regulation of co-operative banks in india

8/9/2019 Regulation of Co-operative Banks in India

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Regulation of Co-Operative Banks

Dr. Prashant S. Desai,

Assistant Professor of Law,

NLSIU


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• It is an important part of financial system in India.

• A sound & healthy network of jointly owned,

democratically controlled, and ethically managedbanking institutions providing need based qualitybanking services, essentially to the middle classesand marginalized sections of the society.


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• It is a financial entity which belongs to its members,who are at the same time the owners and thecustomersof their bank.

•

It provides its members with a wide range of banking and financial services viz., loans, deposits,banking accountsetc.

• It is supervised & controlled by banking authorities

and has to respect prudential banking regulations.


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•

It is retail & commercial banking organized on a co-operative basis.

• Origin of 19th century inspired by the success of theexperiments related to the cooperative movement

in Britain & the co-operative credit movement inGermany.

• Based on the principles of co-operation, mutual

help, democratic decision making, & openmembership.

• They represented a new & alternative approach toorganization asagainst proprietary firms, partnership

firms, & joint stock companies which represent thedominant form of commercial organization.


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•

They mainly rely upon deposits from members &non-members and in case of need, they getfinance from either the district central co-operativebank to which they are affiliated or from the apex

co-operative bank if they work in big cities wherethe apex bank has its Head Office.

• Co-operative banking institutions take deposits and

lend money in most parts of the world.• They are small-sized units which operate both in

urban & non-urban centres.


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•

They finance small borrowers in industrial & tradesectors besides professional & salary classes.

• They mobilize savings from the middle & lowerincome groups & purely credit to small borrowers,including weaker sections of the society.

• They have traditionally played an important role increating banking habits among the lower & middle-

income groups and in strengthening the rural creditdelivery system.


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• Co-operative banks in India are registered underthe Co-operative Societies Act.

• Scheduled co-operative banks are under closer

regulatory and supervisory framework of the RBI.• Rural co-operative banks operate mainly for the

benefit of rural areas, particularly the agriculturalsector.

• Regulated by the RBI, they are governed by theBanking Regulation Act 1949 and Banking Laws (co-operative societies) Act, 1965.


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Features of Co-operative Banking

• Customer-owned entities: not to maximize profit butto provide the best possible products & services to

its members.• Democratic member control: democratically

elected board of directors, equal voting rights.

• Profit allocation: usually allocated to constitutereserves, distributed to members through dividendor an interest which is related to the number ofshares subscribed by each member.


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Co-operative banking structure in India

Primary

Co‐operative

Credit Society

Central

Co‐operative

Banks

State Co‐

operative

Banks

Land

Development

Banks

Urban Co

‐operative

Banks


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Functions of Co-operative Banks

• To cater the needs of rural areas and small

borrowers• More concerned with the financing of agriculturists.

• Also perform the main banking functions.


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Organisational differences betweencommercial & co-operative banks

Commercial Banks Co‐operative Banks

Registered under Companies

Act

/

any

law

of

Parliament

Established under Co‐operative

Society’s

Act

Branch Banking Structure A 3 tier setup, with State Co‐

operative bank at apex level,

Central/District Co

‐operative

bank at District level, & Primary

Co‐operative Societies at rural

level

BR Act fully applicable Only some sections of BR Act

applicable, resulting only in

partial control by RBI


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Commercial Banks Co-operative Banks

Functions on commercialparameters

Functions on the principleof cooperation & notentirely on commercial

parameters.

Audited by externalauditors

Audit & inspection is doneby State Co-operative

Department & RBI

Deposits from public,borrowings from RBI being

only marginal

Rely on borrowings fromRBI at concessional rates.

Less dependency ondeposits from public.


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Required to maintainminimum ratios betweentheir balances with RBI,other cash & investmentsin approved securities &demand deposits

Maintains cash reserves &liquid assets in relation todeposits only.

Deposits may be

collected in one area &lent in other areas & theycan be shifted from onecentre to another.

Deposits raised by Central

Co-operative Banks canbe used for financingagricultural activities only.

