Regulation of Co-Operative Banks

Dr. Prashant S. Desai,

Assistant Professor of Law,
NLSIU

 It is an important part of financial system in India.

A sound & healthy network of jointly owned,
democratically controlled, and ethically managed
banking institutions providing need based quality
banking services, essentially to the middle classes
and marginalized sections of the society.

 It is a financial entity which belongs to its members,

who are at the same time the owners and the
customers of their bank.
It provides its members with a wide range of
banking and financial services viz., loans, deposits,
banking accounts etc.
It is supervised & controlled by banking authorities
and has to respect prudential banking regulations.

 It is retail & commercial banking organized on a cooperative basis.

Origin of 19th century inspired by the success of the
experiments related to the cooperative movement
in Britain & the co-operative credit movement in
Germany.
Based on the principles of co-operation, mutual
help, democratic decision making, & open
membership.
They represented a new & alternative approach to
organization as against proprietary firms, partnership
firms, & joint stock companies which represent the
dominant form of commercial organization.

 They mainly rely upon deposits from members &

non-members and in case of need, they get
finance from either the district central co-operative
bank to which they are affiliated or from the apex
co-operative bank if they work in big cities where
the apex bank has its Head Office.
Co-operative banking institutions take deposits and
lend money in most parts of the world.
They are small-sized units which operate both in
urban & non-urban centres.

 They finance small borrowers in industrial & trade

sectors besides professional & salary classes.
They mobilize savings from the middle & lower
income groups & purely credit to small borrowers,
including weaker sections of the society.
They have traditionally played an important role in
creating banking habits among the lower & middleincome groups and in strengthening the rural credit
delivery system.

 Co-operative banks in India are registered under

the Co-operative Societies Act.
Scheduled co-operative banks are under closer
regulatory and supervisory framework of the RBI.
Rural co-operative banks operate mainly for the
benefit of rural areas, particularly the agricultural
sector.
Regulated by the RBI, they are governed by the
Banking Regulation Act 1949 and Banking Laws (cooperative societies) Act, 1965.

Features of Co-operative Banking

Customer-owned entities: not to maximize profit but
to provide the best possible products & services to
its members.
Democratic member control: democratically
elected board of directors, equal voting rights.
Profit allocation: usually allocated to constitute
reserves, distributed to members through dividend
or an interest which is related to the number of
shares subscribed by each member.

Co-operative banking structure in India

Primary

Central

Cooperative
CreditSociety

Cooperative
Banks

StateCo
operative
Banks

Land
Development
Banks

UrbanCo
operative
Banks

Functions of Co-operative Banks

To cater the needs of rural areas and small
borrowers
More concerned with the financing of agriculturists.
Also perform the main banking functions.

Organisational differences between

commercial & co-operative banks
CommercialBanks
Registeredunder Companies
Act/anylawofParliament

CooperativeBanks
EstablishedunderCooperative
SocietysAct

BranchBankingStructure

A3tiersetup,withStateCo
operative bankatapexlevel,
Central/DistrictCooperative
bankatDistrictlevel,&Primary
CooperativeSocietiesatrural
level

BRActfully applicable

OnlysomesectionsofBRAct
applicable,resultingonlyin
partialcontrolbyRBI

Commercial Banks

Co-operative Banks

Functions on commercial
parameters

Functions on the principle

of cooperation & not
entirely on commercial
parameters.

Audited by external
auditors

Audit & inspection is done

by State Co-operative
Department & RBI

Deposits from public,

Rely on borrowings from
borrowings from RBI being RBI at concessional rates.
only marginal
Less dependency on
deposits from public.

Commercial Banks
Required to maintain
minimum ratios between
their balances with RBI,
other cash & investments
in approved securities &
demand deposits
Deposits may be
collected in one area &
lent in other areas & they
can be shifted from one
centre to another.
They can invest more
freely

Co-operative Banks
Maintains cash reserves &
liquid assets in relation to
deposits only.

Deposits raised by Central

Co-operative Banks can
be used for financing
agricultural activities only.
They have to follow the
rules for investments laid
down by the Registrar of
Co-operative Societies

Commercial Banks
They enjoy more
discretion in their lending
policies which are
determined by their board
of directors subject to the
regulations of RBI
Rate of interest payable is
controlled by RBI & is less
than those payable by
Co-operative banks

Co-operative Banks
They are to follow the loan
policies laid down by RBI
& Co-operative
Department

Borrowers have no voice

in the management &
policies of the banks

Borrowers being members,

have some say in the use
of the funds

More rate of interest

payable.

