1

1.1. Background:

1.1.1. The co-operative movement has completed 100 years in India in the year

2006. During this period the movement has played a very crucial role in

developing the Indian economy. Banking system has its own importance in the

economy of any country. Co-operative banking system is an integral part of

banking system in India. Thus, it has its own significance in the Indian banking

system.

1.1.2. In the year 2004-05 the Governor of Reserve Bank of India (RBI), in its six

monthly credit policy, appreciated the need to study the future role of Co-operative

Banks from the view point of security of the depositors and requirements of

banking facility at local level. Accordingly, a committee was appointed that

submitted its report to the RBI on 31.12.2004. This report is called as „VISION

DOCUMENT‟.1

The Vision Document reveals that the growth achieved by the Co-

operative Banks during about 15 years of reforms is very encouraging.

Vision Document states that2:

1. Number of Co-operative Banks increased from 1307 to 2105 during this

period and recorded a rise of 61.06%

2. Deposits of Co-operative Banks increased from Rs. 8,600 crores to Rs.

1,10,000 crores during this period. As such, it has achieved a growth of

1179%

3. Advances of Co-operative Banks increased from Rs. 7,800 crores to Rs.

65,000 Crores during this period recording a growth of 733.33%.

----------------------------------------

1 RESERVE BANK OF INDIA, web site

2 RESERVE BANK OF INDIA, web site

2

These figures itself speaks about the importance of co-operative banking in India.

Maharashtra is one of the pioneer states in co-operative banking sector. It

constitutes almost 60% of the total deposits and credit base of the co-operative

banking system of the country.

1.1.3. Position of functioning and non functioning Urban Co-operative Banks

(UCBs) in India as on 31.03.2006 is as under:

Graph 1.1

Statistical Data of UCBs in India

(Source: The Maharashtra State Co-operative Banks Association Ltd., Mumbai)

Graph 1.1 shows that as on 31.03.2006, 2079 UCBs were registered. Functioning

UCBs means urban banks in co-operative sector that are permitted to carry out

regular banking business by the Reserve Bank of India. The number of such UCBs

stood at 1853. This in terms of percentage works out to 89.13. Non functioning

UCBs means urban banks in co-operative sector that are not permitted to carry out

Total registered UCBs

Functioning UCBsNon functioning

UCBs

Series1 2079 1853 226

0

500

1000

1500

2000

2500

3

any banking business by the Reserve Bank of India. The number of such UCBs

stood at 226. This in terms of percentage works out to 10.87.

1.1.4. Under these UCBs there are various categories. The details of the category

wise functioning UCBs as on 31.03.2006 is presented in table 1.1

Table 1.1

Category wise details of functioning UCBs in India

Multi-state Scheduled UCBs 24

Scheduled UCBs 31

Women‟s UCBs 117

Salary Earners UCBs 79

Single Unit UCBs 914

Multiple Units UCBs 688

(Source: The Maharashtra State Co-operative Banks Association Ltd., Mumbai)

Table 1.1 shows license wise break-up of functioning UCBs in India as on

31.03.2006. Out of 1853 operating UCBs, 24 are Multi-State Scheduled UCBs

(1.29% of total UCBs). These banks are permitted to operate in more than one

State of India. In all, there are 31 Scheduled UCBs (1.67% of total UCBs) and are

permitted to operate only in one State of India. The status of „Scheduled Bank‟ is

conferred by the Reserve Bank of India and the names of these banks are included

in the Second Schedule of the Reserve Bank of India Act.3

Thus, out of 1853

UCBs only 55 UCBs (2.97%) are considered as big banks on the basis of business.

As such, remaining 1798 UCBs that form 97.03 per cent of the total are not big

banks as their size is concerned. These are small local banks cater the banking

----------------------------------------

3 The Reserve Bank of India Act, 1934, Bare Act, Professional‟s, p 42

4

requirements of common people. Further, to be more precise there are 117

Women‟s UCBs specifically provide service to the women, 79 Salary Earners

UCBs specifically meet the banking needs of the employees of that particular

organization, 914 Single Unit UCBs and 688 Multi Units UCBs. These 1798

UCBs provide services to some particular section of the society or to the common

people. Thus, play a very important role in their respective field. These banks

should survive because they are much needed by the society.

1.2 Significance of the study:

1.2.1 Unfortunately, this glorious era of the Co-operative banking movement is

now becoming history that the country may remember with pride. At present, the

UCBs are in great trouble. This trouble shooting exercise started since 1992 when

India opened up its economy and went to its peak when the Regulator of banking

system in India i.e. the RESERVE BANK OF INDIA, deregulated interest rates.

1.2.2. The number of UCBs has come down from 2105 in the year 2002 to 2079 in

the year 2006. This indicates that 26 UCBs are closed down by the regulator during

short period of 4 years. In terms of percentage it works out to be 1.28. The

percentage of non functioning banks to total banks as on 31.03.2006 constitutes

10.87. The rate of failure of UCBs has increased during last few years. Hence, it

has become very important to find out the exact reason behind this failure and to

study whether this failure has any co-relation with application of Asset-Liability

Management and Risk Management and Pricing of Products i.e. Interest Rates in

UCBs?

1.2.3 The things have further worsened rapidly during the period of study.

Following statistics of failed UCBs substantiate the statement.

5

Table 1.2

Numbers of failed UCBs in India during the pre and post period of study

Prior to the period of study During the period of study Result

Numbers Period in

months

Average

P. M.

Numbers Period in

months

Average

P.M.

