The Reserve Bank of India (RBI) on Tuesday placed the Punjab and Maharashtra Co-operative Bank (PMC) under “directions”. Consequently, cash withdrawals have been capped at Rs 1,000 per account for six months, and the bank will not be able to extend credit, take fresh deposits or make any payment. Predictably, the decision has resulted in panic among depositors. While the details on why the banking regulator was forced to put such restrictions are still sketchy, the issue is reportedly related to the bank’s exposure to Housing Development & Infrastructure (HDIL). The company has been admitted by the National Company Law Tribunal for insolvency proceedings, though it has been challenged by the realty firm. There are differences between the auditor and the regulator in terms of treatment of loans extended to HDIL. There could also be issues related to governance as the bank and HDIL have had links in the past. The collapse of PMC appears to have been sudden and is shrouded in mystery, and things will become clear once the regulator completes the examination. At the end of the last financial year, PMC declared a net profit of about Rs 100 crore with deposits over Rs 11,000 crore. At the net level, non-performing asset was at a modest 2.19 per cent.
The regulator and the government would do well to re-evaluate the importance of cooperative banks in the current financial landscape to avoid recurrence of such an incident. According to the RBI, at the end of the last financial year, India had a total of 1,542 urban cooperative banks, of which 26 were under directions of the regulator and 46 had a negative net worth. There have been delays in adoption of core banking solution in some cases because of a lack of expertise and capital. Governance is a real issue in many of these banks. It doesn’t help that they are regulated by both the RBI and the Registrar of Cooperative Societies of the state concerned. Further, there are issues related to capital. Urban cooperative banks cannot raise capital through a public issue or issue shares at a premium. They also face difficulties in meeting short-term liquidity requirement because not all can directly access RBI’s liquidity support. Cooperative banks fail often because of their small capital base — for example, urban cooperative banks can start with a capital base of Rs 25 lakh compared to Rs 100 crore for small finance banks. Also, such banks are hijacked by vested political interests.
To be sure, cooperative banks played an important role in the past, including in the colonial period, but their relevance has declined with the spread of scheduled commercial banks and adoption of technology in recent years. Given their lack of expertise and capital, it will be difficult for these banks to compete with other financial institutions. Therefore, it is important to carry out a comprehensive review and make changes in the law to give more power to the RBI in terms of regulation, mergers, and conversion of some entities into commercial or small finance banks. This will allow them to raise capital and attract talent. In the absence of policy initiatives, these banks would increasingly become more vulnerable.