Twenty-one government owned banks. Another 21 private banks. Ten small finance banks. Six payments banks. Those are the banking entities which have received a bulk of the policy attention in recent years.
But India’s banking market is much deeper than that.
At the base of the banking pyramid is a large network of cooperative banks and societies. Among them - 1,562 urban cooperative banks (UCBs), some of which date back nearly a century and still form the backbone of smaller towns and cities.
The Reserve Bank of India now wants to give UCBs a shot at mainstream banking. Last week, the central bank said that it would allow a subset of these lenders to voluntarily convert into small finance banks (SFBs), in line with recommendations made by a committee headed by former RBI Deputy Governor R Gandhi in 2015.
While the details of the scheme are yet to be announced, the Gandhi committee had recommended that large UCBs, with a business size of more than Rs 20,000 crore, should look to convert into commercial banks if they want to expand further. Smaller UCBs can voluntarily convert into SFBs provided they meet the eligibility criteria and licensing conditions laid down by the RBI, the committee suggested.
“For a long time, it was felt that UCBs were given step-motherly treatment by the RBI,” said Usha Thorat, former RBI deputy governor. “Conditions on branch licensing and capital raising have been very restrictive, which has not allowed these entities to grow,” Thorat told BloombergQuint, while adding that the RBI’s move is a good one.
Former RBI Governor YV Reddy shares the view that UCBs should be allowed to grow.
There is trust in UCBs, Reddy said in a speech on Saturday. “Each state government should be encouraged to bring down out a white paper to promote urban cooperative banks as institutions that can expand and grow, Reddy said, while adding that these institutions could help overcome disruptions in the banking system at this juncture.
UCBs: Potential With A Past
Behind the RBI’s plan to make UCBs more relevant to modern banking is the understanding that these banking entities have potential. But they also have a past.
UCBs had over 10,000 branches as on March 2017, shows the latest data available on the RBI’s website. They had deposits of Rs 4.4 lakh crore and advances of Rs 2.6 lakh crore. Together, UCBs made a profit after tax of Rs 3,620 crore in 2016-17, the data shows. Their asset quality performance, too, has improved over the years and the gross non performing assets ratio was at just above 7 percent in 2016-17.
This network can play a wider role, the Gandhi committee had suggested in 2015.
As UCBs form an important vehicle for financial inclusion and facilitate payment and settlement, it may be appropriate to support their growth and proliferation further in the background of the differentiated bank model.Gandhi Committee Report (2015)
But UCBs have always come with their share of problems.
One key concern has been that while these entities are regulated by the RBI, they also fall under the purview of state governments. This dual control, which can allow state governments to interfere in the banking business, has been perceived to be troublesome.
UCBs, being cooperative societies, also do not follow board and management structures applicable to the rest of the banking sector, leading to concerns about weak governance. For instance, the RBI has no power to supersede the board of a UCB as it does in the case of commercial banks.
The management and financial track record of these entities has also been chequered.
At the turn of the century, the Madhavpura Mercantile Cooperative Bank in Gujarat collapsed following its dealings with stock broker Ketan Parekh. When the RBI looked deeper into these banking entities following the Madhavpura incident, it found that the sector was in poor financial health with gross NPA ratios exceeding 20 percent.
What followed was a period of strict supervision and consolidation, which, the RBI believes has paid dividends and helped bring the sector back on track.
Will The SFB Model Work For UCBs?
With UCBs looking now healthier, the RBI hopes that some of them can adopt the differentiated banking model followed by small finance banks.
At the core, the objective of these entities is similar - to provide banking services to small businesses and industries. However, the regulations governing these entities are very different.
The branch licensing policies and capital raising policies would need to be liberalised for starters, said Thorat. She highlighted the experience of NBFCs, which have seen rapid growth because they were not subjected to the restrictions faced by UCBs. “These entities can play the role that small finance banks are intended to play even better should they be managed well and encouraged to grow,” Thorat said.
On-par regulatory treatment of SFBs and UCBs would be welcome, said Bindu Ananth, chair of Dvara Trust, an organisation that works in the sphere of financial inclusion.
Conceptually, I think this will be welcomed as it will provide a level playing field with respect to regulation and supervision and also significantly ease barriers to capital raise. Also, access to refinance facilities, from institutions like MUDRA would for example, would start to be available.Bindu Ananth, Chair, Dvara Trust
Ananth, however, added that some of the larger UCBs may not fit the asset criteria of SFBs and may choose to retain their current structure. As per the RBI’s small finance bank guidelines, SFBs have to ensure that 75 percent of advances go to segments categorized as priority sector lending.
Larger UCBs may not fit that mould, Ananth points out while citing data from two of the large UCBs. Saraswat Bank, for instance, has about 30 percent of its advances directed towards priority sector lending. In the case of Cosmos Bank, this proportion is even lower at 23 percent.
Ananth suggests that these banks could be allowed to incorporate more MSME credit in priority sector loans since direct agricultural lending may not be their forte.
A conversion from UCBs to SFBs may also help these banks draw in more management talent and private capital. In this regard, the experience of the recently listed SFBs has been encouraging. SFBs like AU Small Finance Bank, Ujjivan and Equitas all trade at price-to-book multiples that are close to or above those enjoyed by traditional lenders.
Can UCBs get the same kind of response from potential investors?
Investors like the India ‘financial inclusion’’story, said Bernstein’s Gautam Chhugani.
They find the market has significant headroom and some of the ‘Inclusion’ focused banks have cracked the microfinance and micro enterprise lending model. So, in general Institutional investors have warmed up to the potential of the theme and, of course, some of the small finance banks are well run, backed by private equity funds in the past and have a previous track record that makes them attractive.Gautam Chhugani, Senior Analyst - India Financials, Sanford C. Bernstein.
In contrast, the past track record of UCBs may lead to tempered investor interest in comparison to SFBs. "UCBs have not really been known for good governance and innovative business models. SFBs so far have done well on both,” Chhugani said.