27 48 0.56 46 30 1.53 + 273%

(Source: web site of The Reserve Bank of India)

Table 1.2 shows that the rate of failure of UCBs has increased substantially during

the period of study. Only 27 UCBs have failed during period of 48 months prior to

the study but 46 UCBs have failed in short period of 30 months during the period

of study, which is very alarming. Further, from the web site of RBI it has been

revealed that out of 46 UCBs failed during the period of 30 months 24 have failed

in Maharashtra State alone. Table 1.3 represents the comparative picture of failure

of UCBs.

Table 1.3

Contribution of State of Maharashtra in failed UCBs during the period of study

All over India State of Maharashtra Result

Numbers Period in

months

Average

P. M.

Numbers Period in

months

Average

P.M.

46 30 1.53 24 30 0.80 +52.29%

(Source: web site of The Reserve Bank of India)

Table 1.3 shows that during the period of 01.07.2007 to 31.12.2009 the

contribution of State of Maharashtra in failed UCBs is almost 52.29% which is

very alarming.

6

1.2.4 Following are the names of UCBs whose license have been cancelled by the

Reserve Bank of India during the period of 01.07.2007 to 31.12.2009 (30 months)

Table 1.4

Names of de-licensed UCBs in the State of Maharashtra

during the period of study

Sr. No. Date Name of the UCB & place of District

1 27.12.2007 The Ravi Co-operative Bank Ltd. Kolhapur.

2 11.06.2008 Shri.B,.J. Khatal Janata Sahakari Bank Ltd., Sangamner,

Ahmednagar.

3 23.07.2008 The Priyadarshini Mahila Sahakari Bank Ltd. Latur.

4 26.08.2008 Miraj Urban Co-operative Bank Ltd. Miraj, Sangli.

5 05.09.2008 Sant Janabai Nagari Sahakari Bank Ltd., Gangakhed,

Parbhani.

6 09.09.2008 The Rohe Ashtami Sahakari Urban Bank Ltd., Roha,

Raigad.

7 25.10.2008 Shri. S.K.Patil Co-operative Bank Ltd., Kurundwad,

Kolhapur.

8 04.11.2008 The Achalpur Urban Co-operative Bank Ltd., Amaravati.

9 03.12.2008 Chalisgaon People‟s Co-operative Bank Ltd., Jalgaon.

10 02.12.2008 Faizpur Janata Sahakari Bank Ltd., Jalgaon.

11 02.12.2008 Goregaon Co-operative Urban Bank Ltd., Raigad

12 06.12.2008 Shri Siddhi Venkatesh Sahakari Bank Ltd., Jalgaon.

13 29.12.2008 Shri P.K.Anna Patil Janata Sahakari Bank Ltd.,

Nandurbar.

14 07.01.2009 Shri. Vasantdada Shetkari Sahakari Bank Ltd., Sangli.

15 22.01.2009 Sadhana Co-operative Bank Ltd. Ichalkaranji, Kolahpur.

16 28.01.2009 Ajit Sahakari Bank Ltd., Pune.

Contd.

7

17 24.02.2009 Indira Sahakari Bank Ltd., Dhule.

18 25.02.2009 Suvarna Nagari Sahakari Bank Ltd., Parbhani.

19 20.04.2009 Yashwant Urban Co-op Bank Ltd., Parbhani.

20 22.06.2009 The Akot Urban Co-op Bank Ltd., Akot.

21 22.07.2009 Shri Parola Urban Co-op Bank Ltd., Parola, Jalgaon.

22 29.07.2009 Yashwant Sahakari Bank Ltd., Sangli.

23 16.09.2009 The Nagpur Mahila Nagari Sahakari Bank Ltd., Nagpur.

24 13.11.2009 Rajlaxmi Nagari Sahakari Bank Ltd., Dhule.

(Source: web site of Reserve Bank of India)

AND

Table 1.5

Names of de-licensed UCBs other than the State of Maharashtra

during the period of study

Sr. No. Date Name of the UCB & Name of the State

1 19.07.2007 The Kittur Rani Channamma Mahila Pattana Sahakari

Bank Niyamit, Karnataka

2 03.10.2007 Indira Priyadarshini Mahila Nagarik Sahakari

Bank Maryadit., Chhattisgarh.

3 27.10.2007 The Urban Co-operative Bank Ltd., Uttar Kannada,

Karnataka.

4 29.01.2008 The Maratha Co-operative Bank Ltd., Hubli, Karnataka.

5 31.01.2008 Shree Janata Sahakari Bank Ltd., Radhanpur, Gujrat.

6 05.02.2008 Laxmeshwar Urban Co-operative Bank Ltd.,

Laxmeshwar, Karnataka.

Contd.

8

7 22.02.2008 Bharuch Nagarik Sahakari Bank Ltd., Bharuch, Gujrat.

8 14.08.2008 Anubhav Co-operative Bank Ltd., Karnataka.

9 06.10.2008 Primary Teacher‟s Co-operative Credit Bank Ltd.,

Nipani, Karnataka.

10 05.11.2008 Nutan Sahakari Bank Ltd., Vadodra, Gujrat.

11 18.11.2008 Ankleshwar Nagarik Sahakari Bank Ltd., Gujrat.

12 20.11.2008 Shree Vardhaman Co-operative Bank Ltd.,

Bhavnagar, Gujrat.

13 10.12.2008 Siddhapur Commercial Co-operative Bank Ltd.

