Indian Cooperative Banks The road ahead
India has been a capital starved country and in hunt for capital, small entrepreneurs, agriculturists and people with no collateral, artisans, petty traders, women and rural folks, invariably lose out. Cooperative bank were conceptualized to cater to these very segments. The segment was supposed to serve the largest section of people who are untouched by commercial banks as these banks can’t venture to the remotest corners of the country and remain viable there. In short therefore, co-operative banks were envisioned as the original vehicle for financial inclusion. They were expected to encourage saving at the grass root level, and make credit available to those unserved by traditional banks. Because of being local in nature, they were also supposed to know the local business environment better and thus assist in economic development of the community.
However, the co-operative banking sector stands at a crossroads today. On the one hand, they have grown tremendously, albeit in not completely desired fashion, have developed substantial deposit and credit base, and are, as a group, a strong force in about half a dozen states; but on the other hand, as a class, co-oeprative banks are structurally weak. Multiple collapses have been bringing management inefficiencies to the fore frequently, most co-operative banks are family run businesses with terrible corporate governance record, political interference and influence is rife, and the regulatory framework within which they operate does not allow for effective supervision by RBI. Further, rural co-operative banks are suffering from major problems related to fund availability and debt quality. In the evolving business environment wherein banking is increasingly becoming a function of technology and smart operations, co-operative banks are faced with a two front challenge. Internally, they have to radically change how they operate, and externally, they need to compete with new entities like small finance banks and new age MFIs who have been envisages to leverage cutting edge technologies to win customers. It is an uphill task for co-operative banks.
Among oldest, yet not most evolved
India is considered to have one of the oldest community-banking movements in the world. The origins of what is known as urban cooperative banking can be traced to the close of nineteenth century when initial cooperative societies were set up drawing inspiration from the successful co-operative experiments in Britain and Germany. Anyonya Sahakari Mandali was perhaps the first mutual aid society in the country and was set up in the princely State of Baroda in 1889. Urban co-operative credit societies were initially organized on a community basis to meet the consumption oriented credit needs of their members. The enactment of Cooperative Credit Societies Act, 1904, however, gave the real impetus to the movement. The first urban cooperative credit society was registered in Canjeevaram (Kanjivaram) in the erstwhile Madras province in October, 1904. Bombay Urban Co-operative Credit Society was the most prominent of the initial ones and was set up in 1906. The Maclagan Committee of 1915, which was appointed to review the performance of Cooperative Credit Societies, observed that such institutions were eminently suited to cater to the needs of the lower and middle income strata of society and would inculcate the principles of banking amongst the middle classes. Incidentally, the mandate of co-operative banks has not changed yet.
The reputation of co-operative banks was quite high during initial years as the crisis years of 1914-15, when over 50 joint stock banks collapsed, proved. According to Maclagan Committee “As a matter of fact, the crisis had a contrary effect, and in most provinces, there was a movement to withdraw deposits from non-cooperatives and place them in cooperative institutions, the distinction between two classes of security being well appreciated and a preference being given to the latter owing partly to the local character and publicity of cooperative institutions but mainly, we think, to the connection of Government with Cooperative movement.”
However, the subsequent years were of uncontrolled and lackluster growth of co-operative banks. The second phase of Co-operative Credit Institutions could be said to have been heralded by the passage of the State Co-operative Societies Act in 1925 by the government of Bombay. The role of co-operative banks in helping the small business and middle class people was underscored by various committees such as Mehta-Bhansali Committee which in 1939 recommended that those societies which had fulfilled the criteria of banking should be allowed to work as banks; and the Rural Banking Enquiry Committee of 1950, which recommended the establishment of such banks even in places smaller than taluka towns. However, the big change came in 1966 when the Banking Regulation Act 1949 (BR Act) was made applicable to urban co-operative banks by extending certain provisions of the same.
