In today's Finshots we talk about how the RBI is trying to fix the urban cooperative banking system in this country


The Story

For the longest time, urban cooperative banks (UCBs) weren’t fully regulated by the RBI. We know that sounds crazy. But there’s a lot of history behind this weird anomaly.

A cooperative enterprise is usually member-driven, member-controlled, and member-protected. The members of the society carry out all the roles and responsibilities enshrined in the cooperative’s constitution and this was an essential feature of post-colonial India — When people had to figure out things for themselves. So by extension, an urban cooperative bank would be a financial institution for the people, by the people. And until 1966, this status quo persisted.

But then it quickly became apparent that financial institutions needed some oversight. After all, an urban cooperative bank isn’t like a milk cooperative. They’re custodians of public funds, and to let a small coterie of people oversee deposits worth crores would be foolhardy at best.

So the RBI took a more proactive approach with these banks. They set out the banking guidelines — dictating the kind of money UCBs were supposed to set aside, the kind of cash they were supposed to hold at all times, and other such matters. And left the regulatory aspects related to governance and auditing functions to state and central governments. But truth be told, they only loosely regulated these functions. By and large, the members were still responsible for most administrative decisions, and for all practical purposes, there was very little oversight here.

So it should come as no surprise that many UCBs have failed in the recent past. Most notably — Punjab and Maharashtra Cooperative Bank or more commonly referred to as PMC bank.

In fact, last year, finance Minister Nirmala Sitharaman told Lok Sabha that the financial situation of at least 277 UCBs was weak, and around 105 cooperative banks were not even capable of meeting the minimum regulatory capital requirement (money-related requirement). Among them, 47 banks had a negative net worth, and as many as 328 urban cooperative banks had bad loans of more than 15%.

And even though, these banks could be considered insignificant in the grand scheme of things, they still meant a great deal to many people. So the government decided it would be best to put RBI in charge of most functions and the Banking Regulation Act was amended by the Parliament in September 2020.

Bottom line — These humble banks are now at par with regular commercial banks as far as regulations are concerned. The only problem — UCBs are still fundamentally different from the likes of SBI and HDFC. And they needed to be dealt with differently.

So, the central bank set up a committee back in February to examine the issues plaguing these special institutions and the kind of recourse they may need to consider if things go awry. And after some waiting, the committee has finally submitted its findings in this report. Now it's impossible for us to parse through every single detail because of the sheer complexity of it all, but what we can do is give you a gist of what the committee is trying to do here.

They believe it’s best to impose different regulatory restrictions depending on the scale and scope of the UCB in question. For instance, the committee wants all UCBs to be categorized into four tiers depending on the size.

  1. Tier-1 with deposits up to ₹100 crores
  2. Tier-2 with deposits between ₹100 — ₹1,000 crores
  3. Tier-3 with deposits between ₹1,000 — ₹ 10,000 crores
  4. Tier-4 with deposits of over ₹10,000 crores, who may be allowed to function like universal banks if they meet some other special money-related requirements.

And with this categorization complete, you can impose different kinds of restrictions on each tier. For instance, you could have strict ceilings on home loans, loans against gold ornaments, and unsecured loans, for some kinds of UCBs—While adopting a more liberal approach with bigger UCBs that are financially stable. All in all, this is perhaps the first time when the central bank is truly putting in the work to optimize its regulatory approach towards these special institutions and we hope that this will bode well for customers and stakeholders of UCBs across this country.

Until then…

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