Siddhapur, Gujrat.

14 10.12.2008 Bhavnagar Mercantile Co-operative Bank Ltd.,

Bhavnagar, Gujrat.

15 05.03.2009 The Haliyal Urban Co-op Bank Ltd., Haliyal, Karnataka.

16 09.03.2009 Deendayal Nagarik Sahakari Bank Maryadit, Khandwa,

Madhya Pradesh.

17 29.05.2009 Citizen Co-op Bank Ltd., Burhanpur, Uttar Pradesh.

18 07.07.2009 Prantij Nagarik Sahakari Bank Ltd., Prantij, Gujrat.

19 10.07.2009 The Katkol Co-op Bank Ltd., Katkol, Karnataka.

20 08.09.2009 Surendranagar Peoples Co-op Bank Ltd., Surendra

Nagar, Gujrat.

21 26.10.2009 Suvidha Mahila Nagarik Sahakari bank Maryadit,

Hoshangabad, Madhya Pradesh.

22 12.11.2009 Shri Kamdar Sahakari Bank Ltd., Bhavnagar, Gujrat.

(Source: web site of Reserve Bank of India)

Table 1.4 and 1.5 indicates that in all, The Reserve Bank of India has cancelled the

license of 46 UCBs during this short period of 30 months. This statistics is

definitely shocking and certainly demands more attention to further study on

priority basis.

9

1.3 Impact of failure of UCB on the society:

1.3.1 Failure of any UCB has direct impact on the financial health of the society. It

not only disturbs the society where the particular bank is operating but also the

entire co-operative banking movement. Civilians as well as customers get shock on

getting this type of news. It generates negative waive and impact throughout the

country and reflect on the other well managed UCBs also. The depositors of failed

banks are affected the most.

1.3.2. Depositors suddenly find it difficult to get back their hard earned money that

they deposited with trust with the failed bank. In India, people save money with

some future plans. Middle class and upper middle class people in the society do not

believe in borrowing money for expenses. Instead they prefer to cut the expenses

in early stage of life and try to save money for the future requirements such as

construction own house, purchase of vehicles, purchase of luxurious household

items, education of children, marriage of children, medicines, medical treatments

etc. Dreams and Risks associated with the life are the key drivers behind this

saving which gets vanished when any bank fails to return the money to depositors.

It also becomes sentimental issue. Depositors find that their dreams are

disappeared and they are now exposed to various risks of life which they would not

be able to manage. This low confidence spreads like fuel in the fire.

1.3.3 After the independence, India was having regulated economy for very long

time. The Regulator of banking system while fixing interest rate structure used to

ensure that adequate „Interest Spread‟ is maintained. In the regulated interest rate

regime, banks were automatically making profits and they were exposed to limited

risks. Due to this the banks in India gained high degree of confidence in the

society. People at large were not aware of risks associated with the nature of

business undertaken by the banks. In India, it was out of imagination of the

depositors that a bank can fail. After 1992 the situation changed dramatically. India

10

adopted globalization policy and Regulator slowly pushed the entire banking

system towards deregulated interest rate regime4.

During this period financial

markets in India grew at vary rapid pace. Lot of new instruments were introduced

in Indian financial markets making its nature very complex. Commercial Papers,

External Commercial Borrowings, Global Depository Receipts, American

Depository Receipts etc. are few to name. During this period technology also has

developed very fast. Use of computers coupled with the advanced

telecommunication facilities changed the face of Indian Banking system. All these

developments resulted in more integration between Indian financial markets and

global financial markets. Indian banking system is now exposed to more risks

compared to the period of protected economy. However, the mentality of Indian

society has not changed at same pace. This mismatch creates many problems when

banks fail in India. In developed countries the depositors are aware of the risks

associated with the banking business. They are aware of safety parameters. The

Regulators are compelling banks to share financial information in more transparent

manner enabling the depositors to take their decisions of depositing money in

banking system more accurately.

1.3.4 Many times it is observed that the Board of Directors of failed banks blame

the Regulator for its policies and the Regulator blames the Board of Directors for

its implementation. Further, the legal procedure in India and overlapping

provisions of different acts makes the merger / take over very complicated.

Depositors of the failed bank find themselves absolutely helpless and frustrated.

----------------------------------------

4 Umesh Inamdar, „Jindagi-Deyata Vyavasthapan Aani Jokhim Vyavasthapan‟, 2nd ed., 2006, p57

11

1.4 Historical Develoments – Reforms: 5

1.4.1 It would be more appropriate to study some of the reforms undertaken during

the liberalization period and how these reforms have created impact on the

environment of banking industry in India, more specifically the UCB sector.

1. Entry of Private Sector Banks: Prior to the Nationalization of banks

in the year 1969 India was having private sector banks in existence.

These banks were doing good business. However these banks were

focusing only in developed and semi developed areas. Large part of

rural India was denied banking services. Hence, the Govt. thought it

good to make these banks „Nationalized‟ and to implement its social

welfare schemes through these banks. Without going into the details of

positive and negative aspects of this decision it is important to note that

this decision has certainly developed network of branches though out

the country. Thus, private sector banking was not new to Indian

banking system but the time gap of around 25 years made it cause of

concern.