The report of the high powered committee on UCBs, headed by R. Gandhi (2015), categorized the evolution of post 1966 co-operative banking segment in three phases. The first one, the growth phase, lasted till 2003 which was marked by tremendous growth in the number of co-operative banks, number of branches, deposits and advances. From 1,100 UCBs with deposits and advances of Rs 1.67 billion and Rs 1.53 billion respectively, in 1966, the segment has grown to over 1579 UCBs and 9722 branches with deposits of Rs 3.55 trillion and advances of Rs 2.24 trillion.
Second phase of the co-operative banks lasted till 2008 and was marked with collapse of multiple banks, Madhavpura Mercantile Co-operative Bank being the most prominent one. Between April 2004 and March 2008, the number of UCBs declined from 1926 to 1770. Stung by such failure, RBI stopped issuing licenses to new banks. It also signed MOUs with state governments as well as the central government to achieve better coordination of regulatory policies and actions, initiating capacity building initiatives and putting in place measures to bring in efficiency through adoption of technology. It introduced the Graded Supervisory Action (GSA) framework in 2003 and classified UCBs into four grades – Grade I, II, III and IV, depending on their financial conditions. This was further improved by Supervisory Action Framework (SAF) in 2012 wherein supervisory action was initiated based on various trigger points such as CRAR, gross NPA, CD ratio, profitability and concentration of deposits. SAF was reviewed and modified in 2014 by advancing the trigger points for imposing directions and cancellation of license.
Post 2008, the segment has been in consolidation mode as per R Gandhi report, which said that “as a result of the new initiatives and sustained efforts by RBI, the number of financially weak banks in the UCB sector declined. Further, due to consolidation in the sector on account of closure and merger, the number of UCBs came down from 1,770 as at end-March 2008 to 1,589 as on March 31, 2014 and further to 1,579 by end-March 2015.” However, the impact of consolidation was a substantial increase in deposits and advances of UCBs which increased from Rs 1,398.71 billion and Rs 904.44 billion as of end-March 2008 to Rs 3,551.34 billion and Rs 2,243.08 billion, respectively, as on end-March 2015.
While expert opinions vary on how co-operative banks have performed or what is store for them, what they all agree on is that co-operative banks are best suited as vehicles to achieve financial inclusion. To a reasonable extent, this has been the case as well. By their very structure and raison d’être, co-operative banks can play a critical role in this area. And the primary reason for their advantage is their local nature. Because of being local and known as local, they are more trusted by small time depositors, helping these banks to mobilize resources from lower and middle-income groups. Bigger commercial banks struggle to reach these sections of population which is invariably financially excluded, as they are unable to create that environment of trust and support. Co-operative banks most often have strong connections with specific communities, and often draw employees from those communities, which increases the trust of small savers as well as borrowers. This trust is the most important ingredient in financial inclusion.
According to a public sector banker, the key advantage that UCBs enjoy over commercial banks is derived from their cost structure. A traditional commercial bank, if interested in opening a semi urban or rural branch, has to incur many expenses which are not justified by the business it generates from that branch, thus making the branch loss making from first year of operation itself. UCBs’ cost structure is generally less than commercial banks’; which includes lower operating costs. They pass part of this cost benefit to customers. They also charge negligible processing fee which is a big source of income for commercial banks.
Secondly, thanks to their local nature, co-operative banks have enormous informational advantage over commercial banks. Often coming from the local community, they are better aware of the business opportunities that are unique to the area, as well as borrowers’ credentials, not fully captured in the financial statements. Commercial banks, mostly alien to the local factors, can’t have that level of information about the ground realities.
As mentioned, UCBs also enjoy operational advantages that emanate from the local nature. These banks are not governed by national and global policies, which allow them the flexibility they can provide to their local clientele. For example, it is not uncommon to find co-operative banks offer loans up to hundred per cent of the education fee and living expenses in case of education loans. No commercial bank goes beyond 90 per cent of the tuition fee as loan amount.
