Eroding Faith and Failed Regulation – The Saga of Urban Coop Banks
Financial institutions are in disarray due to a serial fraud perpetration, whether commercial banks or cooperative banks. Serious fraud investigations have invariably taken such long time that makes the system forget about the result and consequence of investigation with impunity. Thanks to Moneylife this time, the Punjab & Maharashtra Co-operative Bank (PMC Bank) fraud is exposed in public with a view to bring relief to the otherwise hapless numerous depositors and other stakeholders. 
 
Urban cooperative banks (UCBs) are just primary credit societies (PCS) in the lexicon of cooperatives. These PCS get converted to ‘banks under certain conditions and the Reserve Bank of India (RBI) provides them license. The joke of whole regulation commences from the stipulation that it is enough to have just a lakh of rupees to get such license!! The rule remains unchanged for decades. How can one expect stability of an institution termed as bank with such ridiculous level of capital? 
 
Several of these societies, when converted, work like community banks or family-controlled and family owned banking institutions with an apology of governance and with least regulatory interference. It has become fashionable for both the state government and RBI similar ‘to pot calling the kettle black’ when anything untoward happens with these institutions. Finally, both of them get away putting the depositors to untold suffering. 
 
UCBs have come to occupy a firm place in the financial system holding nearly 10 crore deposit accounts of which around 18 lakhs are no-frill accounts and nearly 3 crore loan accounts just in urban and metro areas. They lend for all the activities that the commercial banks do with low penetration in foreign exchange and exotic financial products like the derivatives. 
 
“It is, therefore, necessary that the UCBs emerge as a sound and healthy network of jointly owned, democratically controlled, and ethically managed banking institutions providing need-based quality banking services, essentially to the middle and lower middle classes and marginalized sections of the society.” (RBI Vision Document, 2005) 
 
Their heterogeneity in terms of geographical spread, restricted operational area, size or performance has potential for systemic risks that need to be insulated without sacrificing the cooperative character. 
 
There are strong Banks with good leadership following cooperative principles in letter and spirit like Visakha Cooperative Bank that has become multi-state after the Andhra Predesh state bifurcation with 38 branches and Gayatri Coop Bank, Jagtial that recently took into its fold a weak Samatha Mahila Bank at Dilshuknagar in Hyderabad. There could be a few more in other states. These few demonstrate that UCBs have a purpose to stay with confidence and inspiration for a good future. 
 
This is the right time to clean up the system. What needs to be done has to be done quickly. Regulatory intransigence has to be tackled firmly. 
 
Threshold Remains Same for Decades
 
Marathe Committee and Madhavarao Committee set up by the RBI have mentioned the need for raising the ridiculously low level of capital required for such UCB. But why did not the RBI raise the threshold for decades is a matter for introspection. No wonder year after year, state after state, are throwing up frauds with the PMC Bank joining the fray, a couple of months ago. 
 
Andhra Pradesh, Maharashtra, and Gujarat yester years and Punjab the latest are top of the five states of UCB concentration in throwing up fraudulent UCBs. Telangana has to its share 52 UCBs of which 40 are in twin cities alone. There are still primary societies that hold unsustainable deposits of over Rs1,500 crore and yet not converted into banks! 
 
This should happen despite a regular call to the registrar of cooperative societies (RCS) from RBI calling for particulars of societies that hold deposits of that size!! 
 
 
A look at the Trend and progress of Banking (RBI) December 2019 reveals the dubious strength of the UCBs, particularly after consolidation efforts.
 
Liquidation proceedings of the closed banks is left to the Registrar of Cooperative Societies (RCS). A person of the cadre of Dy. Registrar or Joint Registrar is appointed by the RCS and the cost of this officer – all salaries and perks – is debited to such Bank. If the liquidation proceedings are finalized, a post is abolished and therefore, the official keeps on postponing selling off the assets and making over the proceeds to the clearance of all dues to the depositors. 
 
From the day liquidation proceedings are issued, RBI washes off its hands. Krushi UCB, Charminar UCB, A.P. Prudential UCB, Tandur Mahila UCB, Vasavi, Gokul in Telangana from 2001 to now are those where the assets are yet to be disposed of. They have own premises in prime localities in twin societies that fetch a fortune to settle majority of the dues. This does not just happen because of the eagle eye of either a politician or RCS himself for some period to grab it for a song!! The song failed to reach the ears for years. 
 
Memory may have faded for a few. During demonetization and post demonetization UCBs harboured many depositors, whose origin was suspect but went fully protected. Necessity of UCB like structures was felt more in situations of distress than when all things were right and this position was exploited by errant directors and unprofessional management. 
 
Fit and proper criteria in the appointment of both directors and chief executives (CEOs) was sacrificed. Who else but RBI were to take the blame?
 
Looking at the data of RBI 2018, UCBs in the aggregate have just Rs483 billion but a deposit base of Rs4,565 billion. Investments, loans and advances together constituted nearly Rs4,303 billion! RBI extols the balance sheet position of the UCBs! Who is at risk except the depositors who do not have voice in the credit committees, risk committees, and the board?
 
The UCBs have put the technology in place in good measure; going ahead fast in implementing core banking solutions; and building capacities to cope with the technology changes. But they are far inadequate in tackling the risks associated with such technological changes and about credit, market and operational risks.  
 
Professional competence is a casualty. They have been enjoined upon to become member of one or the other registered Credit Information Companies. Now they should assign 2.5% additional risk weight towards covering market risk. They should assign a risk weight of 100% against foreign exchange and gold and should build an investment fluctuation reserve up to a minimum of 5% of the investments held in held for trading and available for sale categories. These changes require continuing efforts in education, training, research and communication across and within the organizations. 
 
