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The Banking Regulation (Amendment) Bill 2020, Explained

Sep 20, 2020 10:40 AM 5 min read

The Lok Sabha yesterday cleared an amendment bill granting the RBI more control over cooperative banks...thereby fundamentally altering the way these lenders would operate going forward.

To understand the significance of this legislation i.e. The Banking Regulation (Amendment) Bill, it is important to revisit the crisis that sparked it in the first place.

What was (rather, is) the ‘PMC crisis’?

A year ago, Mumbai-based Punjab and Maharashtra Cooperative (PMC) Bank was caught in dire straits due to a slew of financial irregularities and fraud allegedly enabled by the lender for years.

About 70% of the cooperative bank’s loan book was against a single borrower, a listed real estate firm by the name of HDIL. To boost lending to HDIL, PMC’s management apparently concocted several fictitious accounts, violated lending rules, and despite non-payment of dues did not classify the firm’s loans as NPAs.

When the irregularities caught the RBI’s eye, the latter stepped in, superseded PMC’s Board, placed it under “moratorium”, which also meant imposing withdrawal curbs on depositors, and the Enforcement Directorate was roped in to investigate the money laundering tresspasses.

The withdrawal curbs were particularly punitive because they affected everyone who had an account at PMC Bank, not just HDIL. Initially, the limit was only ₹1,000 ($13.6) per account, which was then raised to ₹50,000 ($680.5) (there were phase wise relaxations to ₹10,000, ₹25,000 and ₹40,000 as well) and later this year to ₹1L ($1,361). But many depositors are yet to withdraw the entirety of their deposits, one year on.

Wait...The PMC crisis is still unresolved. As are many of the crises plaguing PMC’s peers in the cooperative banking sector. But in the case of another infamous banking controversy that dominated business news the past year - the Yes Bank chaos - a bailout scheme was announced swiftly and an SBI-led consortium was conjured to salvage the private-sector lender.

PMC’s resolution wasn’t as prompt as that of Yes Bank’s. In fact, the former’s crisis continues to drag on to this day.

This brings us to question #2…


What are cooperative banks and why exactly are they not ‘designed’ for a crisis?

India has over 1,500 cooperative banks. Together, they have a depositor base of 8.6 crore and at least ₹4.84Lcr ($65.8bn) is harboured with these banks.

Cooperative banks operate similarly to commercial banks, except for five major differences:

  1. The former mainly cater to rural credit requirements, especially in the agricultural sector.
  2. Cooperative banks have a federal structure i.e. they are governed in different ways in the village and state levels. Their governance is also shared by States and the Centre. Commercial banks have no such feature - and their governance is the exclusive prerogative of the Centre (FYI: “Banking” comes under the Union List in the Constitution.)
  3. Shareholders and deposit holders are separate when it comes to commercial banks. As counterparties, they are mutually exclusive. But when it comes to cooperative banks - the deposit holders ARE also the shareholders. They are called members of the cooperative. 
  4. The shareholding structure in commercial banks is thus determined by the number of shares he/she holds. But in cooperative banks, one member (= deposit holder = shareholder) has one vote regardless of the number of shares (which is driven by amount of deposits) he may hold.
  5. The RBI has complete supervision over commercial banks. For their cooperative counterparts, however, the RBI’s regulatory powers are shared with the Registrar of Cooperative Societies, meaning the Central Bank has had to make do with indirect supervision. (For smaller cooperative banks, the RBI’s role is replaced with that of NABARD.)

This was the scenario before yesterday. But the now-passed Banking Regulation (Amendment) Bill fundamentally alters points 2, 3, 4 and 5.


What does the Banking Regulation (Amendment) Act change?

  1. First and foremost, the RBI will now have direct supervisory powers over cooperative banks. 
  2. The RBI can intervene in a distressed cooperative lender without having to place it under moratorium.
  3. Cooperative banks can now raise capital by issuing equity, debentures and other securities i.e. non members can become shareholders, which means the basic model of a cooperative bank is changing.
  4. By giving the Central Bank more powers, the amendment brings cooperative banks’ regulation further under the Centre’s supervision, as opposed to the previous dual Centre-State oversight.

Finance Minister Nirmala Sitharaman said the amendment’s primary objective was to protect the interests of the depositors, stressing that the cooperative banking sector has been suffering under considerable duress for a long time now.


What’s plaguing India’s cooperative banks?

The problems with PMC Bank are not an isolated incident in the cooperative banking sector. A growing list of these lenders have been slapped with withdrawal limits and loan and deposit regulations in recent months.

Some are particularly stressed, like CKP Cooperative Bank, whose Gross NPAs were found to be an alarming 97%.

All in all, the RBI has put as many as 44 cooperative banks under its watch this year alone.

What’s ailing these banks? As is the case with the banking industry in general, the issue of bad loans, mainly. For cooperative lenders, the Gross NPAs surged to over 10% as of March 2020 - a figure that is likely to have increased since then considering the COVID-19 lockdown and economic downturn.

But what cast the financial situation for these lenders in further doubt were (1) the issues of dual regulation, (2) frequent political interference, and (3) gross mismanagement.

To be fair, many of these problems are prevalent among commercial banks as well, but in the latter’s case the RBI has considerable powers to intervene and keep them in check. In the case of cooperatives, the banking regulator’s hands were relative tied...until now. For example, a commercial bank with a weak capital position could recapitalise by issuing equity to institutional investors. For a cooperative bank, this was naturally difficult considering only members could recapitalise by parking more deposits. Until now...

That being said, increased centralised regulation to ensure transparency can often be oxymoronic, because excessive centralisation seldom solves a problem.

Opposition MPs have also criticised the changes, saying it violates the federal governance structure and the one member-one vote system of these lenders.

Furthermore, smaller cooperative lenders such as primary agricultural credit societies and cooperative land mortgage banks have been exempted from the amendment’s purview, which is surprising because these smaller entities are plagued with more instances of misgovernance and fraud.

But clearing the air around who supervises cooperative banks, at least, is probably a step in the right direction. If nothing else, it may encourage buyers for PMC’s HDIL assets and other banks to respond to PMC’s merger requests, which still have no takers.


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