How to Improve Co-Operative Banks through Regulations and Risk Based Pricing
Moneylife Digital Team 05 November 2019
The Indian financial system's regulatory architecture is complex - both in terms of the sheer number of regulating bodies and also because of their overlapping spheres of concern and influence. Post the PMC Bank scam, there is a need to bring in some changes in co-operative banks through regulations and risk based pricing, says a research note from State Bank of India (SBI).
In the report, Dr Soumya Kanti Ghosh, group chief economic adviser of SBI says, "Regulation of cooperative banks in India with their regulation largely left to the registrar of cooperatives. Though Reserve Bank of India (RBI) has the expertise, it does not have the regulatory power to regulate these institutions, and the registrar of cooperatives though not having the expertise regulates such entities. Additionally, the urban cooperative banks (UCBs) are currently regulated under the less stringent Basel I norms as opposed to Basel II and III norms applicable to commercial banks. The result, creation of Punjab and Maharashtra Cooperative Bank (PMC Bank) type behemoths! We need to change this!"
The Madhavpura Mercantile Cooperative Bank failure of 2001 caused severe damage to the sector. Nevertheless, the bank had to be kept alive for a decade before cancellation of its licence on 4 June 2012, as RBI does not have full powers for resolution of issues that deal with UCBs. It has no powers for moratorium, amalgamation, supersession and liquidation and in the absence of resolution powers at par with commercial banks, RBI faces constraints when these banks grow.
According to SBI, there are three ways to bring changes in cooperative banking, including converting urban cooperative banks (UCBs) into small finance banks (SFBs) or commercial banks, empower RBI to handle these banks, and creation of an umbrella organisation (UO) that are prevalent across several countries. 
"We believe that urban cooperative banks or UCBs registered under the Multi-state Co-operative Societies Act may be immediately considered for conversion to small finance banks or commercial banks. Currently, UCBs has more relaxation in regulation compared to SFBs, and hence they do not convert and hence there is an urgent need to cap the business size of UCBs, for example at Rs20,000 crore.
There after the UCBs has to mandatorily convert into a CBs or SFBs. RBI may come out with a detailed scheme in this regard." 
"Second, at present, no powers are available with RBI for constituting boards of UCBs, removal of directors, supersession of board of directors (BoDs), auditing of UCBs and winding up and liquidation of UCBs. Government should amend the desired laws and empower RBI for supervision and regulation of UCBs by RBI at par with commercial banks," it says. 
In line with the recommendations of several committees, SBI says the central bank should now form an umbrella organisation for UCBs in India to make them more financially resilient and to enhance depositor's confidence. It says, "As prevalent in many countries, the UO will extend liquidity and capital support to the member UCBs, setup information technology (IT) infrastructure for shared use and enable them widen their range of services at a lower cost. The UO can also offer fund management and other consultancy services."
Moneylife has a different view on capping business size of UCBs to Rs20,000 crore. We all know how RBI and others struggling to revive scam-hit PMC Bank which has a business size of about Rs11,000 crore. So if conversion of UCBs is the intention, then why not reduce the business size to Rs10,000 crore or even lower?
Talking about deposit insurance, SBI says, this system in India like an ex-ante flat-rate premium system or one size fit all approach for all banks are invariant to the level of risk that banks pose to the deposit insurance system. Flat-rate premium systems are also unfair in practice as 'low-risk' banks are required to pay the same premium as 'higher-risk' banks. Thus, with no incentive for 'higher risk' banks to improve their risk profile it introduces an element of moral hazard in the system and perpetuates the same, it added.
In the Indian context there is a flat premium rate of Rs0.10 per deposit of Rs100 since April 2005 with a static insurance cover of Rs1 lakh per depositor since May 1993.
Most countries in the world including South Asian countries now adopt a risk-based premium for deposit insurance. For example, Federal Deposit Insurance Corp (FDIC) in the US adopts a risk based pricing model that is determined by capital ratios based on financials and CAMELS ratings derived from on-site examinations. 
"Given that banks in India are already being monitored by RBI under risk based supervision (RBS) it would be prudent and sound to introduce a risk based pricing model for deposit insurance in India with premium tied to risk rating of the bank. Further, with hardly any claims, there is room for the premium rate itself to be reduced. The insurance expense being significant, this is yet another area where profitability of banks is adversely impacted without adding commensurate value to customers," the report added.
SBI constructed a scenario of risk based premium for deposit insurance and found that banking industry can save a significant amount in comparison to flat premium with better risk management. "Our assumptions based on market experience suggest that nearly 70% of bank customers can be low risk, while 25% carries medium risk and 5% might be high risk. If the Deposit Insurance and Credit Guarantee Corp (DICGC) were to introduce a differential risk based premium by bifurcating the customers into high, medium and low, the banking industry can add at least Rs3,641 crore to their bottom-line," it added.
Moneylife has a different view on deposit insurance as well. With the government constantly rescuing public sector banks (PSBs) and pumping money from the exchequer, these banks have zero risks for depositors. Under such scenario, why not exclude PSBs from the mandatory deposit insurance scheme and bring down the cost further?
Co-operative institutions play a significant role in credit delivery to unbanked segments of the population and financial inclusion within the multi-agency approach adopted in India in this context. 
The cooperative structure in India can broadly be divided into two segments. While the urban areas are served by UCBs, rural cooperatives operate in the rural parts of the country. As per the latest data available, there are 1,551 UCBs, including 54 scheduled and 1,497 non-scheduled and 96,612 rural cooperatives are working in India. 
There have been several Committees, which have attempted to streamline the functions and working of cooperative banks in India, including Satish Marathe Committee (1991), Madhav Rao Committee (1999), NH Vishwanathan Working Group on augmenting capital of urban cooperative banks (2005), R Gandhi Working Group on information technology systems in urban cooperative banks (2007-08), VS Das Group on an umbrella organisation for the urban cooperative banking sector (2009), YH Malegam Committee on licensing of new urban cooperative banks (2011), and R Gandhi Committee (2015). 
The Gandhi Committee (2015) recommended, inter-alia, an accelerated winding up or merger  process, effective regulation of such banks and meeting the capital needs of urban cooperative banks in a greater measure.
During 1993-2004, RBI pursued a liberalising policy and based on the recommendations of the Marathe Committee, the number of UCBs increased to 1,926 by March 2004 from 1,311 in 1993. However, SBI says, due to weak financial conditions of the newly UCBs, with the help of state or central government, RBI introduced appropriate regulatory and supervisory policies in 2005 and merged weak but viable UCBs and closure of unviable ones. 
As a result, the number of UCBs declined significantly but there was consistent growth in deposits and advances to Rs4,565 billion and Rs2,805 billion in 2017 from Rs1,398 billion and Rs904 billion in 2008, respectively recording a compounded annual growth rate (CAGR) of 14.1% and 13.4%, respectively. 
The UCBs accounted for 31.3% of the total asset size of all co-operatives taken together. 
Among the rural cooperatives, there are 33 State co-operative banks (StCBs), 370 district central co-operative banks (DCCBs), 95,595 primary agricultural credit societies (PACS), 13 state cooperative agriculture and rural development banks (SCARDBs) and 601 primary cooperative agriculture and rural development banks (PCARDBs). 
Regional rural banks (RRBs) have also been created to bring together the positive features of credit cooperatives and commercial banks and specifically address credit needs of backward sections in rural areas. As per 31 March 2019, there are 51 RRBs, consolidated from 196 RRBs that were originally set up.
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