There were number of occasions when the regional office of RBI recommended deterrent action that was promptly rescinded by the central office that shows the power of the directors and interested politicians of the UCB on one side and the top regulatory official holding such position for decades!
 
Year after year, inspections by the RBI and audits by RCS and chartered accountants (CAs) winked at the misdemeanors and frauds of directors!! 
There are certain community-owned banks where the RBI inspection staff dare not enter. 
 
Net interest margins (NIMs) were always under pressure. The axe must surely fall on them from the origin of the fraud date if the system needs a remedy. If the fate of PMC Bank were not to be similar, the highest court should give a ruling fulling examining regulatory failures.
 
Several community savings banks in the US that are on par with our UCBs collapsed not because they did something wrong of the magnitude of the Wall Street Investment Banks, but because of their being part of the larger payment and settlement systems. 
 
In India, we could stall the size of damage because of the strong muscle of the regulator but could not escape the shadow. The reason is simple: Globalisation takes away as much benefit as it gives. 
 
UCBs that are growing in size due to mergers and acquisitions, and diversification of business in India, would be part of the overall financial system. The swings in the growth of UCBs have the potential of causing systemic risks. 
 
Pope Benedict XVI, in his June 2009 "Charity in Truth" encyclical, noted the misuse of financial methods that "wreaked such havoc on the real economy." 
 
He added, "Financiers must rediscover the genuinely ethical foundation of their activity, so as not to abuse the sophisticated instruments which can serve to betray the interests of savers." 
 
If there was a worry that conversation was not happening in regard to the disconnect between ethics, values and banking between the Wall Street and Main Street, the same worry would descend on us ere long.
 
The glue that holds markets together is a sense of trust and self-regulation among the participants, Lawrence Baxter, a former top executive at Wachovia said in a recent speech in Johannesburg, South Africa. "Mutual understanding endures only on the basis of a deep and widespread commitment to moral integrity within a market," he said. "So even though it has lately been unfashionable to focus on market morality and ethics, we ignore the moral dimensions at our own peril." 
 
Baxter points out that Adam Smith, the 18th-century economist, wrote an ethics book, "The Theory of Moral Sentiments," years before he wrote his famous free-market manifesto, "The Wealth of Nations." 
 
There is also a push for banking to become a smaller, simpler, less-profitable industry. Banking's original purpose was to take in deposits and make loans so that the rest of the economy could function, but it became an industry focused on making profits for itself through esoteric products with questionable usefulness. The future of UCBs is here.
 
The Committee on Financial Stability Assessment 2009 (p30) assessed Basel Core principles in respect of UCBs and the position has not changed substantially despite consolidation that followed:
 
 
The above analysis clearly indicates that the UCBs are mostly non-compliant on risk management. Fundamentals of risk management prescribe that a risk culture should spread in the entire organization and not limited just to either compliance or Board purview. 
 
The experiment of TAFCUB revealed that the over-debated issue of regulatory overlaps has been resolved to mutual satisfaction. Even Rating mechanisms have also undergone changes. The revised CAMELS rating will be applicable to UCBs with Rs100 corer deposits and above and a revised simplified rating version thereof would be applicable to UCBs with deposits of less than Rs100 crore. 
 
Potential for systemic risk
 
UCBs have the potential for exposing Indian banking to systemic risk when they fully fall in line with the mainstream banking and open channel banking.  
 
McKinsey’s survey of wholesale banking in Asia observes that the wholesale banking space would be gobbled up by the commercial banks as they would found it to be within their technology reach and cost effective. 
Retail banking space would be available for the cooperatives of all hues, regional rural banks, micro credit institutions and non-banking finance companies (NBFCs). This space is not small and unprofitable but certainly not as comfortable and as cost-effective as the wholesale banking that would have global reach. 
 
Exploiting this space, however, requires that the risk capabilities of UCBs need to be professionalized and strengthened. Their products should be subject to stress testing and resilience. The boards of UCBs should devote adequate time on these issues at least on quarterly basis. 
 
Instead of crying over spilt milk, we need to see that the glass that holds the milk does not tilt. Technology is as much a facilitator as a contributor to risk. Technology risks arise from the life of technology – both hardware and software. The more one moves close to technology, the more the banks becomes vulnerable to new risks. There must be a professionally managed Risk Management Committee in the Board.
 
The UCBs during the past few years have put the technology in place and moved fast in implementing core banking solutions. Professional competence is a casualty. They have been enjoined upon to become member of one or the other registered Credit Information Companies. Now they should assign 2.5% additional risk weight towards covering market risk. They should assign a risk weight of 100% against foreign exchange and gold and should build an investment fluctuation reserve up to a minimum of 5% of the investments held in held for trading and available for sale categories. These changes require continuing efforts in education, training, research and communication across and within the organisations. 
 
The UCBs will drive the force of retail banking, in equal measure with that of commercial banks under the influence of globalization. 
 
National Federation of Urban Cooperative Banks and Credit Societies Ltd (NAFCUB) and the state federations need to brace up with emerging challenges and reformulate their skilling, re-skilling the staff at all levels, prescribe recruitment procedures (today, most banks have appointed relatives of directors or politicians surrounding them or the relatives of the cooperative department staff) and re-engineering the Banks to cope with technology risks also that are increasingly surfacing. 
 
With the repeat occurrences of the nature of PMC Bank frauds and overleverage deliberately passed off by the regulators, they are not far from being categorised as systemically important financial institutions as per the prescriptive norms of the Financial Stability Board: It is trust that matters and the growth driven UCBs have to preserve the trust carefully.  Ethics count. Each UCB shall have Ethics Committee and Whistle Blower Committee carved out of the huge mass of depositors and other stakeholders.
 
(The author is an economist and risk management specialist. He is co-author of ‘A Saint in the Board Room’. The views expressed are personal.
Comments
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