From Madhavpura Mercantile To PMC Bank: Why Little Has Changed In Cooperative Banking

The crisis in Punjab and Maharashtra Cooperative Bank has yet again shaken the Indian banking system. Cooperative banks are much smaller than scheduled commercial banks and hence pose less of a systemic risk. But their connection to the rural masses is much stronger, so signs of weakness in these entities cannot be ignored.

The PMC Bank crisis brings back memories of similar turmoil in the late 1990s, when Madhavpura Mercantile Cooperative Bank brought on similar nightmares for depositors and regulators.

The Story Of Madhavpura Mercantile Cooperative Bank

The Ahmedabad-based Madhavpura Mercantile Cooperative Bank was established in 1968 and became a scheduled cooperative bank in 1994. In 1999, the bank started providing finances to stockbrokers, among whom was Ketan Parekh.

The stockbrokers used these funds for speculative trading, leading to losses for the bank. On the liabilities side, the bank had both depositor money and inter-bank deposits, especially from other cooperative banks in Gujarat.

That’s exactly what happened. In 2001, trouble hidden beneath the surface in Madhavpura Mercantile Cooperative Bank came to light. This led to concerns for other cooperative banks as well. On April 4, 2001, the Reserve Bank of India issued a press release asking stressed banks to borrow from scheduled commercial banks against government securities. If cooperative banks still needed funds, the RBI, as the lender of last resort, would provide special liquidity support to such banks against their eligible holdings of appropriate assets for a temporary period of up to 90 days.

The previous month, in March 2001, RBI had issued a notice restricting certain operations of Madhavpura Mercantile. RBI’s inspection revealed a plethora of horrors.

• The entire capital and reserves and 91 percent of deposits were eroded.
• Net worth was a negative Rs 1,150 crore.
• Net loss was at Rs 1,200 crore.
• Non-performing assets were at 88.2 percent of gross advances.

In August 2001, the government and the Central Registrar of Cooperative Societies decided to reconstruct the bank and placed it under a scheme for 10 years. The scheme included infusing capital, retaining deposits, improving governance, etc.

Eventually, the scheme expired in August 2011. The financials progressively worsened with NPAs at nearly 100 percent. There was a complete erosion of deposits!

In June 2012, nearly 11 years after the bank was found to be insolvent, the RBI decided to cancel Madhavpura Mercantile’s licence. The fight to recover depositors’ money continued and just last year the Gujarat Urban Cooperative Banks Federation issued a statement saying that those who had deposits up to Rs 2 lakh would get their money back.

Not One-Off Cases

While the crisis at PMC Bank has brought back memories of Madhavpura Mercantile, what is more important to remember is that these cases are not exactly one-offs. Cooperative banks have struggled for a long time now.

If we compare the NPAs of urban cooperative banks, (where the likes of Madhavpura Mercantile and PMC Bank are categorised) with scheduled commercial banks, we get a sense of the troubled history of these organisations.

After the outbreak of the Madhavpura Mercantile crisis, the NPA ratio across urban cooperative banks jumped from 12-13 percent in the 1990s to 23 percent by 2004-05. The ratio fell to 5.7 percent by 2013-14, before rising to 7.2 percent in 2017-18. In the same period, commercial banks saw their bad loan ratio fall from 16 percent to 2.2 percent by 2008, and rise to 11.2 percent by 2017-18.

Commercial banks’ bad loan ratios have risen mainly because of an asset quality review undertaken by the RBI. One would imagine that a similar exercise by urban cooperative banks will also lead to higher NPA levels.

Several Attempts At Review

It is not as if the regulator doesn’t recognise that a review of cooperative banks, starting with urban cooperative banks which are regulated by the RBI, is needed.

A number of committees have looked into the matter.

Just before the failure of Madhavpura Mercantile Cooperative Bank, an RBI committee chaired by K Madhava Rao in 1999 had raised concerns over a rise in number of urban cooperative banks and their weak financial performance. The number of urban cooperative banks had risen as licensing was liberalised following the 1991 reforms. The Rao Committee also pointed to a lack of professionalism and corporate governance, which was leading to these cooperative banks being in weak health. The committee was of the view that entry barriers for cooperative banks were low and had to be upgraded.

Following Madhavpura Mercantile's failure, and the clean-up in 2004-05, the RBI discontinued fresh licensing for cooperative banks, and entered into MoUs with state governments for co-ordination of regulatory policies governing these entities.

There were other working groups and committees on urban cooperative banks.

• In 2006-07, a working group was established to examine augmenting capital of urban cooperative banks, chaired by NS Vishwanthan.
• In 2007-08, another group, chaired by R Gandhi, was established to improve information technology systems in urban cooperative banks.
• In 2009, another such group, chaired by VS Das, deliberated on establishing an umbrella organisation for the urban cooperative banking sector.
• In 2011, a committee was formed to study licensing of new urban cooperative banks, chaired by YH Malegam. This committee noted that only 57 percent of urban cooperative banks were financially sound and one should be careful in granting new licences. It raised the entry-point norms for new players and said that all new urban cooperative banks should meet conditions related to board governance.
• In 2015, the RBI formed yet another committee, led by R Gandhi, to study urban cooperative banks. The committee noted that the these banks had higher aspirations and could be transitioned towards becoming small finance banks or commercial banks, provided they meet all the conditions laid out. In fact, the committee’s analysis showed that small finance banks, despite having more stringent capital requirements of Rs 100 crore and 15 percent capital-to-risk assets ratio, cannot do many of the activities which urban cooperative banks can, with a much smaller capital base of Rs 25 lakh.

One table in the Gandhi Committee report catches the eye. It shows how some of the largest urban cooperative banks were bigger than the smaller private sector banks. It is interesting to note that PMC Bank features in the table as the seventh largest urban cooperative bank in 2015. Within four years, its fortunes have totally reversed.

Too Big To Ignore

With everything else that has been going on in the financial sector, urban cooperative banks have not been top-of-the-mind for stakeholders. Yet, their network and size is too big to ignore.

The number of urban cooperative banks has declined from 1,872 in 2004-05 to 1,551 in 2018-19. But their assets have increased from Rs 1.3 lakh crore to Rs 5.6 lakh crore in the same period. In Maharashtra alone, 130 urban cooperative banks were merged into 72 entities.

The Madhavpura Mercantile Cooperative Bank crisis emerged from diversion of funds to stock brokers whereas the PMC Bank crisis stems from funds being funneled into a corporate group linked to real estate. It is shocking to see how closely the top management of PMC Bank and HDIL were allegedly connected.

In a way, the current crisis is not difficult to understand, as the most important recommendations of many of the groups that have studied the sector—of ending dual-control of cooperative banks and fixing governance—remain unaddressed. In fact, we have similar problems of dual control in public sector banks as well where the central government holds the cards.

Perhaps, one central lesson from the recent banking and cooperative banking crises is that the regulation has to become ownership-neutral. If we do not rectify this, we will be caught unawares each time a new crisis surfaces.

Amol Agrawal is a faculty member at Ahmedabad University. He has a PhD in Indian Banking History and writes the Mostly Economics blog.

The views expressed here are those of the author and do not necessarily represent the views of BloombergQuint or its editorial team.