A lot is happening in the cooperative banking space. Last week, the Reserve Bank of India took over the board of Abhyudaya Co-op Bank because it suspected corporate governance issues. And over the weekend, Karnataka announced that the CBI would conduct an inquiry into a multi-crore scam run by the Directors at 3 cooperative banks in the state.

So in today’s Finshots, we decided to look at a major problem plaguing cooperative banks.

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The Story

The RBI has fined 172 banks so far this year!

But here’s the thing — 127 of these banks are the ‘cooperative’ kind. And the fines levied on cooperative banks have been soaring each year. In 2020, the RBI fined only 22 cooperative banks. In 2021, it rose to 124. And in 2022, it was a whopping 180 banks.

So, what’s going on here? Are these entities flouting banking rules en masse, you ask?

Well, to answer that, we first need to understand the concept of these cooperative banks.

Let’s say that your local community isn’t serviced that well by the big banks. People still need to deposit money and save. Or they need money to live their lives — to set up a barber shop, a kirana store, or to buy a means of transport to travel to their place of work. Now typically, they’d end up going to a money-lender who’d charge a very sharky rate of interest that’ll drown people in debt.

But you might think, “What if I can make life better for the community by involving them?” We’ll all pool our resources and set up a cooperative for banking. It’ll be owned and run by the community to serve the same community.

And that is how a cooperative bank takes shape. Now because it is driven by the community, people tend to trust these cooperative banks a tad bit more. Heck, when 57 regular banks owned by private individuals collapsed during a banking crisis in 1913 in India, people rushed to withdraw their monies and deposit them in cooperative banks.

Now you’d imagine the RBI would’ve overseen them, right especially considering the crucial role they perform?

Well, no. The RBI never regulated these cooperative banks. It treated them differently and left oversight in the hands of the government. Even in 1966, when it finally decided to get involved, it implemented a dual regulatory structure. It simply laid down the banking guidelines — dictating the kind of money these cooperatives were supposed to set aside, the kind of cash they were supposed to hold at all times, and other such matters. It left the regulatory aspects related to governance and auditing functions to state and central governments. It was a loose oversight.

And guess what happened as a result of the RBI staying in the shadows?

Corporate governance issues cropped up!

For instance, banks started becoming the personal fiefdoms of the people who controlled them. People like the Directors of the bank. See, banks would collect deposits and then lend them out freely to the directors, or to the family members of the directors, or even to companies in which the directors were involved. Heck, it’s pretty easy to do this if the people at the top also appoint staff as they please. These staff will be quite loyal to the people who give them the jobs. And they’ll do anything to stay in the good books. So if the Director asks for a loan, it’s in their interest to sanction it.

And when The Print parsed through the data on RBI fines for 2023, they found that nearly 25% of fines levied on cooperative banks were because of this issue. Basically, the Directors were running the show based on their whims and fancies.

But why did the RBI start imposing fines only since 2020, you ask?

Well, that’s probably because the central bank had an epiphany back then. It decided that cooperative banks were just like other banks at the end of the day. So as a banking regulator, it needed more oversight. It couldn’t let lax governance standards affect the crores of rupees worth of customer deposits. It couldn’t leave everything in the hands of the State governments. So it tweaked the rules. And it granted itself more authority to lay down the rules and audit the banks. Bring them at par with any other bank in the country.

And maybe it’s this extra scrutiny that’s laying bare the problems at cooperative banks. Maybe that’s why the fines are rising in number.

But wait…there’s still one problem that the RBI might have on it hands. You see, what we didn’t say so far is that we’ve been talking about ‘urban’ cooperative banks. There are also cooperative societies that operate in rural areas. They take deposits from members and lend money out too. Many don’t have a banking licence even if they attach the word ‘bank’ to their name. And these cooperatives aren’t still heavily regulated by the RBI. They remain under the ambit of the state.

And the RBI might be getting worried about this segment too.

Now you might have missed this news. But a massive cooperative bank scam had rocked Kerala recently. And a few months ago, the Enforcement Directorate alleged that ₹300 crores was siphoned off from the Karuvannur Service Co-operative Bank. And guess who they pointed fingers at? The ruling party — CPI(M). After all, they’re the ones who’d governed the bank for decades. The ED says that leaders from the party took fake loans in the name of customers and moved the money into their personal accounts. They tampered with the bank’s software to approve loans without proper collateral or documents. And they diverted all those crores for personal gains.

Who knows how many such cooperatives have outsized political influence? And maybe this will force the RBI to tighten the screws. After all, crores of deposits are at stake even here. And if this spurs the RBI into action, the fines could pile up even more quickly.

Until then…

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