In response to the new liberalization policy of the Government, when

the Regulator started issuing licenses to the Private sector banks this

time, the situation was totally different. Because of the development in

Capital markets these banks could collect huge amount of capital from

equity markets in India. This huge capital facilitated these banks to

introduce latest high class technology and to employ qualified

professional staff. Both these aspects improved customer service in

Indian banking dramatically. Further, the huge capital base and

advanced technology placed these banks to an advantage position to

access low cost foreign funds. This helped them to keep its cost of fund

at very low level. As a result, these private sector banks started lending

----------------------------------------

5 Umesh Inamdar, „Jindagi-Deyata Vyavasthapan Aani Jokhim Vyavasthapan‟, 2nd ed., 2006, p

54 to p 59

12

money at very low rate of interest. Improved services and low rate of

interest on advances attracted not only the middle class and higher

middle class customers in the society but also large corporates. On the

basis of this strength, the new generation private sector banks

succeeded in creating their own customer base in short period of time.

2. Entry of Foreign Sector Banks: Earlier Foreign Banks use to operate

in India through their Representative Offices. Thus, these banks were

not in position to offer range of banking services. These banks were not

competitors in real term. However, things changed rapidly after 1992

when India opted for opening of the economy.

After the reforms, these banks are now allowed to operate in India at

par with other Indian banks. Taking advantage of changed scenario,

these banks also started opening their branches and offered full fledged

banking services. These banks have very huge capital base. In

developed economies the rate of return on capital is very low as

compared to the underdeveloped or developing economies. Prior to

reforms the interest rates were very high in India. Due to this reason

huge capital from developed economies started flowing to the Indian

economy. This facilitated foreign sector banks to access huge working

capital at very low cost. As a result of this, these banks also started

lending money at very low rate of interest. On the basis of huge capital

base and low cost of funds, these foreign sector banks adopted world

class technology and hired qualified staff. This could enable efficient

customer service. Like private sector banks, these foreign sector banks

also succeeded in creating their own customer base in short period of

time.

3. Entry of Non Banking Finance Companies: During the last 10-12

years the Non Banking Finance Companies have grown at phenomenal

13

pace in India. These companies are incorporated under the Companies

Act, 1956. In India, almost all leading automobile manufactures floated

non banking finance companies to finance its own vehicles. Being listed

companies on stock markets these Non Banking Finance Companies

were allowed to collect share capital from general public. Similarly,

they were also eligible for floating non convertible debentures and bank

cash credit limits for raising funds. Depending on the gradation made

by the regulator they were also allowed to accept deposits from general

public. In this period lot of Non Banking Finance Companies got

registered for providing financial services.

Access to raise funds from capital market and acceptance of fixed

deposits from general public helped these Non Banking Finance

Companies to garner substantial funds for the purpose of lending. These

Non Banking Finance Companies were competing with Banks in

mobilizing deposits and distributing credit. However, due to the failure

of some of the large Non Banking Finance Companies in subsequent

period of time, banking industry got some relief. It is the fact that for

some period of time when these Non Banking Finance Companies were

doing very well they created pinch to the banking industry.

4. Deregulation of Interest Rates: Till 1992 the RESERVE BANK OF

INDIA used to administer the Maximum Interest Rates on Deposits and

Advances. Thus, most UCBs use to offer maximum rate on deposits as

permitted by the Reserve Bank of India. Similarly, these UCBs use to

charge maximum interest rate on credit as permitted by the Reserve

Bank of India. Hence, there was no competition in real sense. The

Reserve Bank of India use to take care of maintaining adequate spread

for running the UCBs in profit. Since 1992 the Reserve Bank of India

started administering Minimum Interest rates on deposits and advances.

Most of the UCBs also changed their strategy and started offering the

14

same rate on deposits as permitted by the Reserve Bank of India and

charged the same rate of interest on credit as permitted by the Reserve

Bank of India. Therefore, there was no real competition. The Reserve

Bank of India use to take care of maintaining adequate spread for

running the UCB in profit.

In short, though the Reserve Bank of India changed its strategy from

administering maximum interest rates to minimum interest rate it has

not affected the UCBs in big way.

However, the move of deregulation of interest rates and allowing the

Board of Directors to set the interest rates for the bank created trouble

for some of the banks in urban co-operative banking sector. The UCBs

by virtue of their nature are supposed to be local banks. They are

expected to cater the banking requirements in the local area. The level

of operations is also supposed to be low. Obviously, the profit as well

as availability of professional staff is also to be low. The members of

the Board are also supposed to be elected members from the

shareholders and not necessarily having background of banking,

economics or commerce. Prior to deregulation of interest rate, these

banks were working in an environment which was as good as protected

environment. Barring few professionally managed UCBs; most of other

UCBs never hired skilled personnel, never looked critically at the

fundamentals of banking, never tried to implement systems and

procedures, and never had professional approach like commercial banks

in running the business. It is very unfortunate that some of the UCBs

were unable to understand the basic mechanism for pricing the various

products. Some of the UCBs even failed to calculate the cost of fund.

Under such circumstances when the Reserve Bank of India deregulated

the interest rates these banks were left with no choice but to copy the

interest rate structure offered by other banks in the area.

15

Over the period of time, the Reserve Bank of India and the Registrar of

Co-operative Societies of the state have issued various directives

thereby educating UCBs on various aspects of banking.

Further, the system of Prime Lending Rate and now P.L.R. (-) are also

key factors. The Regulator has slowly pushed the entire banking system

towards deregulated regime.