Issues of Regulatory & Supervisory Concern

Sharp increase in number of banks and
branches
Large number of financially unsound banks
Steep increase in interest expenses on deposits
consequent to deregulation
High rate of interest on deposits and advances
Adverse selection of borrowers
Low capital base
High exposure to real estate and other sensitive
sectors

Lack of professionalism & management expertise

Political interference
Unlicensed UCBs
Low level of computerization
No Central recruitment - Faulty recruitment system /
excess staff / poor skill up-gradation
High operating costs
Dual control and regulations by the RBI & respective
state governments on UCBs leads to delay and
difficulties.

Regulatory Issues concerning RBI

Concerns regarding the professionalism of UCBs
gave rise to the view that they should be better
regulated.
Large co-operative banks with paid-up share
capital & reserves of Rs. 1 lakh were brought under
the purview of BR Act from 1966 & within the ambit
of RBI supervision.
Beginning of duality of control over these banks.

 Banking related functions (licensing, area of

operations, interest rates) were to be governed by
RBI and registration, management, audit &
liquidation, etc. governed by State Governments as
per the provisions of respective State Acts.
Towards the late 1960s there was debate regarding
the promotion of the small scale industries. The
working group (Damry group, 1968) on industrial
financing through Co-operative Banks attempted
to broaden the scope of activities of UCBs by
recommending these banks should finance the
small & cottage industries. This was reiterated by the
Banking commission in 1969.

 The Madhavdas Committee (1979) evaluated the

role played UCBs in greater details & drew a
roadmap for their future role recommending
support from RBI & Government in the establishment
of such banks in backward areas & prescribing
viability standards.
The Hate Working Group (1981) desired better
utilization of banks surplus funds & that the
percentage of the CRR & SLR of these banks should
be brought at par with commercial banks, in a
phased manner.

 The Marathe Committee (1992) redefined the

viability norms & ushered in the era of liberalization,
The Madhava Rao Committee (1999) focused on
consolidation, control of sickness, better
professional standards in UCBs and sought to align
the urban banking movement with commercial
banks.
A feature of the urban banking movement has
been its heterogeneous character & its uneven
geographical spread with most banks
concentrated only in some states.

RBI Policies for co-operative banks

RBI appointed a high power committee in May 1999
under the chairmanship of Shri. K. Madhava Rao, to
review the performance of Urban Co-operative
Banks (UCBs) & to suggest necessary measures to
strengthen this sector.
The committee identified six broad objectives:
1) To preserve the co-operative character of UCBs
2) To protect the depositors interest
3) To reduce financial risk

4) To put in place strong regulatory norms at the entry

level to sustain the operational efficiency of UCBs in a
competitive environment and evolve measures to
strengthen the existing UCB structure particularly in the
context of ever increasing number of weak banks.
5) To align urban banking sector with the other
segments of banking sector in the context of
application or prudential norms in to & removing the
irritants of dual control regime.
6) RBI has extended the Off-Site Surveillance System
(OSS) to all non-scheduled urban co-operative banks
(UCBs) having deposit size of Rs. 100 Crore and above.

Measures
Separate umbrella organization is necessary
exclusively for urban co-op. banks may be
designed on the similar lines of NABARD.
UCBs with their unique & exclusive organizational set
up will be the most effective tool for the financial
inclusion of urban poor.
RBI has appointed a committee on licensing of new
UCBs under the chairmanship of Shri Y H Malegam.

The Committee was assigned the following

terms of reference:
To review the role and performance of UCBs over
the last decade and especially since the adoption
of VISION document in 2004,
To review the need for organization of new UCBs in
the context of the existing legal framework for UCBs,
the thrust on financial inclusion in the economic
policy and proposed entry of new commercial
banks into the banking space,
To review the existing regulatory policy on setting up
of new UCBs and lay down entry point norms for
new UCBs,

 To examine whether licensing could be restricted

only to financially sound and well managed
cooperative credit societies through conversion
route
To make recommendations relating to the legal
and regulatory structure to facilitate the growth of
sound Urban Co-operative Banks especially in the
matter of raising capital consistent with cooperative principles;
To examine the feasibility of an umbrella
organization for the Urban Co-operative Banking
Sector; and
To examine other issues incidental to licensing of
Urban Co-operative Banks and make appropriate
recommendations.