They can invest morefreely

They have to follow therules for investments laiddown by the Registrar of

Co-operative Societies


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They enjoy morediscretion in their lendingpolicies which are

determined by their boardof directors subject to theregulations of RBI

They are to follow the loanpolicies laid down by RBI& Co-operative

Department

Rate of interest payable iscontrolled by RBI & is lessthan those payable byCo-operative banks

More rate of interestpayable.

Borrowers have no voicein the management &policies of the banks

Borrowers being members,have some say in the useof the funds


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Issues of Regulatory & Supervisory Concern

• Sharp increase in number of banks andbranches

• Large number of financially unsound banks• Steep increase in interest expenses on deposits

consequent to deregulation

• High rate of interest on deposits and advances• Adverse selection of borrowers

• Low capital base

• High exposure to real estate and other sensitivesectors


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• Lack of professionalism & management expertise

• Political interference

• Unlicensed UCBs

• Low level of computerization

• No Central recruitment - Faulty recruitment system /excess staff / poor skill up-gradation

• High operating costs

• Dual control and regulations by the RBI & respectivestate governments on UCBs leads to delay anddifficulties.


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Regulatory Issues concerning RBI

• Concerns regarding the professionalism of UCBsgave rise to the view that they should be better

regulated.• Large co-operative banks with paid-up share

capital & reserves of Rs. 1 lakh were brought underthe purview of BR Act from 1966 & within the ambitof RBI supervision.

• Beginning of duality of control over these banks.


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•

Banking related functions (licensing, area of operations, interest rates) were to be governed byRBI and registration, management, audit &liquidation, etc. governed by State Governments as

per the provisionsof respective State Acts.• Towards the late 1960s there was debate regarding

the promotion of the small scale industries. The

working group (Damry group, 1968) on industrialfinancing through Co-operative Banks attemptedto broaden the scope of activities of UCBs byrecommending these banks should finance the

small & cottage industries. Thiswas reiterated by theBanking commission in 1969.


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• The MadhavdasCommittee (1979) evaluated therole played UCBs in greater details & drew aroadmap for their future role recommending

support from RBI & Government in the establishmentof such banks in backward areas & prescribingviability standards.

• The Hate Working Group (1981) desired better

utilization of bank’s surplus funds & that thepercentage of the CRR & SLR of these banks shouldbe brought at par with commercial banks, in a

phased manner.


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• The Marathe Committee (1992) redefined theviability norms & ushered in the era of liberalization,

• The Madhava Rao Committee (1999) focused on

consolidation, control of sickness, betterprofessional standards in UCBs and sought to alignthe urban banking movement with commercialbanks.

• A feature of the urban banking movement hasbeen its heterogeneous character & its unevengeographical spread with most banks

concentrated only in some states.


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RBI Policies for co-operative banks

• RBI appointed a high power committee in May 1999under the chairmanship of Shri. K. Madhava Rao, to

review the performance of Urban Co-operativeBanks (UCBs) & to suggest necessary measures tostrengthen this sector.

• The committee identified six broad objectives:

1) To preserve the co-operative character of UCBs

2) To protect the depositors’ interest

3) To reduce financial risk


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4) To put in place strong regulatory norms at the entrylevel to sustain the operational efficiency of UCBs in acompetitive environment and evolve measures tostrengthen the existing UCB structure particularly in the

context of ever increasing number of weak banks.

5) To align urban banking sector with the othersegments of banking sector in the context of

application or prudential norms in to & removing theirritants of dual control regime.

6) RBI has extended the Off-Site Surveillance System(OSS) to all non-scheduled urban co-operative banks(UCBs) having deposit size of Rs. 100 Crore and above.


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Measures

• Separate umbrella organization is necessaryexclusively for urban co-op. banks may bedesigned on the similar lines of NABARD.

• UCBs with their unique & exclusive organizational setup will be the most effective tool for the financialinclusion of urban poor.

•

RBI has appointed a committee on licensing of newUCBs under the chairmanship of Shri Y H Malegam.


