Cracks in co-ops? Irregularities persist in UCBs despite RBI interventions

RBI's initiatives to promote sound governance practices in UCBs include introducing a four-tiered regulatory framework, direct engagement with directors on UCB boards

The cooperative banking sector is in the headlines again – not for the right reasons, though. An urban cooperative bank (UCB) has invited regulatory ire for alleged financial irregularities. It is not the first one.

 

This is despite the many initiatives of the Reserve Bank of India (RBI) to promote sound governance practices in UCBs. These include introducing a four-tiered regulatory framework, direct engagement with directors on UCB boards, and efforts to address IT and cybersecurity risks within these banks.

 

Earlier this month, the RBI prohibited the Mumbai-based New India Cooperative Bank from issuing fresh loans, and also suspended deposit withdrawals for six months, starting February 13. However, it has now allowed depositors to withdraw up to ₹25,000, which in effect means 50 per cent of the bank’s depositors will be able to retrieve all their money.

 

Meanwhile, the Deposit Insurance and Credit Guarantee Corporation has also started the process of claim settlement, which is to be completed by May 14.

 

The RBI’s intervention was triggered by allegations of fund misappropriation by some officials of New India Cooperative Bank.

 

Since the Economic Offences Wing of the Mumbai Police lodged a first information report (FIR) on the complaint of the bank’s chief compliance officer, the authorities have arrested Hitesh Mehta, the former general manager who allegedly embezzled ₹122 crore from the bank’s safe. Dharmesh Paun, a developer who allegedly helped Mehta route the embezzled funds, and the bank’s former chief executive officer, Abhimanyu Bhoan, have also been arrested.

 

Satish Marathe, senior banker and director on the RBI’s board, is of the view that the collapse of New India Cooperative Bank was the fault of the bank’s board. The situation was the result of a complete lack of checks and balances, a degraded work culture, and dynastic control over the bank, he said.

 

Marathe also highlighted that the bank had been on the RBI’s radar for some time. “The bank’s working and governance will need to be overhauled. That is the reason the RBI has appointed an administrator and advisory panel,” he said, adding that the regulator’s priority would be to salvage the bank, if possible, rather than shut it down. 

 

The merger option

 

Earlier, merging struggling UCBs with sound banks was an option, since these cooperative banks operated through branch licences, Marathe said. But that’s not the case anymore. With the easing of norms to open branches, banks now prefer to set up branches on their own and are less keen on absorbing troubled banks to expand their presence, he explained.

 

During the Punjab and Maharashtra Cooperative (PMC) Bank crisis, for instance, the RBI and the central government had intervened to prevent its liquidation and had amalgamated it with Unity Small Finance Bank, a newly created institution.

 

In 2019, the RBI had imposed regulatory restrictions on PMC Bank over irregularities in loan accounts related to real estate player Housing Development and Infrastructure (HDIL). HDIL promoters had allegedly colluded with PMC bank’s management to draw loans. The bank’s officials did not classify these as non-performing loans, despite their non-payment. PMC Bank’s overall exposure to the HDIL group was more than 73 per cent of all of its advances – and all of it had turned sour.

 

As its immediate aftermath, the central government intervened to reform and fortify the sector by increasing the RBI’s regulatory powers under the Banking Regulation Act. This was done to resolve the issue of dual regulation of the sector (earlier states too could regulate UCBs). It also granted cooperative banks greater freedom to raise capital, and introduced deposit insurance reforms to boost depositor confidence in the sector.

 

Additionally, the government raised the deposit insurance coverage from ₹1 lakh to ₹5 lakh — a measure it undertook after nearly 27 years.

 

The insurance cover

 

The crisis facing New India Cooperative Bank has brought the question of raising deposit insurance cover to the fore again.

 

M Nagaraju, secretary, financial services, Ministry of Finance, said at a press conference that a proposal to increase deposit insurance is being considered, and the finance ministry will notify it once the Cabinet takes a decision on it.

 

Meanwhile, despite reforms in the sector after the PMC Bank crisis, there have been frequent instances of irregularities in such banks, which have subsequently invited regulatory action.

 

In November 2023, the RBI superseded the board of the Mumbai-based Abhyudaya Cooperative Bank due to concerns of poor governance. Similarly, in April 2024, the regulator imposed restrictions on Sarvodaya Cooperative Bank, also based in Mumbai, because of its deteriorating financial condition. Then in July 2024, the RBI imposed restrictions on the Bengaluru-based National Cooperative Bank due to its weak financial position.

 

According to Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services, the cooperative banking system presents a significant systemic challenge for the RBI due to the sheer number of such banks. Lack of technological upgrade in these banks means that the regulator often relies on onsite audits.

 

However, given their sheer number, it is not easy for the RBI to assess them all effectively. Additionally, many of these banks engage in creative accounting practices to conceal poor decision-making, further complicating the RBI’s ability to maintain control over the sector, he said.

 

“While there have been efforts to reduce the number of such banks, including the RBI's encouragement for consolidation, political factors also influence the situation,” Parekh added. “Despite there being regulations and frameworks for UCBs, the sheer volume of these entities makes it challenging for both the system and the regulator to conduct thorough audits.”

 

The number of UCBs surged in the 1990s following a liberal licensing policy. Over the years, nearly a third of the newly licensed banks became financially unsound. Starting 2004-05, the RBI initiated a process of consolidation, including the amalgamation of unviable UCBs with their viable counterparts, closure of non-viable entities, and suspension of new licences. As a result, the number of UCBs declined over the last two decades — from 1,926 to 1,472. Since 2004-05, the sector has witnessed 156 mergers, including six in 2023-24.

 

A few bad eggs?

 

In its Trend and Progress Report for 2023-24, the RBI highlighted that the UCB sector had shown an improvement in capital buffers, profitability, and asset quality.

 

This raises the question: Is it fair to paint the entire sector with the same brush because of a few entities? Ajay Seth, secretary, Department of Economic Affairs, doesn't think so.

 

“Cooperative banks in the country are generally quite robust, and the RBI takes regulatory action whenever issues arise,” Seth said at a press conference in Mumbai earlier this month while addressing depositors’ concerns. “It’s not fair to generalise for the entire sector based on regulatory action against one bank. Across different states, many cooperative banks are operating effectively. It is a well-regulated sector now,” he added.

 

According to R Gandhi, former deputy governor, RBI, certain lessons will be learnt from this event. For example, he added, the RBI may  consider the following measures: The need for cash reconciliation by assurance through an annual audit; surprise checks during the course of the year by the RBI or through its appointed auditors; back-office analysis like the pattern in cash movements, etc.

 

In the last few years, the RBI has been encouraging cooperative banks to become small finance banks to improve their governance practices. Small finance banks have a mandate to list on the bourses once their business reaches a certain threshold.

 

However, not many UCBs have shown interest in this. Incidents, such as the crisis in New India Cooperative Bank, only reaffirm the view that the sector might require closer scrutiny.