Recommendations of the Committee

Need for a greater presence of UCBs in unbanked
districts & in centres having population less than 5
lakh.
It is necessary to encourage new entrants to open
banks & branches in states & districts which are
unbanked or inadequately banked.
It is equally necessary to discourage new entrants
from opening branches in districts and population
centres which are already adequately banked.

 The existing well managed co-operative credit

societies meeting certain financial criteria like
profits, capital adequacy, NPAs proportion etc.
should be given priority for granting licenses as
urban co-operative banks particularly in unbanked
or inadequately banked centres.
Its has also recommended an umbrella organization
that will provide temporary liquidity to the member
UCBs. The funds required for providing temporary
liquidity shall be mobilised from member UCBs who
shall be permitted to keep their CRRs with this
umbrella organization bank. All the non-scheduled
UCBs in India shall be the compulsory members of
this Umbrella Organization.

Organization Structure of New UCBs

There should be segregation of the ownership of the
UCB as a co-operative society from its functioning
as a bank. The new organization structure shall
consist of a Board of Management in addition to
the Board of Directors.
The Board of Directors (BoD) would be elected in
accordance with the provisions of the respective
Co-operative Societies Acts and would be
regulated and controlled by the RCS / CRCS.

 The (BoD) will establish a Board of Management

(BoM), consisting of persons with professional skills,
which shall be entrusted with the responsibility for
the control and direction of the affairs of the Bank
assisted by a CEO who shall have the responsibility
for the management of the Bank.
RBI would have unfettered powers to control and
regulate the functioning of the UCB and of its BoM
and of the CEO in exactly the same way as it
controls and regulates the functioning of the Board
of Directors and the Chief Executive in the case of a
commercial bank.

 It should be made a condition of the license that

every new UCB should be required to have a Board
of Management (BoM) to be appointed by the
Board of Directors (BoD) and a Chief Executive
Officer (CEO) to be appointed by the BoM.
While the BoD will be responsible for laying down
the broad contours of strategy, the BoM will be
vested with the mandate to direct and control the
day-to-day operations of the UCB within the limits
set by the BoD. At least 51 per cent of the members
of the BoM should have special knowledge or
practical experience in the matters specified in
Section 10 A(2) of the B. R. Act, 1949.

 Members of the BoD can be members of the BOM

provided they fulfill the conditions specified.
Members of the BoM can be paid such sitting fees
as the BOD may decide subject to a ceiling to be
specified by RBI. The BoM to follow a Code of
Corporate Governance to be specified by RBI.
The CEO shall be responsible for the management
of the whole or substantially the whole of the affairs
of the UCB but shall be subject to the control and
direction of the BoM. The appointment of the CEO
shall be subject to the prior approval of RBI.

 Audit by a Chartered Accountant to be appointed

by the BoM from out of a panel of approved
auditors maintained by RBI and subject to rotation
after four years.

Umbrella Organization
There should be two separate Umbrella
Organizations viz. a national level organization
which provides payments and settlement services
and other services normally provided by central
banks as also liquidity support to its members; and
one or more organizations which provide the
management, IT training and other services which
the UCB sector needs.
The national level UO should preferably be in the
form of a multi-state UCB with membership being
restricted to and mandatory for all UCBs other than
scheduled UCBs.

 Member UCBs should be required to maintain their

CRR in the form of deposits with the UO.
The UO should invest its funds only in the form of
balances with RBI, deposits with commercial banks
or in SLR securities and in no other form.
The UO should offer Repos and Reverse Repos
facilities to UCBs in the same manner as RBI offers to
commercial banks and at the same rates of
interest. In turn, it should enjoy Repos and Reverse
Repos facilities with RBI.

 UCBs can avail of Repos facilities only to the extent

of their excess SLR holdings.
Until the Payments and Settlements facilities are
provided directly to UCBs, the UO will act as a
gateway to provide these services for a fee to
UCBs. In turn, the UO will be a member of the
Payments and Settlement System.
Being a UCB, the UO would have a Board of
Management and will be subject to the regulation,
supervision and inspection of RBI.

