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The RBI must bat for conversion of co-operative banks into more regulated entities

Just as they were coming to terms with the bad loan saga of public sector banks and the crisis in deposit-taking NBFCs, Indian savers have been jolted by RBI’s sudden directions on Tuesday, freezing the deposit and loan operations of Punjab and Maharashtra Co-operative (PMC) Bank. The RBI’s strictures on PMC Bank came as a surprise given that the bank’s latest audited numbers sent out no alarming signs. As per its audited accounts for FY19, PMC Bank reported comfortable capital adequacy of 12.6 per cent, a significant deposit base (₹11,600 crore) and operations spanning seven States. Though the bank disclosed a spike in its net non-performing assets to 2.19 per cent, it remained both profit-making and dividend-paying. Thus, RBI’s directions capping deposit withdrawals from the bank at ₹1,000 per account and barring it from granting new loans, making payments or accepting deposits for the next six months, have come as a shock both to its depositors and MSME customers.

Though depositors flock to co-operative banks lured by their high interest rates, these banks today represent the weakest link in the Indian banking system, with scams and failures laying low hundreds of such banks in the last decade. Initially set up to further financial inclusion, co-operative banks have failed to evolve with the times in terms of lending practices and governance structures. Lax dual regulation by the RBI and the Registrar of Co-operative Societies has led to these banks falling into a sort of regulatory no-man’s land, with prudential norms and capital requirements supposed to be set by the RBI, while management constitution, audits and distress resolution are left to the Registrars of Co-operative Societies. Large borrowers in co-operative banks doubling up as key shareholders has made for weak governance, leaving depositors exposed to misdirected lending and rampant funds diversion. Though several RBI committees have expressed their unease over the functioning of co-operative banks, reforms have made slow progress with an active nexus between bank managements and State-level politicians. But given the significant damage that mis-governance of co-operative banks is inflicting on hapless retail depositors, it is high time RBI pushed for their mandatory conversion into more regulated entities such as small finance banks. Insurance protection to depositors in these banks needs to be raised from the woefully inadequate ₹1 lakh, with insurance premiums charged to co-operative banks aligned to their high risk profile.

The RBI also has some soul-searching to do on the opaque manner in which it communicates its sudden strictures on co-operative banks to the investing public. Its latest direction on PMC Bank, while drastically curtailing the bank’s operations, offers no reasons for these actions. After slapping restrictions on co-operative banks in the past, the RBI has offered no regular updates to the investing public. In its zeal to crack the regulatory whip on erring banks, the RBI must not forget that it also owes accountability to consumers whose interests it is tasked with protecting.

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