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The Committee was assigned the following

terms of reference:

• To review the role and performance of UCBs overthe last decade and especially since the adoptionof VISION document in 2004,

• To review the need for organization of new UCBs inthe context of the existing legal framework for UCBs,

the thrust on financial inclusion in the economicpolicy and proposed entry of new commercialbanks into the banking space,

•

To review the existing regulatory policy on setting upof new UCBs and lay down entry point norms fornew UCBs,


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• To examine whether licensing could be restricted

only to financially sound and well managedcooperative credit societies through conversionroute

•

To make recommendations relating to the legaland regulatory structure to facilitate the growth ofsound Urban Co-operative Banks especially in thematter of raising capital consistent with co-

operative principles;

• To examine the feasibility of an umbrellaorganization for the Urban Co-operative Banking

Sector; and• To examine other issues incidental to licensing of

Urban Co-operative Banks and make appropriaterecommendations.


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Recommendations of the Committee

• Need for a greater presence of UCBs in unbankeddistricts & in centres having population less than 5

lakh.• It is necessary to encourage new entrants to open

banks & branches in states & districts which areunbanked or inadequately banked.

• It is equally necessary to discourage new entrantsfrom opening branches in districts and populationcentres which are already adequately banked.


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• The existing well managed co-operative creditsocieties meeting certain financial criteria likeprofits, capital adequacy, NPA’s proportion etc.should be given priority for granting licenses asurban co-operative banks particularly in unbankedor inadequately banked centres.

• Its has also recommended an umbrella organization

that will provide temporary liquidity to the memberUCBs. The funds required for providing temporaryliquidity shall be mobilised from member UCBs whoshall be permitted to keep their CRRs with thisumbrella organization bank. All the non-scheduledUCBs in India shall be the compulsory members ofthis Umbrella Organization.


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•

The (BoD) will establish a Board of Management(BoM), consisting of persons with professional skills,which shall be entrusted with the responsibility forthe control and direction of the affairs of the Bank

assisted by a CEO who shall have the responsibilityfor the management of the Bank.

• RBI would have unfettered powers to control and

regulate the functioning of the UCB and of its BoMand of the CEO in exactly the same way as itcontrols and regulates the functioning of the Boardof Directors and the Chief Executive in the case of a

commercial bank.


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•

It should be made a condition of the license thatevery new UCB should be required to have a Boardof Management (BoM) to be appointed by theBoard of Directors (BoD) and a Chief Executive

Officer (CEO) to be appointed by the BoM.• While the BoD will be responsible for laying down

the broad contours of strategy, the BoM will bevested with the mandate to direct and control theday-to-day operations of the UCB within the limitsset by the BoD. At least 51 per cent of the membersof the BoM should have special knowledge or

practical experience in the matters specified inSection 10 A(2) of the B. R. Act, 1949.


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• Audit by a Chartered Accountant to be appointedby the BoM from out of a panel of approvedauditors maintained by RBI and subject to rotationafter four years.


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Umbrella Organization

• There should be two separate UmbrellaOrganizations viz. a national level organization

which provides payments and settlement servicesand other services normally provided by centralbanks as also liquidity support to its members; andone or more organizations which provide the

management, IT training and other services whichthe UCB sector needs.

• The national level UO should preferably be in the

form of a multi-state UCB with membership beingrestricted to and mandatory for all UCBs other thanscheduled UCBs.


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•

Member UCBs should be required to maintain theirCRR in the form of deposits with the UO.

• The UO should invest its funds only in the form ofbalances with RBI, deposits with commercial banks

or in SLR securities and in no other form.

• The UO should offer Repos and Reverse Reposfacilities to UCBs in the same manner as RBI offers to

commercial banks and at the same rates ofinterest. In turn, it should enjoy Repos and ReverseRepos facilities with RBI.


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• UCBs can avail of Repos facilities only to the extentof their excess SLR holdings.

• Until the Payments and Settlements facilities are

provided directly to UCBs, the UO will act as agateway to provide these services for a fee toUCBs. In turn, the UO will be a member of thePayments and Settlement System.

• Being a UCB, the UO would have a Board ofManagement and will be subject to the regulation,supervision and inspection of RBI.


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J PC recommendations

1. Strengthening of Audit:

• Concurrent audit made mandatory for all UCBs

• Audit committee of board as stated in circulars byRBI from time to time

• Audit committee to monitor for all audit functions

as also compliance with RBI inspection reports, RBIguidelines etc.


