Relevance: GS-3: Indian Economy, mobilization of resources, Banking Sector & NBFCs

Key phrases: Cooperative banks, NPA, Dual regulation, RBI, Rural credit, Banking Regulation (Amendment) Act, 2020.

Why in News?

• The licence of Independence Co-operative Bank, Nashik has been cancelled as it does not have adequate capital and earning prospects, the RBI said on Thursday. Independence Co-operative Bank has ceased to carry on banking business with effect from the close of business hours on February 3, 2022 (Thursday), the RBI said in a statement.

Background:

• Cooperative banks in India have been struggling to survive for the last few years. The issue came into the limelight after the Punjab and Maharashtra Cooperative (PMC) bank fiasco, which left frantic depositors visit the branches in attempts to withdraw their hard-earned money.
• According to Trends and Progress of Banking in India report published by the Reserve Bank of India (RBI), urban commercial banks have witnessed a decline in deposits from 6.1 per cent in 2018-19 to 3.5 per cent in 2019-20.
• In terms of loans and advances too, there has been a sharp decline from 8 per cent in 2018-19 to 0.8 per cent in 2019-20.
• By the end of March 2020, the sector comprised 1,539 UCBs and 97,006 rural cooperative banks, with a depositor base of 8.6 crore. Rural cooperatives make up 65 per cent of the total asset size of all cooperatives taken together.

Why cooperative banks in India are struggling?

Diminished share in agricultural lending:

• Cooperative banks have played a major role in providing financial support to the rural sector. They started with an aim to promote saving and investment habits, specifically in the rural areas.
  The RBI report noted that despite a crucial role played by the sector, its share in total agricultural lending diminished considerably over the years, from as high as 64 per cent in 1992-93 to just 11.3 per cent in 2019-20.

Sinking balance sheet:

• In recent years, Urban Cooperative banks (UCBs) have witnessed a sharper decline in terms of both loans and deposits. In the initial decade after consolidation of certain UCBs, their combined balance sheet had expanded consistently on back of robust players and profitable financial performance.

Competition with Schedule commercial banking:

• However, as they started facing increased competition from niche players like small finance banks and non-banking financial companies (NBFCs), their growth started to decline. It was also impacted by the fact that UCBs now had to reaffirm their credibility to depositors. The average growth rate of deposits declined from 13.1 per cent in the first decade of the consolidation drive to 8 per cent during 2014-15 to 2019-20. It is to be noted that growth in deposits constitutes 90 per cent of the total resource base of UCBs which comprises capital, reserves, deposits and borrowings. Since 2017-18, the deposit deceleration in UCBs was starker than in SCBs, pointing to the difficulties faced by UCBs in raising resources.

Asset quality declined:

• The UCBs have always had higher level of non-performing assets (NPAs) than the SCBs. However, in 2019-20 the asset quality of both SUCBs and NSUCBs started to deteriorate with the later recording a significant rise in GNPA ratio. This rise in NPAs can be attributed to stagnant growth in loans and advances and a weak balance sheet.

Dual control:

• For years, such banks have escaped scrutiny despite failures and frauds due to dual regulation by state registrar of societies and the Reserve Bank of India (RBI). During the mid-1960s, as demands for extension of the deposit insurance scheme to cooperative banks increased, banking laws were made applicable to these banks so that the Reserve Bank may be able to exercise some control over them.
  This led to the dual control of the sector. The Central Registrar of Cooperative Societies (CRCS) was empowered to look after their incorporation, registration, management, recovery, audit, supersession of Board of Directors and liquidation.
• The Reserve Bank was vested with regulatory oversight on banking activities of UCBs, state cooperative banks (StCBs) and district central Cooperative banks (DCCBs). However, the RBI's regulatory and supervisory powers were limited in many ways which impacted its ability to take prompt actions in case of irregularities.

Abusing Power by the Leadership:

• Those who control cooperative societies are locally powerful, with strong political affiliations. The political class as a whole, irrespective of party, is loath to dilute, let alone give up the power that they get to garner electoral support, reward their supporters and mobilize funds from their control of cooperatives. Under the existing regime, they are able to abuse this power brazenly and with impunity.

Measure to be taken:

• Corporate Governance: Good corporate governance inessential for the effective functioning of any financial entity. to this end, the Madhava Rao committee suggested that at least two directors with suitable professional qualification and experience should be present on the boards of UCBs and that the promoters should not be defaulters to any financial institutions or banks and should not be associated with chit funds//cooperative banks/commercial banks as director on the board of directors.
• Number of Directors: Out of the total members minimum 1%persons should be the directors/representatives. This will ensure decentralization of power and more participation of members in the activities of the society.
  Coordination between Various Stakeholders: Cooperative banks should try to co-ordinate between the board of management, members, depositors, employees & other stakeholders of bank.
  Increase Resources: The cooperative banks should try to increase their deposits by opening branches in business areas, improve the services to their clients, and introduce different types of deposit schemes & offer competitive rates of interest.
• Fair Audit: Audit plays an important supervisory role in ensuring the best performance of the society. But, it is observed that lots of irregularity & negligence take place while conducting audit. Hence, an appropriate mechanism of checks& balances may be evolved & made mandatory for all the Societies. Accountability for erroneous audit along with penal action should also be ensured through appropriate statue. Further, the state government should also conduct a forensic Audit of the loan portfolios & purchases of a representative sample of cooperative societies.
• Loan Sanctioning Measures: The loan from credit societies should be granted in such a manner and under such conditions that these are used productively and not misused. It is in this way that the recourses of the movement will be correctly used and their repayment is ensured. It is only then that the problem of over dues can be properly tackled.

Way Forward:

• They started with an aim to promote saving and investment habits, specifically in the rural areas. Failure of cooperatives would mean failure of best hope for rural India.
• It is expected that the provisions suggested above will not only Ensure the autonomous and Democratic Functioning of co-operatives, but also ensure the accountability of management to the members and other stakeholders and shall provide for deterrence for violation of the provisions of the law.

Source: The Print

Mains Question:

Q. The licence of Independence Co-operative Bank, Nashik has been cancelled by RBI, as it does not have adequate capital and earning prospects. In this context discuss what is the reason behind failure of cooperative banks in India? What should be the measure for tackle these issues? Critical analyse.