UCBs drudging towards oblivion
Effective intervention is required to infuse life back in the segment
A SOUND financial sector is supremely important for the economic health of a nation. The financial sector acts as a bridge for channeling resources from final savers to final investors. As a result, the greater the ease of resource intermediation, the lower the cost at which these resources can be available to final investors, enhancing investment and growth. The Urban Cooperative Banks UCBs drudging towards oblivion Effective intervention is required to infuse life back in the segment CO-OPERATIVE BANKS or the UCBs were set up with the objective of promoting sustainable banking practices amongst a relatively specific target clientele viz., the middle income strata of the urban population. They were brought under the regulatory ambit of the Reserve Bank of India (RBI) by extending certain provisions of the Banking Regulation Act, 1949, effective from March 1, 1966.
The performance of the cooperative banking sector in the country as a whole has attracted considerable attention in the recent years especially in the context of the ongoing phase of financial sector reforms. More specifically, financial and managerial weakness of a good number of cooperatives has been a matter of concern for policy makers and the RBI, which is the banking sector regulator. State governments and the cooperatives have been demanding capital infusion for wiping out past losses. But, there is a broad agreement that unless the question of inherent weakness of these banks is adequately addressed, funds infusion will not solve the problem; it may just be like throwing good money after bad. In this respect, the areas that need careful examination include the pattern of resources of cooperatives (owned funds, deposits, and borrowings), the deployment of resources, the management and supervision, the role of cooperative banks in the financial system and the regulatory framework for cooperatives.
The essential spirit of the regulatory and reform measures adopted for the commercial banks need to be extended to the cooperatives as well with necessary adaptations to suit the circumstances in which cooperative banks operate. This would imply that areas such as strengthening of regulatory and supervisory framework, enhancing capital adequacy standards, introducing stringent licensing norms for new entrants into the sector, enabling legal amendments and corporate governance measures need to be given very close attention.
Some years ago, the government had set up a committee under the chairmanship of M Narasimham to study the financial sector reforms. The Committee recommended many steps for reforming in the UCB too. The Committee suggested that the RBI should review the entry norms in respect of UCBs and prescribe revised prudent minimum capital norms for them. To achieve an integrated system of supervision over the financial system, the committee recommended that UCBs should also be brought within the ambit of the Board of Financial Supervision. In response to these recommendations of the Committee, the Reserve Bank set up a High-Powered Committee on Urban Cooperative Banks under the chairmanship of Shri K. Madhava Rao, former Chief Secretary to the government of Andhra Pradesh, to review the performance of UCBs and suggest measures to strengthen
them. The committee gives its views on important functional and supervision areas.
On the issue of licensing policy, it said that in the new liberalized regime, licensing policy for new UCBs is expected to be not only
transparent, but also precise and objective, based on established standards and procedures.
On the issue of jurisdiction, the Committee said that the UCBs are controlled by the state government and the RBI and this Duality in command does come in the way of effective supervision. Academics and bankers made vociferous representations to the Madhava Rao Committee that dual control over UCBs must end as that was instrumental in stifling their growth.
The Narsimham Committee had also unequivocally recommended for ending dual control regime over UCBs. In the case of commercial banks, the RBI has the wherewithal under the Banking Regulation Act for dealing with crucial aspects of functioning, but in the case of co-operative banks, many areas which directly relate to supervision over them have been kept beyond the Reserve Bank’s authority. Since UCBs are primarily credit institutions, rationally, the responsibility for their supervision devolves on the RBI. The Committee recommended that this duality of control be done away with and the responsibility of regulation of UCBs be placed on the Board for Financial Supervision.
Good corporate governance is essential for the effective functioning of any financial entity. To this end, the Rao Committee suggested that at least two directors with suitable professional qualification and experience should be present on the boards of the UCBs and that the promoters should not be defaulters to any financial institutions or banks. As for capital adequacy, the Madhava Rao Committee also reiterated that a majority of the UCBs was in favor of extending the CRAR discipline to UCBs.
The Narasimham Committee in its report had rightly observed that a legal framework that clearly defines the rights and liabilities of the parties to contracts and provides for speedy resolution of disputes is an essential bedrock of the process of financial intermediation and that the UCBs are no exceptions to this basic principle. It was also recommended to include a new law for granting statutory powers directly to banks (and financial institutions) for possession and sale of securities backing a loan, an enabling framework for securitization of receivables and strengthening the recovery mechanism.
The existence of a large number of unlicensed banks has been the result of a mild screening process in the past. In view of the regulatory discomfiture that such banks impose on the system as a whole, it was suggested that these banks be licensed provided they satisfy the quadruple criteria of (a) minimum prescribed CRAR, (b) net NPA ratio not exceeding 10 per cent, (c) have made profits continually for the last three years, and (d) have complied with the RBI regulatory directions.
The road ahead
Acknowledging that the UCB sector is an integral part of financial system, the RBI has brought in a series of reforms to better govern the segment. The recommendations of the Madhava Rao Committee has dwelt extensively on certain regulatory issues related to UCBs’ licensing policy, but the issues related to dual control necessitate legislative changes to State and Central Acts and there is hardly any progress in this area. In the backdrop future agenda for reforms in urban co-operative banking sector would focus on some critical areas.
Most important aspect of improvement is aligning UCB sector with rest of financial system. Unlike the other segments of cooperative credit sector, UCBs today undertake multifarious banking activities. Some of them have also been permitted to undertake forex and merchant banking activities. There is a view emerging in the recent past that because UCBs are members of payment system, beneficiaries of deposit insurance scheme and enjoy unlimited access to public deposits, should be subject to exactly the same regulatory rigors as other scheduled commercial banks are.
As part of risk management, it is important to realize that today, main risk exposure of UCBs’ is not the credit risk but interest rate risk. Most of the UCBs’ interest rates particularly on deposits are out of sync with the rest of the banking sector. This puts the profitability of these banks in stress. In this backdrop, observance of Risk and Asset Liability Management guidelines assume great importance in the overall functioning of these banks.
Disclosure and auditing of returns
As market discipline is an important supervisory tool in approach to new capital adequacy framework, prescription of disclosure standards for UCBs is of imminent necessity. UCBs, therefore, should be made to disclose crucial financial data such as level of owned funds, unimpaired net worth, CAR, Gross/Net NPAs, operating results, ROA, compliance with reserve requirements, per employee productivity, etc. along with balance sheet. This issue is engaging the attention of the Reserve Bank. The other part is of strengthening the audit system for the segment. The RBI has advised States to follow the standard audit norms with regard to UCBs. Unfortunately, many State Governments have yet to respond positively despite many years of persistent persuasion by the RBI.
It is extremely important that there is a mechanism to ensure that an effective system of internal governance is in place in all UCBs to ensure not only proper and ethical functioning of these banks but also to ensure the safety of depositors and investors’ money. And right manning of the boards is an important aspect of governance. As such, the chief executive should be a person of clean image and display a professional attitude. The board should consist of knowledgeable persons who are aware of their responsibilities. There should be a board level committee which should focus attention on the findings of audit and inspection teams and ensure compliance thereof.
Urban co-operative banking sector had once occupied a formidable space in the Indian financial system. However, because of unprofessional management and lax supervision, it has wilted and reduced to mere shadow of its past stature. Unfortunately for customers, depositors and investors, governments have mostly chosen to ignore the segment which could have been a useful tool for increasing the banking footprint in the rural areas.
Hopefully, the new push towards financial inclusion by the government and the zeal of the RBI to restructure the Indian banking sector would come to help UCBs out of morass.