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2. Compliance to RBI Report:

• Compliance to be furnished within 6 weeks

• All defects pointed out in inspection report to be

removed within 4 months• Certificate to the effect submitted to RBI within 4

months

•

False certificate or delayed compliance to attractpenal action

• Strict penalty for non-compliance of RBI directives


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Other J PC Recommendations

• Dual control should go

• Inspection report should comment on the quality ofaudit report

• Improvement of on-site / off-site supervision

• Provisions of loans & advances to directors & their

relatives and concerns in which they are interested


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Amendment to BR Act

• Management related functions like elections,conduct of directors etc., to be with Registrar of Co-operative societies (RCS)

• Banking related functions to be with RBI

• Audit function, including statutory audit to be withRBI

• Section 56 of BR Act to be deleted


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• Make all provisions of the parent Act applicable

• Sections 10B & 10BB requiring RBI approval forappointment of full time chairman / MD

• Section 10C would enable non-member aschairman

• Serving MPs/MLAs/MLCs as also stockbrokers

banned from being a director of the bank


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Disclosure Norms

• Applicable to UCBs with deposits of Rs.100 Crore &more

• Capital to Risk Assets Ratio (CRAR), investments,advances against real estate / shares, interest ofdirectors, profitability etc., to be declared.


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97th Constitutional Amendment Act, 2011

• Inclusion of the term “co-operative societies” inArticle 19.

•

Article 243ZI of the Act provides that the State mayby law make provisions with respect toincorporating, regulating and winding upcooperative societies based on the principles of

voluntary formation, democratic member control,member economic participation, autonomousfunctioning and professional management.


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• The other important provisions of the Act, inter-alia,include:

• The number of directors in the Board of a co-operativesociety shall not be more than 21.

• The Act provides for co-option of two directors, inaddition to a maximum number of 21, having

experience in the field of banking, management,finance or specialisation in any other field relating to theobjectives and activities undertaken by the society.

• The term of office of the elected members of the Board

and its office bearers shall be five years from the date ofthe election and the term of the office bearers shall becoterminous with the term of the Board.


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• The Board of a society shall not be superseded and keptunder suspension for a period exceeding six months. Thisperiod would be one year for a co-operative society,other than a multi-state co-operative society, carryingon the business of banking. In the case of a co-operativesociety carrying on the banking business, the provisionsof the Banking Regulation Act, 1949 shall also apply.

• The accounts should be audited within six months of the

close of the financial year to which such accountsrelate, by an auditor or auditing firm appointed by thegeneral body of the co-operative society.

• AGM shall be convened within a period of six months of

close of the financial year to transact business as maybe provided by law.

I li i f UCB


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Implications for UCBs

• Supersession of Board: At present, many of the StateCo-operative Societies Acts have provisions tosuspend/ supersede the Board of UCBs for amaximum period of five years. The period will berestricted to six months.

• However, the requirement that Registrar of Co-

operative Societies (RCS) would supersede theboard of a UCB at the request of the Reserve Bankwill continue. The Board of a multi state co-operative bank, can be superseded for a period offive years as provided under section 36AAA of theBanking Regulation Act, 1949 (AACS).


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• Co-option of professional directors: Since the Actprovides for co-option of two professional directorshaving experience in the field of banking,management and finance, it will bringprofessionalism in the working of UCBs. The ReserveBank had earlier prescribed that UCBs should have

at least two professional directors on their Boards.Amendments to the State Acts in this regard willmake the RBI’s prescriptions enforceable under law.


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• Appointment of an auditor: The Act provides for

audit by a qualified auditor appointed by thegeneral body of the co-operative society from apanel of qualified auditors approved by the StateGovernment. As per the existing provisions in the

State Co-operative Societies Acts, the appointmentof an auditor is being done by RCS.

• Election of the Board: Since the Act provides thatelection of a Board shall be conducted before theexpiry of the term of the Board, the elections to theBoard of UCBs will not be postponed indefinitely.

• The Act would also increase participation by

members in the activities of the UCBs as theminimum requirement for attending meeting andutilising the services by members has to be providedby the States by law.

regulation of co-operative banks in india

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