Insights into Editorial: Converting Urban Cooperative Banks into Commercial Banks
Cooperatives continue to be important and the ideal organisations even in the changing economic environment, as participation and inclusion are central to poverty reduction. Cooperative organisations in many countries have exhibited greater resilience during global crises, underscoring their importance in macroeconomic and financial stability. In this background, a Reserve Bank of India (RBI) committee, in 2015, suggested that multi-state urban cooperative banks with a business size of Rs.20,000 crore or more be converted into full-fledged commercial bank, if the lender has no special need to remain a cooperative bank.
What are UCBs?
The term Urban Co-operative Banks (UCBs), though not formally defined, refers to primary cooperative banks located in urban and semi-urban areas. UCBs are registered as cooperative societies under the provisions of either the State Cooperative Societies Act of the state concerned or the MultiState Cooperative Societies (MSCS) Act, 2002.
Scheduled UCBs are those listed in second schedule of RBI Act 1934 and have access to liquidity support from the central bank and are also required to maintain Cash Reserve Ratio and Statutory Liquidity Ratio. Scheduled UCBs are relatively large in terms of business and branch network and some of them have been covered under the Multi-State Cooperative Societies Act.
These banks, till 1996, were allowed to lend money only for non-agricultural purposes. This distinction does not hold today. These banks were traditionally centred around communities, localities work place groups. They essentially lent to small borrowers and businesses. Today, their scope of operations has widened considerably. The sector was brought under the Banking Regulation Act of 1949.
The growth and performance of UCBs has shown three distinct phases, namely, growth phase (1966–2000), crisis phase (2002–08), and consolidation phase (2008 onwards).
Significance of UCBs:
- From its origins then to today, the thrust of UCBs, historically, has been to mobilise savings from the middle and low income urban groups and purvey credit to their members – many of which belonged to weaker sections.
- They constitute an important component of the non-agricultural credit cooperative structure.
- These banks generally cater to the banking needs of small traders, microenterprises, individuals, and others not adequately served by commercial banks.
- The sector also displays high degree of heterogeneity in terms of deposit/asset base, area of operation, and nature of business.
Challenges faced by UCBs:
- Limited ability to mobilize resources.
- Low Level of recovery.
- High transaction cost.
- Administered rate of interest structure for a long time.
- Duality of control: They are regulated both by state governments and RBI.
- They are not able to formulate their respective policies for investment of their funds that include their surplus resources because of certain restrictions.
- NPA levels in UCBs are also disproportionately high.
- Rising competition, low capital base and scams have only added to the problem.
Some of the problems that arise out of the applicability of the cooperatives legislative are:
- Deliberate control of cooperatives by the government.
- Nomination of board of director by the government.
- Participation of the nominated director by the government.
- Deputation of government officials to cooperative institution etc.
UCBs should be into commercial banks for the following reasons:
- As the UCBs become larger and spread to more states, the familiarity and bonding amongst their members diminishes and commercial interests of the members overshadow the collective welfare objective of the organisation. In the process, some of them become too big to be a cooperative. The collective ownership and democratic management no longer suit their size, and competition and complexities in the business force them to explore alternative forms of ownership and governance structures in order to grow further.
- Large UCBs have aligned their business models and goals with that of commercial banks and are undertaking activities that are not permitted for the proposed small finance banks (SFBs) with stricter capital norms.
- Besides, UCBs are regulated under less stringent Basel I norms as opposed to Basel II and Basel III norms for commercial banks. Thus, the regulatory arbitrage may create incentive for large UCBs to have greater leverage. Further, on account of duality of control, in the absence of resolution powers on par with commercial banks, the RBI is constrained when UCBs acquire size comparable to banks in the private sector.
- Some large UCBs aspire to conduct business like private sector commercial banks and expect relaxations in the regulatory restrictions in order to grow further. They have also aligned their business models and goals with that of commercial banks. Some of the large UCBs are bigger than the smaller commercial banks in terms of deposits, advances, and total assets.
- Also, on account of softer regulation, UCBs are not permitted to undertake certain kinds of businesses like investments in shares and government business on the one hand, and on the other, regulations are tight with respect to financing certain sectors. There is thus, no level playing field between UCBs and commercial banks. In addition, the capital-augmenting avenues as also instruments are limited in the case of SUCBs.
There have been several arguments against the conversion of UCBs and amongst them, a significant reduction in the size of the UCB segment post-conversion, a slower pace of mergers within the UCB sector, as large UCBs have been active in taking over weaker small UCBs, and loss of cooperative type of organisation resulting in reduced diversity in the financial sector, are noteworthy.
However, these concerns could be addressed through suitable policy measures.
Urban Cooperative Banking is a key sector in the Indian Banking scene, which in the recent years has gone through a lot of turmoil. Though some UCBs have shown credible performance in the recent years, a large number of banks have shown discernible signs of weakness. In the interest of healthy competition, the urban cooperative banks should be encouraged to grow. Once large urban cooperative banks become commercial banks, RBI will have much more power over these banks, which the banks’ management or even shareholders may not prefer.