Managing urban co-op banks

Big changes are afoot in how urban co-operative banks (UCBs) are regulated. According to a report in this newspaper, large UCBs are expected to come solely under the provisions of the Banking Regulation (BR) Act. The move will affect over 1,500 Indian UCBs, with deposits in excess of Rs 4.5 trillion. This is a fairly important sector of the financial system — about 11 per cent of the deposits in scheduled commercial banks, or SCBs, in 2017 — but it has for decades suffered under a problem of divided regulation. The Registrar of Co-operative Societies (RoCS) is currently the nodal regulator, and has control of management elections and external audits. But some provisions of the BR Act also apply — under which they are inspected by the banking regulator, the Reserve Bank of India (RBI), and conform to its capital adequacy requirements. As with all such arrangements, there is scope for regulatory confusion and arbitrage. In particular, the RBI had fewer instruments with which to enforce its regulatory diktat, since it could not supersede UCB boards the way it could with other private-sector SCBs.

The context of this action is, of course, the massive fraud unearthed at PMC Bank, with major consequences for depositors. While it could be argued that there is no direct linkage between the PMC Bank issue and the problem of dual regulation — and PMC Bank, with a size of Rs 12,000 crore, was in fact under the Rs 20,000-crore threshold being considered for transfer to RBI sole supervision — it was certainly an opportune moment to consider the future of UCBs in general. One important change must be, given the PMC Bank depositors’ distress, that UCBs should have the same protection as regular banks. Many PMC Bank depositors did not know that they were putting money into a differently regulated and protected entity in comparison with a regular commercial bank. If the difference cannot be clearly and transparently communicated to depositors, then the difference itself is unsustainable.

There is no clear reason for the continued presence of UCBs in their current form in a banking landscape that has changed so drastically. It has become extremely difficult for UCBs to compete because of a lack of trained manpower and their inability to raise sufficient capital. A recent high-level committee led by a former deputy governor of the RBI, R Gandhi, suggested that mergers and re-orientation of existing UCBs be continued in such a manner that many important ones eventually become small finance banks. Such small finance banks will find it easier to grow their capital, although their capital adequacy requirements might also be more stringent. The crucial aspect must be to mainstream the board’s control of management and bring it in line with a proper incentive structure. The regulatory reframing will be successful only if it can transform the nature of governance for the large UCBs that will be directly affected by the change. The RBI must also recognise that, as its responsibilities grow, so must its capacity. In particular, its auditing capacity and supervision of boards must have greater depth and reach. The build-up of non-performing assets in the banking system and the trouble in non-banking financial companies suggest that the regulator has a long way to go. Simply changing the regulatory structure will not automatically result in stability in the UCB segment.

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