Urban co-op banks in ICU, post- Covid

The Cooperative Credit Structure (CCS) in India is broadly made up of urban cooperatives and rural cooperatives. The urban CCS is mostly the Urban Cooperative Bank (UCB). The financial health of UCBs, numbering about 1,500, have been a matter of concern for decades, necessitating the constitution of a plethora of committees at the national and regional levels to find solutions to the myriad issues plaguing this sector.

The fragility of the UCB is likely to increase during the period following the Covid-19-induced lockdown(s), principally due to the ‘concentration risk’ such banks are exposed to. The extent of frailty can be gauged from the fact that by March-end 2020, 357 UCBs were liquidated/amalgamated/reconstructed involving a sum of Rs 4,903 crore as the DICGC claim settlement. Also, during the calendar year 2020, the RBI had issued directions to four UCBs, extended directions to 28 UCBs, cancelled three licences and imposed monetary penalties on 17. Besides, their weak capital strength may not be able to cushion the UCBs from emerging shocks.  

The question is not who controls the UCBs; if the UCBs can manage themselves efficiently, there will be increasing freedom for them.

The recommendation to set up cooperative societies to provide rural credit began with a report prepared by Sir Fredrick Nicholson, commissioned by the Madras Presidency, to study cooperatives in Germany, in the year 1892. The report submitted by him in 1895 paved the way for passing the Cooperative Society Act of 1904. The first committee to review the progress of the cooperative movement was constituted under the chairmanship of Sir Edward Mac Lagan in 1914. The committee’s findings – illiteracy and ignorance of the masses, embezzling of funds, rampant nepotism – are relevant even today. Since then, over a dozen committees appointed by the Union and various State governments, and the central bank have dissected the prevailing regulatory norms and the undulating financial health of the UCBs. Their recommendations notwithstanding, the sector continues to remain anaemic.

In February this year, the central bank appointed yet another committee at the national level, headed by a former RBI Deputy Governor, N S Vishwanathan, to formulate “effective measures for faster rehabilitation and resolution of UCBs and also assess their potential for consolidation in the sector”. The group has also been tasked with examining the need for differential regulations and charting out potential permissible activities for the UCBs with a view to enhancing their resilience.

This was preceded by the central bank acquiring full-scale supervisory authority over the UCBs through an amendment to the Banking Regulation Act, 1949 in September 2020. However, these amendments have not gone down well with the Maharashtra government (the State with the highest number of UCBs), and it has charged the Union government with demolishing the cooperative banking sector by vesting the central bank with powers to consolidate, amalgamate, etc. The Maharashtra government has constituted a State-level committee under its Minister for Revenue to protect the interests of cooperative banks in the State.

Geographical Concentration

The UCBs carry three types of concentration risk: (a) geographical concentration, (b) sectoral concentration and (c) loan size-wise concentration. At the end of March 2020, out of 1,539 UCBs, Maharashtra and Gujarat housed 712 (46 percent) of them. These two States accounted for nearly 70 percent of the total UCB branches in the country. In terms of business (deposits + advances), the two States commanded as high as three-fourths of the all-India UCB business. These States have been brutally mauled by COVID-19. A similar pattern can be observed in Karnataka and Tamil Nadu representing 25 percent of the total UCBs and 10.5 percent of the total business. Therefore, it is quite likely that in these four geographically contiguous States, the business, profitability and efficiency parameters of the UCBs must have been seriously under pressure.

Sectoral Loans Concentration

At March-end 2020, almost a third of the total advances by the UCBs were outstanding against MSMEs, a sector which has been badly affected by the lockdowns. Their revival will necessitate recapitalisation by the State, return of the migrant workers, restoration of supply and demand dynamics, and above all, speedy and widespread vaccination. Moreover, the sector is in the cusp of a major structural and compositional ‘churning’ in the post-lockdown period. It will take considerable time for the sector to make a quantum comeback, after accounting for the economic time lost. Combined with the exposure to agriculture and housing, the total outstanding of the UCBs stood at over 43 percent of the total advances.

Size-wise Concentration of Advances

At March-end 2020, 71 percent of the UCBs in the country had aggregate outstanding advances of over Rs 35,000 crore, i.e., almost 12 percent of the total advances. By contrast, just seven percent of the UCBs commanded an aggregate outstanding of over Rs 1,97,000 crore, i.e., about 65 percent of the total advances. While the former group reflected the dominance of relatively small borrowers, the latter mainly catered to large borrowers.

Both the groups potentially make the UCBs more vulnerable; while several small borrowers have lost income and employment, defaults by a few large borrowers can generate fissures. Expecting a government bail-out, many small and large borrowers would be reluctant to repay despite their capability. Perhaps, a less skewed distribution of advances across the UCBs would have been less risky.

Size and Strength

The slim net worth of many UCBs may not cushion them against the financial impact of the concentration risks if those don’t pay off. At March-end 2020, the average net worth was woefully low at Rs 19 crore for Non-scheduled UCBs (NSUCBs) compared to `361 crore for Scheduled UCBs (SUCBs). The corresponding average deposits were Rs 183 crore and Rs 4,260 crore. Therefore, there is always a lurking fear that in case a UCB goes down, its net worth may prove to be grossly inadequate to pay back its depositors.

The slim net worth of many UCBs may not cushion them against the financial impact of the concentration risks if those don’t pay off.

Further, a back-of-the-envelope calculation shows that, if during 2020-21, the GNPA amount of all UCBs increase by 57 percent, compared to 52 percent in 2019-20, and assuming the last year’s provision coverage ratio at 59.6 percent, the provisions would increase to over Rs 31,000 crore, wiping out almost 66 percent of the current net worth of the UCBs, compared to 42 percent in 2019-20.

Way Forward

Recent amendments giving the central bank more regulatory and supervisory leeway will probably encourage the UCBs to function in a disciplined manner which will not only make them future-ready, but will stem the frequent disruptions in banking activities through failures that inflict pain on millions of depositors. Besides, with the shrinkage of ‘dual’ control, the central bank will be able to regulate UCBs more directly and effectively. Consequently, a lot of the rigmarole and legal complexities will also reduce.

The financially sound ones having a diversified geographical presence, beyond a threshold balance sheet size, need to be converted into SFBs.

The evolving changes in the financial sector combining and integrating micro finance, FinTech companies, payment gateways, social platforms, e-commerce companies and NBFCs challenge the continued presence of the UCBs, which are mostly small in size, lack professional management and have geographically less diversified operations.

Most of the unit banks could be sold to those new generation banks who need to improve their footprint, if need be, by a DICGC financial bail-out. The financially sound ones having a diversified geographical presence, beyond a threshold balance sheet size, need to be converted into SFBs.

Further, there is an urgent need to review the desirability or otherwise of having a genre of banks creating confusion and doubts in the minds of depositors and obliging the regulators to persist with differential treatment. The question is not who controls the UCBs; if the UCBs can manage themselves efficiently, there will be increasing freedom for them.

(Ganga Rath is a former Chief General Manager of the Reserve Bank of India. Manas Das is a former senior economist with State Bank of India) (Views are personal)