[Manasvini Vyas is a 5th year student at National Law University Odisha]
On 26 June 2020, the Banking Regulation Act, 1949 (“the Act”) was amended by way of a presidential ordinance (the Ordinance’). The amendment seeks to bring urban cooperative banks (‘UCBs’) and multi-state cooperative banks (‘MCBs’) under the complete regulatory control of the RBI. This development assumes significance in the backdrop of the PMC Bank crisis which brought to the fore the maladies that have plagued cooperative banks for years. In 2020 alone, 44 such banks were placed under RBI supervision for violating prudential norms. In view of the same, this Ordinance is believed to provide a respite for the problems ailing the sector.
In this post, the author seeks to discuss the issues present in the sector and analyse the provisions of the Ordinance that are aimed at resolving the same.
Application of the Act on UCBs and MCBs
Pursuant to section 5(b) of the Act, “‘banking’ means accepting for the purpose of lending or investment of deposits of money from the public repayable on demand or otherwise and withdraw able by cheque, draft, and order or otherwise”. Notably, acceptance of deposits from the public is a core characteristic of banking. In other words, entities that do not accept deposits from the public would not be engaged in the business of banking and are therefore outside the scope of the Act. Keeping this in view, section 3 of the Act entirely excludes primary agricultural credit societies and cooperative land mortgage bank from its purview as they are primarily focused on providing financial services to their members only and they do not accept deposits from the public. On the other hand, the Act is applicable to other cooperative societies such as UCBs and MCBs only to a limited extent as specified in part V of the Act.
The Ordinance substitutes this provision and excludes from its scope, (1) primary agricultural credit societies and (2) co-operative societies primarily involved in the business of providing long-term finance for agricultural development. Provided that such societies do not use the word ‘bank’, ‘banker’ or ‘banking’ in their names and that they do not issue cheques to its customers.
The effect of this amendment is that it brings UCBs and MCBs under complete regulatory control of the RBI. Under the extant regime, these banks operate under dual control of the RBI and the Registrar of Cooperative Societies (‘Registrar’) established by the respective state governments or the Central Registrar established by the Central Government. The Registrar performs the administrative functions such as incorporation, registration, audit, management and liquidation of the co-operative banks. On the other hand, the RBI manages the banking related functions such as issuing banking license; issuing guidelines for loan policies, interest rates, prudential exposure norms, investments etc.; carrying out off site and on site surveillance and issuing directions to safeguard the depositors’ interests.
Over the years, various RBI Committees such as the Malegam Committee (2010) and the R. Gandhi Committee (2015) have observed that existence of dual centres of command results in overlapping of jurisdiction. This has led to significant delay in responding to occurrences of mismanagement and implementing corrective policies in the banks. The Ordinance seeks to rectify this position by extending the supervisory jurisdiction of the RBI and giving it additional powers to regulate UCBs and MCBs without infringing upon the existing powers of the Registrars.
For instance, presently the audit of these banks is conducted by the auditors of the cooperation department of respective states, unlike the audit of banking companies conducted by qualified CAs whose appointment is subject to RBI’s approval under section 30 of the Act. The Ordinance amends this and makes section 30 applicable to the cooperative banks, thereby, giving the RBI the power of exercising control over the auditor’s performance and mandating that the books of cooperative banks be audited as per norms applicable to commercial banks.
Additionally, in order to strengthen the asset-liability management in the cooperative banks, section 25 of the Act is being made applicable on them. Pursuant to this, they will now be required to maintain assets of value not less than 75% of their time and demand liabilities in India at the end of each quarter.
Further, given their small scale of operation, cooperative banks often appoint KMPs and directors who lack banking knowledge and are poorly qualified. This grossly impacts the banks’ ability to provide quality services, tap expansion opportunities and generate profits. Now that UCBs are brought under the Act, it has become mandatory for them to ensure that at least 50% of their board comprises of individuals who have professional experience and knowledge in banking, law, finance or any other allied streams. Such appointment shall also be subject to the RBI’s approval. Additionally, the RBI will have the power to supersede the board for a period up to 5 years to protect interests of the depositors after due consultation with the Registrar.
Access to Capital Market
Unlike commercial banks which are primarily concerned with profit maximisation, the principal objective of the co-operative banks is serving the interests of its members. Given this business model, their ability to raise capital is limited in order to ensure that the members’ rights are not diluted. These banks can only rely upon member shares, retained earnings or borrowed funds from the RBI, the governments and the commercial banks for financing their activities. These financial constraints jeopardize their subsistence considering that these banks face competition not only from commercial banks but also from payment banks and small finance banks.
In light of this, the Ordinance has introduced a new provision in the Act which permits the co-operative banks to access the capital market. Pursuant to this, these banks can issue, through public issue or private placement, (1) equity shares or preference shares or special shares at par or at premium, and (2) unsecured debentures or bonds or other debt instruments having maturity of 10 years or more. The issue is to be made only after prior approval of the RBI is obtained and the RBI can specify any condition or limitation that it may deem fit.
It is further provided that any person to whom shares are issued under this provision cannot demand payment towards surrendering of these shares. Also, a co-operative bank is not entitled to reduce or withdraw its share capital, except in the manner specified by the RBI.
Not only will this amendment increase the growth potential of the co-operative banks but will also inculcate a sense of discipline in the management. Raising funds in the capital markets would require these banks to follow due diligence and to comply with regulations pertaining to listing requirements, disclosure norms etc. This would compel the management to maintain a stable financial record and practice good governance.
Power to Order Reconstruction or Amalgamation of the Banks Without Imposing Moratorium
Under section 45 of the Act, a scheme for reconstruction or amalgamation can be devised only after the bank is placed under moratorium. An imposition of moratorium disrupts the bank’s operations and prevents the depositors from withdrawing cash beyond a specified amount. As a consequence of this, depositors’ confidence in the financial system is undermined and often leads to erosion in the bank’s value.
The Ordinance amends section 45 to empower the RBI to order reconstruction or amalgamation of the banks without imposition of a moratorium. This power can be exercised if the RBI is satisfied that such a scheme is necessary in public interest, or in the interest of the depositors, or in order to secure proper management of the banks or in the interest of the banking system of the country. Thus, the Ordinance has enabled RBI to restructure these banks without causing any adverse impact on the lives of the depositors.
Cooperative banks play a vital role in channelizing financial services to rural borrowers. Thus, an overhaul in the regulatory structure governing these banks will be instrumental in economic growth. The Ordinance aims to protect the interests of the depositors and improve governance. However, to say that this Ordinance will ensure that PMC-like crisis can never happen again would be an overstatement. It is true that the RBI is now given more teeth to regulate cooperative banks, however, it is pertinent to note that the RBI had always had sufficient powers for the supervision of co-operative banks such as the power to conduct off site and on site surveillance, calling for statutory/other returns etc. Yet, it failed to detect the red flags on time. In fact, even when the RBI has complete control over commercial banks, it stepped in too late in the Yes Bank imbroglio. Now, with 1540 co-operative banks brought under the RBIs umbrella, it is yet to be seen if it has sufficient bandwidth to ensure sound regulation. Even though this Ordinance is not a one-stop solution for the failing banking sector, it does mark the beginning of steps taken in the right direction.
– Manasvini Vyas