How to defuse the co-operative bomb

The minimum capital requirement for a co-operative bank is Rs 1 lakh - an amount that has remained unchanged since 1949

The government is ready to bring in changes in the laws governing multi-state co-operative banks. A three-member committee is being set up to look into the issues and suggest legislative changes to prevent another Punjab and Maharashtra Co-operative (PMC) Bank-like scandal and empower the banking regulator. The changes in legislation could happen as early as during the winter session of Parliament.

It’s fashionable to talk about dual control (by the central bank and the respective state governments) and political interference but the rot is deeper. Not legislative changes alone — the co-operative banking sector needs to be overhauled in every possible way. For instance, many community-based urban co-operative banks (UCBs) do not advertise staff vacancies but hire relatives of past and/or present directors and people from their own community. In other cases, the vacancies are not advertised widely and, even after advertisements, community and political affiliations play a key role in the selection of staff. They are mostly chosen because of “connections” and/or recommendations from existing directors of the banks or local politicians. The prospective candidates are often encouraged to seek recommendations from the directors of the bank before appearing for an interview.

Once the “connected” employees are placed in key positions, it becomes easier for the bank management to have its way in sanctioning loans to the undeserving borrowers. Ideally, the UCBs should play the role of financial intermediaries in urban and semi-urban areas, catering to the needs of the non-agricultural sector, particularly small borrowers. In reality, the money borrowed from an UCB, in many cases, is used to repay a loan of another commercial bank till the UCB loan itself turns into a non-performing asset (NPA). The huge divergence in reported/audited figures of such banks and assessed figures of the Reserve Bank of India (RBI) is no secret and the possibility of auditors being hand in glove with the corrupt management cannot be entirely ruled out. 

Huge exposures to borrowers whose financials do not warrant sanction of such loans by the board of directors is a recurring theme in most UCBs — large and small. There are several instances of large-scale diversion of funds among group companies and the so-called ever-greening of NPAs by round-tripping of funds — within the co-operative banking sector and between the co-operative banks and the commercial banks. 

Restructuring of loans with retrospective effect and/or without assessment of the viability of the restructuring package to manage NPAs — an offshoot of “commission-based” lending — is also a concern. If the RBI decides to take a close look at the key lending decisions in some of the UCBs with politically affiliated management, the pattern is uniform. Typically, the UCBs follow a three-step approach. First, money is given to politically-affiliated borrowers at concessional rates, diluting risk management; then a benign stand is taken towards NPA identification and provisioning; and, finally, they are not too eager to recover the bad loans, unless they are exposed, a la PMC Bank.

 

Similarly, lending under a consortium arrangement is not based on independent, professional assessment but political affiliations even as loans are also given to trusts created by the directors and their relatives to circumvent regulations that ban loans to the directors. Loans are thrust upon the employees first and then diverted to such trusts. The staff accounts are often money mules — conduits to serve the interests of the corrupt management.

That’s the story of HR and lending. It does not end here. The contracts/tenders for sourcing of products (stationery, furniture, fixtures, air conditioners etc) and services (AMC contracts, IT, security, etc.) are typically bagged by entities owned by relatives of the directors and/or politically connected entities. The same rule follows when these banks identify premises to open new branches.

How do we change the ways these banks work? Here are some unsolicited suggestions.

The minimum capital requirement for a co-operative bank is Rs 1 lakh. The amount has remained unchanged since 1949. How can an UCB — spreading over many states or confined to one — operate with such a small capital base? Shouldn’t it be raised many times more? For the first set of new private banks, the RBI licensing norms of 1993 had asked for Rs 100 crore as minimum capital; by 2014, it was raised to Rs 500 crore.

There must be a limit on the amount these banks can lend to a borrower and even deposits they can accept. Payments banks cannot take more than Rs 1 lakh deposit from one person; small loans form three-fourths of the loan books of the small finance banks; microfinance entities need to give unsecured loans to 85 per cent of the borrowers. However, for UCBs, there is no norm. They are treated on a par with large commercial banks. Often such banks are used to park black money. A cap on deposits will deal a blow to this.

The link between the subservient staff and the shady management can be broken by creating a centralised recruitment platform which can be overseen by the Registrar of Co-operative Societies (RCS), representing the state governments, responsible for managing the UCBs, while the RBI can oversee regulations and supervision. The banking regulator should prescribe the minimum criteria for being a director and the so-called fit and proper norm must be applicable to key management personnel. The auditors should be appointed by the RCS or the RBI instead of allowing the banks to choose from a panel.

Of course, the entire crop of co-operative banks should not be painted with the same brush. Small and beautiful banks such as Shri Mahila Sewa Sahakari Bank Ltd in Ahmedabad and Mann Deshi Mahila Sahakari Bank Ltd at Mhaswad (Maharashtra) be nourished in niches, changing the lives of millions, but the big ones should be encouraged to become small finance banks or merge with commercial banks, and the bad ones should not be allowed to exist. A higher capital requirement will force consolidation.

Co-operation being a state subject, any reform in this area requires consultation with various stakeholders but since they are allowed to take public deposits, the onus is on the RBI to defuse the co-operative bomb. 

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd. Twitter: @TamalBandyo