RBI's Attempt To Extend Control Over Cooperative Banks Faces Pushback

Stung by the collapse of Punjab and Maharashtra Cooperative Bank Ltd. in 2019, the Reserve Bank of India embarked on an ambitious attempt to gain greater control of cooperative banks. The state legislations that these lenders function under made PMC Bank's resolution a long-drawn-out affair, leaving the government and the regulator red-faced.And so began a process of fixing a decades-old problem of dual control over these lenders. That ended in an amendment to the Banking Regulation Act in 2020, which is now facing pushback in the form of legal challenges, political resistance and some practical concerns. .The 2020 amendment was the second major attempt to give the RBI greater control over cooperative banks. The first such amendment was brought in 1965. At the time, a separate chapter was added to the Banking Regulation Act, bringing cooperative banks under the purview of the RBI.However, certain important aspects of banking—governance, capital, audit, resolution and winding up—were still kept out of the RBI's purview since it was believed that these were influenced more by the cooperative nature of the institution.Over the years, it became clear that without control over these aspects, the regulator could only achieve part of what it set out to do. The realisation hit home when a large fraud emerged at PMC Bank.And so, the 2020 amendment took the next step in the journey of greater RBI control over cooperative banks by bringing governance, capital and audit under it..The principle established by the BR Act amendment is that if you are providing banking services, the bank function comes before the cooperative society function. Hence, you are more amenable to the BR Act.NS Vishwanathan, Former Deputy Governor, RBI.With the amendment under its belt, the RBI issued a series of circulars to bring governance practices in line with the rest of the banking sector. Among them was the June 25, 2021 circular, which laid down conditions for management and whole-time directors of cooperative banks.The most contentious of these was a cap of 15 years on the tenure of the chief executive officer and whole-time directors. Another condition said members of Parliament and legislative assemblies will not be eligible for these roles.In effect, the RBI's fit-and-proper criteria now apply to cooperative banks as well, explained a person familiar with the matter, speaking on the condition of anonymity. This brings cooperative banks almost on par with commercial banks, the person added..The greater control envisaged for the RBI has been challenged in a number of courts across the country.Soon after the government moved an ordinance to bring in the changes, two cooperatives in Tamil Nadu—Big Kanchipuram Cooperative Town Bank Ltd. and the Velur Cooperative Urban Bank Ltd.—moved the Madras High Court. Hearings in the matter are continuing.Two cases have also been filed in the Rajasthan High Court. The one filed at the Jaipur bench by petitioner Dharmendra Verma argues that service conditions for the managing director and chief executive officer are governed by the bylaws and rules framed under the Cooperative Societies Act. The court, saying that the matter requires consideration, issued a stay application.The Madhya Pradesh High Court, in an order earlier this month, issued a stay on the June 25 circular in response to a writ petition filed by Mahanagar Nagrik Sahakari Bank Ltd. This petition, too, argued that service conditions were governed by the Cooperative Societies Act.This petition in the Madhya Pradesh High Court further argued that "the power to legislate in the field of Cooperative Societies falls exclusively with the State and does not lie within the domain of the Union, much less the Reserve Bank of India". It cites a 2013 ruling by the Gujarat High Court on the 97th Constitutional Amendment, which was further examined at the Supreme Court. A three-judge bench of the apex court had struck down one part of the 97th Amendment in a split verdict, as it believed that the amendment detracted from the exclusive power given to states over the management of cooperative societies under the state list of the constitution. As such, it would need ratification by states, the court held..There has been pushback beyond the legal challenges too.According to Satish Marathe, a founder member of Sahakar Bharati and a member of the RBI's central board of directors, a number of representations have been made to the regulator to review the cap on the tenure of chief executives and whole-time directors.The Sahakar Bharati, a pan-India umbrella organisation of cooperatives, has approached the RBI to reconsider the cap, said Marathe, adding that several practical aspects have to be taken into consideration. .This (cap on CEO tenures) should be done prospectively as several organisations will find it difficult to replace chief executives quickly given the localised nature of their operations. It could also result in job losses.Satish Marathe, Founder Member, Sahakar Bharati.Opposition has also emerged from Maharashtra's government, which said it would set up a committee to review the state cooperative act in light of the amendment to the Banking Regulation Act, the Times of India reported.Maharashtra has the largest concentration of cooperative banks at 494.Marathe said political parties are merely posturing. He said there should be no concern about the restriction on MPs and MLAs being appointed as chief executives or whole-time directors as this is anyway under the "office of profit" rules governing elected officials.According to the person quoted earlier anonymously, since the restriction applies only to the chief executives and whole-time directors, and not to the boards of cooperative banks, opposition to this particular provision is not justified. .Behind the arduous and decades-long journey to gain greater control of cooperative banks is the belief that these lenders still have an important role to play in the economy but that they cannot do so unless regulation and governance is strengthened. Urban cooperative banks currently hold about Rs 5 lakh crore in deposits, accounting for just 3.24% of the banking system deposits. These lenders have over 11,000 branches across the country. On the flip side, these lenders have also been the most frequent to fail. According to data from the Deposit Insurance and Credit Guarantee Corporation, claims paid out for 365 failed cooperative banks since inception amounted to Rs 5,466.9 crore. In contrast, claims worth Rs 296 crore have been paid out for 27 commercial banks. This track record has meant that the regulator has been reluctant to let the sector grow until now."Owing to lack of the desired level of regulatory comfort on account of the structural issues including ‘capital’ and the gaps in the statutory framework, the regulatory policies for cooperative banks have been restrictive," said the committee headed by former RBI Deputy Governor Vishwanathan in its report. "With the enactment of the Banking Regulation (Amendment) Act, 2020, the statutory gaps have been addressed to a very large extent."It went on to recommend an umbrella entity to help smaller urban cooperative banks grow. It also suggested a four-tiered regulatory structure based on the size of deposit base and stayed away from any forced conversion of larger lenders into commercial banks. It said these organisations should be allowed to grow in terms of branches, should they meet regulatory requirements."While there have been some challenges to the RBI's circular, there is no stay on the amendment to the BR Act," said Vishwanathan, adding that the matter is before the court. "As such, the committee went on the premise that the amendments will hold." In general, good governance should be the fulcrum, even more so in the case of banking, he said. "In light of that, the principles imposed on commercial banks and now extended to urban cooperative banks are reasonable."

RBI's Attempt To Extend Control Over Cooperative Banks Faces Pushback

Cases have been filed across several states challenging the RBI's circulars on urban cooperative banks.

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