JPC recommendations
1. Strengthening of Audit:
Concurrent audit made mandatory for all UCBs
Audit committee of board as stated in circulars by
RBI from time to time
Audit committee to monitor for all audit functions
as also compliance with RBI inspection reports, RBI
guidelines etc.

2. Compliance to RBI Report:

Compliance to be furnished within 6 weeks
All defects pointed out in inspection report to be
removed within 4 months
Certificate to the effect submitted to RBI within 4
months
False certificate or delayed compliance to attract
penal action
Strict penalty for non-compliance of RBI directives

Other JPC Recommendations

Dual control should go
Inspection report should comment on the quality of
audit report
Improvement of on-site / off-site supervision
Provisions of loans & advances to directors & their
relatives and concerns in which they are interested

Amendment to BR Act
Management related functions like elections,
conduct of directors etc., to be with Registrar of Cooperative societies (RCS)
Banking related functions to be with RBI
Audit function, including statutory audit to be with
RBI
Section 56 of BR Act to be deleted

 Make all provisions of the parent Act applicable

Sections 10B & 10BB requiring RBI approval for
appointment of full time chairman / MD
Section 10C would enable non-member as
chairman
Serving MPs/MLAs/MLCs as also stockbrokers
banned from being a director of the bank

Disclosure Norms
Applicable to UCBs with deposits of Rs.100 Crore &
more
Capital to Risk Assets Ratio (CRAR), investments,
advances against real estate / shares, interest of
directors, profitability etc., to be declared.

97th Constitutional Amendment Act, 2011

Inclusion of the term co-operative societies in
Article 19.
Article 243ZI of the Act provides that the State may
by law make provisions with respect to
incorporating, regulating and winding up
cooperative societies based on the principles of
voluntary formation, democratic member control,
member economic participation, autonomous
functioning and professional management.

 The other important provisions of the Act, inter-alia,

include:
The number of directors in the Board of a co-operative
society shall not be more than 21.
The Act provides for co-option of two directors, in
addition to a maximum number of 21, having
experience in the field of banking, management,
finance or specialisation in any other field relating to the
objectives and activities undertaken by the society.
The term of office of the elected members of the Board
and its office bearers shall be five years from the date of
the election and the term of the office bearers shall be
coterminous with the term of the Board.

 The Board of a society shall not be superseded and kept

under suspension for a period exceeding six months. This
period would be one year for a co-operative society,
other than a multi-state co-operative society, carrying
on the business of banking. In the case of a co-operative
society carrying on the banking business, the provisions
of the Banking Regulation Act, 1949 shall also apply.
The accounts should be audited within six months of the
close of the financial year to which such accounts
relate, by an auditor or auditing firm appointed by the
general body of the co-operative society.
AGM shall be convened within a period of six months of
close of the financial year to transact business as may
be provided by law.

Implications for UCBs

Supersession of Board: At present, many of the State
Co-operative Societies Acts have provisions to
suspend/ supersede the Board of UCBs for a
maximum period of five years. The period will be
restricted to six months.
However, the requirement that Registrar of Cooperative Societies (RCS) would supersede the
board of a UCB at the request of the Reserve Bank
will continue. The Board of a multi state cooperative bank, can be superseded for a period of
five years as provided under section 36AAA of the
Banking Regulation Act, 1949 (AACS).

 Co-option of professional directors: Since the Act

provides for co-option of two professional directors
having experience in the field of banking,
management and finance, it will bring
professionalism in the working of UCBs. The Reserve
Bank had earlier prescribed that UCBs should have
at least two professional directors on their Boards.
Amendments to the State Acts in this regard will
make the RBIs prescriptions enforceable under law.

 Appointment of an auditor: The Act provides for

audit by a qualified auditor appointed by the
general body of the co-operative society from a
panel of qualified auditors approved by the State
Government. As per the existing provisions in the
State Co-operative Societies Acts, the appointment
of an auditor is being done by RCS.
Election of the Board: Since the Act provides that
election of a Board shall be conducted before the
expiry of the term of the Board, the elections to the
Board of UCBs will not be postponed indefinitely.
The Act would also increase participation by
members in the activities of the UCBs as the
minimum requirement for attending meeting and
utilising the services by members has to be provided
by the States by law.