5. Introduction of Uniform Practices for standardization of financial

statements: During the period of reforms the Reserve Bank of India

introduced uniform practices in financial accounting system of banks

operating in India. These changes were introduced for bringing greater

Transparency in published Financial Statements. Earlier each bank used

to have its own system of finalizing annual accounts. As a result, the

depositors / investors were finding it very difficult to assess the exact

financial status of the bank. In short, prior to the introduction of these

uniform practices the published financial statements of banks in India

were not representing the true financial position of the bank or they

were not transparent in real sense. Initially, these changes were made

mandatory for the scheduled commercial banks and over the period of

time such changes were also made mandatory for the co-operative

sector banks. Introduction of Income Recognition and Asset

Classification norms (also popularly called as N.P.A. norms or IRAC

norms in banking industry) can be considered as the best example. Prior

to the introduction of N.P.A. norms banks in India used to debit interest

to the borrower‟s account and made equivalent amount of credit to

bank‟s Profit and Loss A/C. As a result the figure of advances used to

go up and figure of profit also used to go up. These banks were not

worried to confirm whether the interest debited to the borrower‟s

account is subsequently recovered or not? If the interest is not

recovered subsequently, it means the figures published earlier were not

16

correct. In some cases, the Auditors also used to write some objections

in their note to account with small asterisk.

Similarly, prior to these norms the banks were not keen to ensure the

recovery of installment of term loans on time. As a result, the quality of

advances made by the bank was very difficult to judge. All these

anomalies in published financial statements are now removed by the

Regulator. With the introduction of N.P.A. norms now there are set

parameters about accounting standards. Now the banks can credit

interest income only as per norms set by the Regulator. Further, the

advances portfolio is to be classified in to two categories i.e.

Performing Assets and Non Performing Assets. This facilitates the

investors / depositors to judge the quality of advances made by the

bank. In addition, the bank has to make the Provision for Non

Performing Assets depending upon the age of default. All advances are

now classified in to four categories. I.e. Standard, Sub standard,

Doubtful and Loss. Depending upon the classification, the rate of

provision will differ from 0.25% (in case of Tier – I UCBs) and 0.40%

(in case of Other UCBs) to 100% except in case of advance to

agriculture and small & Medium enterprises where flat rate of 0.25% is

applicable. The definition of classification is also very clear. Same is

the case with Investment portfolio. Investments appear on the asset side

of the Balance Sheet. Considering the mandatory nature of investments

(S.L.R. securities) and other investments the Reserve Bank of India has

standardized the norms of classification of investments, its provisions,

its accounting etc. It has also made it mandatory for the banks to

publish the purchase value, market value of the investment portfolio

and provide for the depreciation on „Mark to Market‟ basis.

In short, introduction of these uniform practices in accounting system of

banks has made their Balance Sheet more transparent.

17

6. Introduction of norms for strengthening the financial health of

banking system: During the period of reforms, the Reserve Bank of

India introduced many new concepts that are aimed to strengthen the

financial health of the banks operating in India. Based on the papers

received from the BASEL, the Reserve Bank of India formed various

committees to study its implementation in India. Narsimhan Committee

– I, Narsimhan Committee - 2, are the few examples. Banking and

Insurance are two businesses where Capital Gearing ratio is very high.

Capital of Banks or Insurance Companies are very small as compared to

its business turnover. Hence, these companies are always exposed to the

risk of inadequate capital. During the period of reforms the Reserve

Bank of India introduced new concept of Capital Adequacy norms,

Concept of „Marked to Market‟ valuations. In phased manner the

regulator made it mandatory to fulfill higher norms of capital adequacy.

It started in 2002 from 7% of risk weighted assets to presently 9% of

risk weighted assets. Considering various risks in globally connected

environment, the Regulator has suggested for strengthening the capital

base of banking industry in India. Further, for understanding the legal

complications in recovery, the new Securitization Act was also

introduced. In short, the Reserve of India took many steps for making

banking system financially more strong.

7. Reforms in various financial markets in the economy: There are

many financial markets in Indian Economy. I.e. Capital Market, Debt

Market, G-Sec Market, Foreign Exchange Market, Money Market etc.

Reform in these markets also had an impact on the Indian banking

system. Prior to reforms, the numbers of players in these different

markets were limited. They were not allowed to play in all markets. The

numbers of instruments available were also limited. But after the

reforms things changed dramatically.

18

Earlier, the corporate sector of India was heavily depending on

Domestic Financial Institutions for term loan purpose and on banking

system for working capital purpose. Reforms related to capital market

made big changes. Developments in Capital Market gave birth to new

instruments such as Commercial Paper, Non Convertible Debentures,

American Depository Receipt, Global Depository Receipt and External

Commercial Borrowings etc. Indian corporate world with

fundamentally sound financial back ground slowly shifted to these new

instruments to meet their financial requirements. As a result, domestic

financial institutions and nationalized sector banks lost assured business

of Indian Corporate Sector. At the same time entry of Private Sector

Banks and permission to Foreign Sector Banks to operate on full scale

increased the competition among the banks in India. Banks from these

three sectors i.e. Nationalized, Private and Foreign, shifted their focus

to common man. Considering the large number of population these

banks started lending to individuals for construction of houses,

purchase of properties, purchase of vehicles, and unsecured loans for

consumption purpose. Before reforms the business of common men was

supposed to be the assured business of UCBs. Unfortunately, UCBs

could not succeed in competing with these giant banks due many

reasons, i.e. high cost of fund, lack of efficient customer service, lack of

product range, lack of professional management etc.