Ratios have improved but problems remain
Over last few years, because of the efforts and focus of RBI on operational efficiency, UCBs as a group have turned the corner and have become more prudent both in terms of operational efficiency and capital adequacy. These banks have been maintaining a higher net interest margin than scheduled commercial banks. For the year 2012-13, the net interest margin of UCBs stood at 3.35 per cent, up from 3.31 per cent during previous year. This is also higher than 2.89 per cent during 2006-07. The gross NPAs came down from 7 per cent in 2011-12 to 6 per cent in 2012-13. Net NPA recorded an even sharper fall from 1.9 per cent to 1.4 per cent during this period. As for capital adequacy, the CRAR (capital to risk weighted assets ratio) of UCBs as a group currently stands at 12.6 per cent. Only five such banks have a CRAR below nine per cent.
Speaking to a national daily, R Gandhi said, “UCBs have gone through various ups and downs. The latest problem they had was in early 2000. We had to tighten the regulations and supervision. Now, they have reached a good position.” He also drove home the point that the provisioning coverage ratio of UCBs had improved significantly from 52.4 per cent in end-September 2014 to 59.7 per cent as of March 2015.
Operationally, more co-operative banks have started to streamline their operations. They have increasingly started using the Banking Correspondents (BC), offering “no-frill” accounts and promoting microfinance activities. These have so far been used mostly by commercial banks. More importantly, majority of co-operative banks have taken to computerization and application of IT. And quite many of these banks have installed a CBS (core banking solution) developed by the National Informatics Centre (NIC). The NIC’s cooperative core banking solution (CCBS) works on the Software as a Service (SaaS) model. The software runs from a remote central server, which individual banks access for their purposes via Internet. NIC hosts the service, besides providing implementation support. CCBS also integrates other services. It is designed to help agriculture societies disburse funds from various government schemes like the rural wage scheme, old age pensions or the mid-day meal scheme directly to beneficiaries’ accounts. This is a major leap in realizing the mandate of financial inclusion by these banks.
However, despite these positive developments, co-operative banks continue to face a number of structural problems that have dogged the segment for most part of its life. Most important is the size. Most of these are still single-branch banks, which makes them extremely vulnerable to the localized problems and business risks. Such banks, when they have exposure to other equally vulnerable banks, and which is a common phenomenon, the systemic risk rises significantly. The failure of the Madhavpura Mercantile Co-operative Bank (MMCB) in Ahmedabad in 2001 is a good example which led to widespread interbank contagion among cooperative banks in Gujarat that kept funds at MMCB.
Lack of professionalism is another major problem. The localized profile of these banks, which keeps cost down, often becomes a drag on professional work ethic. The problem is not restricted to lower levels; the quality of people and processes at the top is also a cause of worry for a sizable number of co-operative banks. Talent acquisition and retention at all levels has been a tough task for co-operative banks as they cannot compete with larger commercial banks as far as salaries are concerned. Because of this, in order to improve the human capital of co-operative banks, free of cost training courses for directors, chief executive officers (CEOs) and other officials of UCBs is being conducted by the RBI at regional locations and in local languages for the convenience of banks.
Family control of UCBs, many of which are frequently very closely connected to local politics, has also been a gray area for long and is alleged to be the reason for majority of loans going bad for these banks. The apathy and uninterested nature of non family directors, especially independent directors, lends credence to this allegation. To tackle these issues, Malegam Committee had suggested a new organizational structure for UCBs consisting of a Board of Management, in addition to the Board of Directors. The idea was to segregate the ownership of a UCB as a co-operative society from its functioning as a bank.
The way ahead
Moving forward, co-operative banks will perhaps be the most impacted segment because of churning and evolution of the financial sector. Looking at operating environment, a few strands emerge that can potentially significantly impact the co-operative banking system. First, banking industry in general is becoming more technology driven. Emergence of banking through hand held devices such as smart phones is an example. Any financial intermediary unequipped or ill equipped to leverage technology faces extinction in this scenario. Second, moving forward, rural banking will be increasingly done by individual representatives of banks with enough back end support from banks. The usage of banking correspondents will increase significantly once their financial viability is ensured. Third, competition in rural banking space would intensify once entities like small finance banks and payment banks become reality.
