UBCs for GoFYI

Urban Co-operative Banks: Analysing the crisis (GDPI prep)

A crisis at PMC Bank that first came to light on September 24, 2019,  with the RBI placing restrictions on the activities of the Mumbai-based bank for six months, brought the Urban Co-operative Banks (UCBs) again into prominence and again, for a wrong reason. What should be the way forward for UCBs? Are they losing their relevance in the current financial space of the country? Let’s find out.

By Ashish Agrawal | IIM Calcutta (alumnus) | Founder, India Business Analysis (knowledge portal)

Restriction of operations at Punjab & Maharashtra Cooperative (PMC) bank by RBI brings Urban Co-operative Banks again into prominence and again, for a wrong reason. The governance issues cited by RBI put a serious question mark on the operations of the entire segment and necessitate an overhaul of the sector. Here is a look at the issues affecting urban cooperative banks and forward path.

Cooperative banks form the third pillar of financial inter-mediation/financial inclusion after scheduled commercial banks and Non-Banking Financial Companies (NBFCs). Cooperative banks are further classified as rural or urban, the focus here being on Urban Cooperative Banks (UCBs). UCBs are largely localised banks owned and operated by its members who are also its customers. (A person desirous of availing loan from a UCB has to become its member first). As per RBI, there are a total of 1,545 UCBs in the country with total assets of Rs 5.6 lakh crore at the end of March’18, (latest available data). This is less than 5% of the total assets of the financial sector implying a rather insignificant role for them.

UCBs gained prominence from 1993 with a liberal licensing policy by RBI in view of their ability to connect well with the local population. However, a number of scams during 2000-2005, most notably, the Madhavpura scam, led to a rethink on their operating framework which continues even till now.

The superseding of the board of PMC bank is primarily because the board granted loan to a particular group far in excess of what is prescribed by RBI and non-reporting of default. The allegations of the chairman being linked to the concerned company raises even greater concern. However, this is not the first case of a UCB entering into fraudulent practice. In another high profile case, Bombay High Court recently directed the concerned authority to file a case against Maharashtra State Cooperative Bank and its board of directors for sanctioning loan worth thousands of crore to a number of factories which defaulted subsequently. RBI’s website lists nearly 25 instances of restriction being put or extended on UCB in last three months alone. UCB were also accused of being a conduit for converting large sums of unaccounted money into white subsequent to demonetisation.

The dual reporting structure lies at the core of the governance crisis being faced by UCB. UCBs are formed as cooperatives and shareholders elect the board of directors (BoD). (A recent RBI paper proposes that UCBs would have to constitute another board of management, different from BoD). However, the election process has largely degenerated with the state political leaders or local businessmen/industrialists retaining their hold on the operations. This has led to serious conflict of interest as many of these banks have acted as easy source of money for them. While RBI has the power to remove the chairman of a commercial bank, it doesn’t have such power in case of UCB. (RBI has the power to suspend the board but that is an extreme step).

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However, it is not only about governance. UCBs are also constrained by their size which limits their profitability and therefore, commercial viability. Average assets of UCBs are close to Rs 370 crore only against over Rs 1 lakh crore for a commercial bank. Almost 60% of UCBs numbering over 900 have deposit base of less than Rs 100 crore with large number of them being, single branch bank. This puts a strain on their profitability because of high overhead costs. Only 5% of them have a deposit base of over Rs 1,000 crore giving them sufficient ‘economies of scale’. While the reported NPA is just about 7%, the development at PMC bank puts a question mark over the credibility of their reporting.  The multiplicity of UCBs and their size makes them ‘too small to govern’ and it would not be surprising if actual NPAs for more of them are worse than this.

While UCBs played an important part in meeting the needs of smaller borrowers till the late 90s, the primary reason for their existence has largely disappeared now. This is because commercial banks have largely reached the farthest corner of the nation with IT based solutions, innovations such as banking correspondent and aggressive banking. The fact that they pose disproportionate risk to the financial sector and can cause severe erosion of confidence warrants a proactive rather than reactive stance. An appropriate path going ahead could be merger of smaller ones with the bigger ones or bunching together of all cooperatives within a state or a region into a special purpose vehicle. This could be taken over as a subsidiary by a commercial bank with suitable incentives. If the government can bite the bullet of large scale mergers of public sector banks, this is a smaller nut to crack.

About the Author:

Ashish Agrawal is an alumnus of IIM Calcutta and IIT Roorkee and the Founder of a business analysis portal. https://www.indiaeconomyandbusiness.com/

He has also written a book, Indian Economy & Business. The book is a collection of articles providing simplified, yet comprehensive analysis of key economic, industry, corporate events. It is an attempt to help students of business management gain a perspective on contemporary business issues.