8. Reforms in the Telecom and Information Technology sector: Prior

to the reforms, Indian banking industry was labour oriented industry.

Lot of man power was being used to complete the routine work. All

accounts were maintained manually with the help of various ledgers.

Every month all ledgers were tallied manually. Even the daily Trial

Balance and other head office returns were done manually. Head office

used to collect all information from various branches, various

departments and regional offices. Then these statements were

19

consolidated and were placed before Board of Directors of the Bank.

All these procedures used to take long time. The Board of Directors of

the bank used to know the real picture of bank‟s financial position after

a very long gap. Calculation of Interest on various deposit schemes and

on various credit schemes were other labor oriented exercise. Since, all

these work were done manually chances of mistakes were higher.

After 1992 during the process of reforms, lot of technological changes

took place in telecom industry and during this period computers were

introduced in banking industry for the first time. Both these

developments changed the entire face of Indian Banking Industry.

Routine and repeated type of work such as maintenance of accounts,

tallying the accounts, calculation of products for interest and its

application in individual deposit and credit accounts, preparation and

submission of various returns etc. are now shifted to computerized

system and slowly Indian banking industry shifted from labor oriented

industry to technology oriented industry. The available manpower is

now being used for more productive purposes. Use of computer also

reduced the possibilities of mistake in repeated and routine work. With

the use of information technology the banks could introduce new

products such as Automated Teller Machines (ATMs), Credit and Debit

cards etc. As the developments in telecommunication system

progressed, banks in India introduced internet banking facilities. With

this, now customers need not come to bank for any of their work. Now

customers can check their accounts by sitting at home, can pay various

bills by transferring funds by using internet banking; can withdraw

currency by using ATM card from any outlet of the bank. Even for

taking loan from bank, representative of the bank can be called to the

place of borrower at convenient time. All these things changed the

scenario of Indian banking industry. More specifically, the customer

service has improved remarkably due to use of telecommunication and

information technology.

20

Development in the telecom sector along with information technology

undoubtedly helped in improving customer service but due to high

initial investment cost, only Private and Foreign Sector banks could

afford it. The banks from the nationalized sector also took longer time

to adopt this new technology. Now UCBs have also realized this

importance. Unfortunately, barring few fundamentally strong UCBs,

others have failed in this area due to inadequate capital and expertise.

1.4.2 Whatever the fact may be, when there is discussion on the subject of failure

of any UCB, these reforms are usually blamed. Top officials of failed banks

generally attribute the failure to increased competition, inability to get adjusted

with the environment of deregulated interest rate, additional requirements of

provisioning due to new directives issued by Regulator to have uniformity in

accounting system, inability to understand the mechanism of integrated markets

and inadequate own funds to introduce latest technology as a whole. It is general

feeling that combination of one or more of these key factors are responsible for the

failure of any UCB.

1.5 Whether the defence of failed UCBs is logical?

1.5.1 The public at large agree to the defenses put forward by the management of

failed bank as stated in para 1.4.2 However, the detailed study of these reasoning

does substantiate it.

1.5.2 The first and the most important factor of growing competition itself is

questionable. The UCBs are in existence for last 100 years and they have adequate

experience to deal with the competition. The competition was in existence in past

also. Further, in the same area of operations some UCBs have performed well and

some have failed. Hence, this defense is not very much acceptable.

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1.5.3 The second most important defense of higher provisioning on account of Non

Performing Assets, depreciation on Investment portfolio on „Mark to Market‟ basis

etc. have resulted in loss. It is acceptable that these are new directives issued by the

Regulator. In earlier days also UCBs used to make provision on account of

possible default by borrowers. Earlier it was called as „Provision for B.D.D.R.‟.

The only difference is earlier it was not related to the age of non performing assets

and non charging of interest on accounts. The purpose of these new directives is to

make banks financially strong. In earlier days also it was mandatory for the banks

to transfer 25 per cent of its net profit to Reserve Fund. Even today banks are

required to transfer 25 per cent of its net profit to Reserve Fund after making all

provisions. Hence, it is not totally a new concept.

1.5.4 The third most crucial aspect of inability is to understand various integrated

markets in the economy. It is acceptable that with the use of latest technology and

various reforms in the financial sector various markets in the economy are now

more integrated. However, careful review at the nature of business undertaken by

UCBs it has been revealed that these banks do not have their presence in all

markets in the economy. Till recent times only two UCBs were granted license of

„Authorized Dealer‟ category in Foreign Exchange by the Reserve Bank of India.

However, these banks are not allowed to make investments in capital / equity

markets. In Maharashtra State the Money Market is active only in Mumbai. Many

of the UCBs do not have any branch in Mumbai. These UCBs are connected only

to the G-Sec market and to some extent Money Market through Maharashtra State

Co-operative Bank Ltd., Mumbai, the Apex Co-operative Bank of the State. Thus,

with careful analysis this argument also does not appeal very much logical.