What is not going to change in times to come is the focus on financial inclusion. If anything, there will be more focus on the requirement to bring unbanked people in banking space, for encouraging entrepreneurship at the bottom of the pyramid and promoting direct transfer of benefits. The role of co-operative banks in these endeavors is unquestionable and so is their ability to make these programs successful.
But for playing their part well, co-operative banks need massive overhaul. They need to change their working style, become more efficient and transparent in their operations, stay clear of regional and local politics and be prudent in credit management. Obviously, it is not going to be easy and would require extreme discipline, something that has not been the forte of banking industry in general and co-operative banks in particular.
The regulatory landscape of co-operative banking has been changing of late. Malegam Committee and High Powered Committee headed by R Gandhi have provided valuable insights on how future regulatory structure should evolve. Current regulatory structure for co-operative banks is quite muddled. Urban cooperative banks are registered and governed by state governments under the respective Co-operative Societies Acts of the concerned states. They also come under the Banking Regulation Act, 1949 and hence they are under RBI jurisdiction as well.
On its part, RBI is gradually allowing more avenues for these banks. For example, in November 2015, it allowed all cooperative banks that have implemented the core banking solution in full, to offer Internet banking services to their customers. They have already been allowed to open branches without restriction with RBI approval. Also they have been permitted to undertake various activities such as opening specialized branches, undertaking intra-day short selling in secondary market transactions in government securities, undertaking ready forward contracts in corporate debt securities, opening currency chests, acting as PAN service agents and issuer of Pre-paid payment instruments etc. These businesses would allow much needed boost in fee-based income.
However, undertaking these activities capacity building. And that is hardly possible in the cozy family owned environment that most co-operative banks are used to. The requirement to professionalize can, therefore, not be more emphasized. More importantly, though, the push for professionalism has to come from inside the system. UCBs need to not only diversify in new territories but also to new activities and for that, they need to have good quality of human capital, even at higher expenses. On their part, regulators need to tighten the leash on the management of these banks by measures like setting up Board of Management (BoM) in addition to Board of Directors; election of Board of Directors in accordance with the provisions of the respective Co-operative Societies Acts; putting BoM and CEO in complete control of RBI etc. All these measures were suggested by Malegam Committee.
Evidently, co-operative banking sector is at crossroads. Historically, they have grown tremendously, even though with intrinsic weaknesses and inefficiencies. However, over last few years they have shown promise and many UCBs have acquired scale and expertise at par with commercial banks. Such banks need to be upgraded as commercial banks and RBI is surely intended to do the same. Majority however, need guided transformation. They need rapid technical upgradation, and gain expertise to increase non fund based income by foraying into other services of financial inclusion such as saving accounts, insurance, and remittance. It is time for Indian co-operative banks to shape up or ship out because competition in coming times will not spare inefficiency or allow complacence which these banks have been used to.
Structure of Cooperative Banking in India
The structure of cooperative network in India can be divided into 2 broad segments-
- Urban Cooperative Banks
- Rural Cooperatives
Urban Cooperatives can be further divided into scheduled and non-scheduled. Both the categories are further divided into multi-state and single-state. Majority of these banks fall in the non-scheduled and single-state category.
- Banking activities of Urban Cooperative Banks are monitored by RBI.
- Registration and Management activities are managed by Registrar of Cooperative Societies (RCS). These RCS operate in single-state and Central RCS (CRCS) operate in multiple state.
The rural cooperatives are further divided into short-term and long-term structures. The short-term cooperative banks are three tiered operating in different states. These are-
- State Cooperative Banks- They operate at the apex level in states
- District Central Cooperative Banks-They operate at the district levels
- Primary Agricultural Credit Societies-They operate at the village or grass-root level.