has now mooted an on-tap framework with significantly higher entry thresholds, including substantial minimum capital and business scale needs.
The banking regulator’s confidence in resuming licensing comes from its framework that has put technology readiness at the forefront, although cybersecurity remains one of the weakest links for many smaller UCBs.
The message is loud and clear that the objective is not to arbitrarily increase the number of UCBs but to establish a smaller number of stronger and well-governed entities, as seen from the RBI stipulation of a minimum capital of ₹300 crore, a capital adequacy ratio of at least 12%, and a net NPA ratio of not more than 3% at the time a licence is granted. It has also proposed that applicants should ideally have been operational for at least 10 years, with a sound financial track record for a minimum of five years.
However, the UCBs’ success in the Indian banking industry depends on how best they avoid the historical follies and adopt modern practices to become an important third pillar, alongside new generation commercial lenders and small finance banks.
Going by the RBI’s proposed yardstick, possible entrants could likely be large urban cooperative credit societies, multi-state cooperative credit societies and large cooperative federations, but none has publicly expressed an intention to seek a new UCB licence.
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