1.5.5 The fourth significant factor is inadequate capital to introduce latest

technology. This defense is agreeable to some extent but could not be the reason

for the failure of bank. In fact, inadequate capital has been the problem for most of

the UCBs for very long time. Till 1960‟s the motive of urban banks was not to

22

make profit. In fact, these banks were expected to do the business on „No Profit No

Loss‟ basis. This trend has slowly been changed over the period of time. This

thinking was also changed from „No profit no loss‟ basis earning profit for long

term viability and survival. In today‟s competitive banking environment, the bank

offering good products and services will survive. Technology driven banks are

definitely poised at much better position in this regard. This factor holds good only

in urban areas. Most of the UCBs have business operation which is restricted to the

rural or semi urban areas. Whether the customers in these areas need technology

driven banking? The state of Maharashtra is the leading state in the urban co-

operative banking field. It is observed that barring Mumbai, Pune and some part of

Nasik, Nagpur and Aurangabad, the customers of the remaining parts of

Maharashtra do not rate banks on the basis of its technology. Customers in the

rural and semi urban areas still hesitate to enter technology oriented banks for the

obvious reason that they are not well conversant with it. Therefore, this defense

could not be considered as logical one.

1.5.6 The fifth most important aspect that points out finger at Regulator. Many

times the Regulator is blamed for its policies and its essentiality in urban co-

operative banking field. Decision to deregulate the interest rate is also one of the

crucial factor. The Regulator is expected to strengthen the financial position of the

banks in India. Urban co-operative banking is integral part of Indian Banking

system. The Regulator has already made announcement that by the year 2010, it

would open doors for foreign sector banks in India in big way. It would also

implement Basel-II norms which require higher capital adequacy norms. Making

provisions for standard assets, increasing the rate of provisioning on Non

Performing Assets and relating it with the age of N.P.A., making investment

portfolio „Marked to Market‟ and asking banks to make provision for the

depreciation in the investment are the major steps taken by the Regulator to make

these UCBs financially strong. In the years to come there would be no sectorial

separation in banking in India. All banks would be treated at par. Hence, it would

23

not be logical to blame the Regulator for its policies and try to shift the

responsibility of failure of UCB.

1.5.7 While analyzing the data of failed banks one crucial aspect that attracts the

attention is the time period in which many UCBs failed. It is worth mentioning that

the rate of failure of UCBs has gone up in recent times, especially after the

deregulation of interest rates. Till 1992 the Regulator was administering maximum

interest rates on deposits and advances. After 1992 the Regulator started

administering minimum interest rates on deposits and advances. During this period

the rate of failure of UCBs was not very significant. After that the regime of

deregulation of interest rate started with introduction of the concept of „Prime

Lending rate‟. It is observed that the rate of failure of UCBs started increasing

during this period.

1.5.8 Under these circumstances it becomes very important to find out whether

there is any co-relation between the failure of UCBs with fixing of interest rates on

deposits and advances? Fixing of interest rates is called as Pricing of Products in

banking terminology. Further, the new techniques of Asset-liability Management

and Risk Management are introduced during this period. Had these tools been used

efficiently, the result would have been different. These justifications appear more

logical.

1.5.9 Hence, the objective of study is focused on the subject of Role of Asset-

Liability Management and Risk Management in Pricing of Products in Urban Co-

operative Banks.

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1. 6. Need to change the mindset of Board of Directors:

1.6.1 In this highly integrated globalized world, India cannot keep itself away from

the rest of the world. Developments in various field allows society to grow and

prosper. Change is always resisted in initial period. It always takes some time to

get adjusted and settle. Same is the case with changes in banking sector all over the

world. Central Banks all over the world are taking efforts to get adjusted with these

changes. Similarly, the policy makers i.e. members of the Board of Directors of the

UCBs will have to get themselves adjusted with the new competitive banking

environment. For this, the most important factor is to change the mindset of Board

of Directors of UCBs.

1.6.2 No doubt the reforms in many fields have taken up our country to prosperity.

Now at grass root level the members of the Board of Directors of the UCBs will

have to change their mindset and understand the fact that in the years to come there

would not be any sectorial difference. Banks from different sectors will be treated

at par. The obvious reason is the business which they undertake is the same and in

open economy there cannot be differentiation. Once agreed on this point,

remaining aspects would be easy to understand. Other aspects include level playing

field and stiff competition, acceptance of international standards and its

implementation for the safety of these UCBs. The basic risks to which UCBs are

exposed are the same risks like banks in any other sector. Therefore, these UCBs

will have to achieve the norms set by the Regulator of the country. Similarly, the

expectations of customers as regards to the services provided by these UCBs

would increase because customer would compare services of UCBs with the other

technology driven banks. Thus, the change in the mindset of the policy makers is

very important.

1.6.3 In this changed environment the Board of Directors of these UCBs will have

to manage the UCBs in more scientific way. The Regulator has time and again

25

highlighted this aspect in various directives. The members of the Board of

Directors will have to adopt recent techniques like Asset-Liability Management for

maintaining Net Interest Margin (NIM). Monitoring of NIM on quarterly basis and

making necessary changes on either Asset side (i.e. Investments and Credit) or on

Liability side (i.e. Deposits and External Borrowings) or on both the sides while

pricing the products. The banks will also have to consider the „Cost of Risk‟ while

pricing the products. Latest techniques like Risk Management will facilitate the

Board of Directors to accept the challenges in more prudent way.

1.6.4. All these aspects would help the members of the Board of Directors to run

the UCBs in profit, maintain profitability and ensure long term viability. With the

adoption of these new aspects the image of UCBs would certainly improve and

would definitely regain the confidence of general public.

1.7 Statement of Aims and Objectives:

1.7.1 The aims and objectives of this research study are to make sincere efforts to

undertake a comprehensive study of Pricing of Products, implementation of Asset-

Liability Management and Risk Management among the UCBs. The following are

the objectives of the study.

