RBI Faces Pushback On Attempt To Modernise Urban Cooperative Banks

Even before an RBI committee on cooperative banks submits its report, it is facing pushback from an RBI central board member.

Punjab and Maharashtra Cooperative Bank’s depositors hold placards and raise slogans during a protest outside Reserve Bank of India at BKC, in Mumbai. (Source: PTI) 
Punjab and Maharashtra Cooperative Bank’s depositors hold placards and raise slogans during a protest outside Reserve Bank of India at BKC, in Mumbai. (Source: PTI) 

The Reserve Bank of India's attempt to modernise urban cooperative banks is facing opposition, with a member of the regulator's central board raising concerns over certain changes being considered.

Since the collapse of Punjab and Maharashtra Cooperative Bank, the RBI has gained greater supervisory and regulatory powers over urban cooperative banks, tightened norms for appointment of top management and boards at these lenders, and put in place tougher risk and reporting standards.

Alongside, a committee is drawing up a roadmap, which may nudge larger cooperative banks to change their corporate structure and transition into small finance banks, according to two people familiar with the matter.

The suggestion, even before it's finalised, has drawn criticism from RBI central board member Satish Marathe, who, in a June 25 letter to the expert committee, said that the "talk of privatisation" doing the rounds is "no solution".

"On the background of amendments to Banking Regulation Act, 1949, the proposal doing rounds to promote privatisation of small and large UCBs is 'No Solution', and merits no consideration as it would lead to emergence of a new breed of corporate moneylenders," Marathe wrote in his letter, a copy of which has been reviewed by BloombergQuint.

According to people familiar with the matter, cited earlier, what's being discussed is allowing private investors to bring in capital to support these lenders.

The proposal being considered is to strengthen the capital raising and growth prospects of urban co-operative banks, one of the two persons cited above said. Privatisation can be an outcome of these discussions, one of the two persons said.

An email sent to RBI on Friday went unanswered.

At present, urban cooperative societies are governed by the Registrar of Cooperative Societies or the Central Registrar of Cooperative Societies, along with the Reserve Bank of India that oversees them through its Urban Banks Department.

The co-operative structure allows its members, usually a community or a group of individuals that have come together to form the bank, to invest and withdraw their shareholding without any requirement of a lock-in period. Each such member is granted voting rights irrespective of the extent of their shareholding in the entity.

Privatisation: The Only Option To Grow?

The first seeds of these changes were sowed by a 2015 committee on urban cooperative banks, chaired by R Gandhi, the then deputy governor at the RBI. The committee had suggested the voluntary conversion of large UCBs, with a threshold business size of Rs 20,000 crore, into small finance banks.

While the conversion to small finance bank was optional, lenders that continued within the co-operative construct beyond the threshold limit, were expected to grow at a slower pace. This meant that their expansion "in terms of branches, areas of operations and business lines, will remain carefully calibrated to restrict unrestrained growth," the report said.

Subsequently in September, 2018 the regulator introduced a scheme for voluntary conversion of urban co-operative banks into small finance banks. However, only one lender—Shivalik Mercantile Co-operative Bank Ltd., has come forward to convert.

According to Gandhi, who spoke to BloombergQuint over phone, changing the corporate structure of UCBs was considered suitable for two main reasons.

The first was the lack of certainty of equity capital. The capital of co-operative banks comprises of membership shares that can be redeemed at the will of shareholders. "Many times we have seen that shareholders use their equity as some sort of a savings type of account, and whenever they have money they buy shares, and whenever they require money they withdraw," said Gandhi.

Second, voting rights in a co-operative structure are based on the number of shareholding members, and not the strength of the capital they provide. So, it's one person, one vote, irrespective of the capital each shareholder brings.

"These reasons hold good even today," said Gandhi.

The Pushback

Marathe argues it differently.

Since urban co-operative banks have been fully brought under the ambit of the RBI, it shouldn't be necessary to convert them into small finance banks for ensuring regulatory supervision, he told BloombergQuint over phone.

"Earlier, if a cooperative bank wanted to grow, they were given an option to convert," he said. "But now they shouldn't have to do that as RBI has full powers to regulate UCBs. So, now there is no necessity to privatise them either."

Marathe, in his letter, said the RBI's approach towards urban cooperative banks has been restrictive ever since the collapse of Madhavpura Mercantile Cooperative Bank in 2001. The regulator has "imposed a complete embargo on issuance of fresh banking licences" to urban co-operative banks, he wrote.

Consequently, "the share of the UCB sector has gradually fallen to about 2.5% to 3% in the overall banking sector."

There are 1,544 urban co-operative banks in the country, which form 3.6% of the total assets of scheduled commercial banks as of March-end 2019, as per RBI's latest estimates.

Gross bad loans of urban cooperative banks fell marginally to 10.3% as of March 31, 2021 from 10.4% in September 2020, as per RBI's Financial Stability Report released on July 7.

Marathe said the argument that urban co-operative banks were weak was untrue.

The general perception that the UCB Sector is weak needs to be dispelled from the minds of the general public and grossly under-informed media as 74% of UCBs have been rated either as A or B+ or B. Significantly 84% UCBs have a capital adequacy ratio of more than 12%.
Satish Marathe, RBI Central Board Member (Letter To Expert Committee)

A Long-Drawn Debate

The debate over changing the corporate structure of urban cooperative banks met with pushback even in 2015, said Gandhi.

At that time, too, the committee’s recommendations were hotly debated and opposed by the cooperative sector. Many campaigned against it as they felt this would kill the cooperative culture. If you allow a cooperative to convert into a corporate structure, then cooperative institutions would die. That was their fundamental opposition.
R Gandhi, Former RBI Deputy Governor

Even as the recently formed expert committee is taking the privatisation matter into consideration, the second person cited earlier said that this is likely to remain optional, as various ways are being discussed to ensure urban co-operative banks get the required capital to grow. Conversion to a small finance bank or a corporate structure is just one of them, he said.

According to Marathe, the regulator should provide enabling regulations for issuance of shares and bonds for urban co-operative banks.

In the recent amendment to the Section 12 of the Banking Regulation Act, cooperative banks were allowed to issue equity shares and bonds with a maturity of ten or more years, after getting RBI's approval.

"The Gandhi committee had also recommended setting up an umbrella entity that can help urban co-operative banks raise funds, while also advising them on technology upgradation. If capital raising is an issue, this could be a more agreeable way to solve that problem," said Marathe.

Jyotindra Mehta, president at the National Federation of Urban Cooperative Banks and Credit Societies Ltd. and part of RBI's eight-member expert committee on urban co-operative banks, said while capital raising has been a concern for co-operative entities, since the new amendment treats them at par with other corporate entities, the RBI has the powers to allow them to grow while remaining within the cooperative structure.

"The structure of a cooperative promotes social benefit and financial inclusion in a democratic manner, as each member has a vote," he said. "Turning the model into a corporate structure will be equivalent to bowing down to capitalisation."

But the issue of governance still remains unresolved as the Companies Act doesn't extend to co-operative banks, said Ashvin Parekh, managing partner at Ashvin Parekh Advisory Services.

"Encouraging UCBs to first consolidate, and then apply for a small finance bank licence will not just allow for greater regulatory supervision, as presently the provisions of Banking Regulation Act apply thinly to such entities, but it will also strengthen their own capital base and asset quality monitoring," said Parekh. "This will improve their capital raising prospects as investors will have greater confidence in these entities."