Just the first step

The Union Cabinet on Wednesday decided to issue an Ordinance to give more powers to the Reserve Bank of India (RBI) to supervise co-operative banks. The supervisory norms, which are applicable to commercial banks, will also apply to urban co-operative and multi-state cooperative banks. The decision will affect 1,482 urban and 58 multi-state co-operative banks. Among other things, the RBI will now be able to decide the eligibility criteria for board members and approve the appointment of the chief executive officer. This is a welcome move as revised norms are expected to improve the functioning of these banks. After the Punjab and Maharashtra Cooperative (PMC) Bank crisis last year, it was argued that the regulator needed more powers to supervise co-operative banks. Although the government’s move is expected to improve things in a set of co-operative banks, this should be treated as just the first step in addressing the problems in the sector. 

There are a number of issues here. For one, the RBI had the responsibility of supervising co-operative banks, but it could not stop a PMC-like crisis. Now additional powers to oversee over 1,500 co-operative banks will make things more difficult for the RBI. The banking regulator would need to substantially increase capacity to improve oversight meaningfully. The RBI is often blamed for not being able to prevent the accumulation of non-performing assets in the banking system in the aftermath of the financial crisis. Even in terms of individual cases, the regulator allowed problems in YES Bank to build up for far too long. There have been serious issues in the non-banking financial company space as well, the failure of IL&FS being the prime example. Thus, just more powers will not be enough.

Further, while co-operative banks played an important role in the past, they have now become a weak link in the evolving financial architecture. Many are just single-branch entities with limited sources of capital. At the aggregate level, despite the large numbers, urban co-operative banks account for less than 4 per cent of the assets of scheduled commercial banks. Since urban co-operative banks cannot raise capital through public issues, it affects their capital adequacy. Also, with the limited scale of operations, they are neither able to adequately invest in technology nor attract talent to manage operations. The increasing use of technology in banking and the emergence of new-age banks like the small finance banks would make things more difficult for co-operative banks. 

As a long-term solution, the government must now evaluate the utility of co-operative banks. Their small asset base can be easily serviced by commercial banks. In fact, the number of weak urban co-operative banks has declined in recent years due to measures taken by the regulator. This process needs to be expedited. Co-operative banks should be encouraged for mergers to gain scale. Depending on the quality of the book, some may be converted into small finance banks. Both the government and the regulator should also work on a smooth exit route for a large number of entities in this category. Evidently, besides better regulatory supervision, co-operative banks need intervention at multiple levels to avoid disruption and ensure safety of deposits.