1. To find out the attitude of the Board of Directors of UCBs to face the basic

problems with regards to the Net Interest Margin (NIM), Asset-Liability

Management (ALM) and Risk Management (RM).

2. To evaluate the present system of fixing prices of various products of the

UCBs to ensure that it is capable of maintaining required Net Interest

Margin.

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3. To ascertain whether the present system of managing Liquidity Risk and

Interest Rate Risk is capable of managing them.

4. To find out whether inaccuracy in Pricing of Products is the main cause of

sickness?

5. To find out whether non implementation of Asset-Liability Management

and Risk Management are the causes of sickness?

1.8. Hypotheses:

Following are the Hypotheses of the research study.

Hypothesis – 1

The Board of Directors do not understand the concept and importance of Net

Interest Margin (NIM). Some of the banks just copy the Interest Rate structure of

other banks which may not suit their bank. This indicates that the pricing of

products is not done properly by UCBs.

Hypothesis – 2

Net Interest Margin is maintained efficiently by UCBs for managing profitability

and managing Asset and Liability side of the Balance sheet.

(In the year 2008, the Reserve Bank of India issued directive and extended the

scope of ALM to all UCBs in India)6

----------------------------------------

6 R.B.I. directive no. RBI/2008-09/175,UBD.PCB.Cir. No. 13/12.05.001/2008-09 Dated 17th September 2008

27

Hypothesis – 3

While fixing the product price, the UCBs consider the rate sensitivity of the

Balance Sheet of the Bank. Majority of the banks are not following this practice.

The Board of Directors of UCBs are unable to run these banks in profit because of

mismatch of the Interest Rates on deposits and advances which generally banks

from other sectors do perfectly.

1.9 Scope of the study:

The scope of this study has far reaching consequences. It would facilitate 1798

UCBs in India. (Excluding 24 Multi State Scheduled UCBs and 31 Scheduled

UCBs to whom concept of Asset-Liability Management and Risk Management is

made mandatory in the year 2002). The concept of Asset-Liability Management

and Risk Management are new to remaining UCBs. The R.B.I. vide its directive

number RBI/2008-09/175, UBD.PCB.Cir. No. 13/12.05.001/2008-09, Dated 17th

September 2008 issued to all UCBs made both these concepts mandatory. The first

return to be submitted under it has been made mandatory since December 2008.

These 1798 UCBs are totally new to these latest techniques. Number wise these

UBCs represent 97.03% of total functional UCBs in India. This research study

would help them to understand the importance of these new techniques. This

would also help them to ensure Net Interest Margin and long term viability. This

study would also facilitate these UCBs to understand the concept of the Risk

Management and Pricing of Products in a more scientific way. In competitive

banking environment these UCBs will have to assess the „Cost of Risk‟ and use it

while pricing the products. The research study would also facilitate these banks to

understand the technique of Management of Inflows and Outflows of funds by

using Gap Analysis. The research study would be more helpful for Grade - „III‟

and Grade - „IV‟ UCBs.

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1.10 Assumptions of the Study:

Alike other studies this study has also been based on certain assumptions which are

as under:

1. Out of 63 UCBs in the district of Pune, 41 UCBs have Head Office in Pune

Municipal Corporation area, 13 UCBs have Head Office in Pimpri

Chinchwad Municipal Corporation area and remaining 9 UCBs have Head

Office in semi urban areas. The performance of each bank varies according

to the area of operation. Rural and Urban areas have their own advantages

and disadvantages. However, for the purpose of this research study all these

UCBs are treated at par.

2. The quality of the Management of the UCBs largely depends on the quality

of the member of the Board of Directors. The educational qualification,

banking knowledge, practical experience, ability to understand the new

concepts, ability to predict about the economy and future interest rate

scenario, interpretation of the directives of the Regulator are few points on

which the quality of the Board of Directors is tested. It is likely that there

would be large difference in the quality of management of the UCBs in

Rural and Urban areas. However, for the purpose of this research study all

UCBs are treated at par. It is assumed that members of the Board of

Directors of all UCBs know the concept of Net Interest Margin, Asset-

Liability Management and Risk Management.

3. The quality of the administration of the UCB largely depends on the quality

of staff members. Staff skills will defer from bank to bank. It is likely that

the staff skills available with Mutli State Scheduled Co-operative Banks

may not match with staff skills available with single unit bank operating in

rural area. Similarly, the degree of automation, computerization differs

29

from bank to bank as these techniques require huge capital deployment.

The availability of capital or own funds depends on financial position of

each bank. However, for the purpose of this research study all these UCBs

are considered at par.

1.11 Limitations of the Study:

1. The basis of this research study is primary and secondary data. In primary

data especially, answers to the questionnaire may not be hundred per cent

correct and honest. It is observed that UCBs in Grade „C‟ and „D‟ have

hesitated to reply on certain points. Further, the replies to the questions

related with the Reserve Bank of India may not be hundred per cent honest.

As regards to the secondary data, the authenticity of the figures printed in

annual reports (though certified by the internal auditors) would not be

hundred per cent dependable. It has happened in past also that the

Inspectors of the Reserve Bank of India have totally disagreed with the

views of Internal Auditors.

2. This research study is limited only to the UCBs having registered in the

district of Pune in the State of Maharashtra. Number wise UCBs covered by

the study are 25%. The period of study is restricted to the five years i.e.

2002-03 to 2006-07.

3. The purpose of using questionnaire in primary data is in support of

secondary data. Therefore, shortcomings of information may arise due to

the limited choice of the respondents.