Urban cooperative banks are again in the news for the wrong reasons as the Reserve Bank of India replaces the board of Abhyudaya Coop Bank, just as the reforms after the PMC Bank episode promised to bring discipline to the sector.
From 2020, urban cooperative banks fell under the direct jurisdiction of the RBI, resulting in increased scrutiny and an increase in fines. In the fiscal year 2022-23, these banks received 83 percent of the total fines levied by the RBI, decreasing to 74 percent in 2023-24. However, the prevalence of fines is expected to remain elevated due to the unique management structure of these banks, often dominated by local politicians.
Of the 172 fines issued by the RBI in the current financial year up to November 24, it illustrates that almost three-quarters (127 fines) were directed at urban cooperative banks, with a quarter of these fines attributed to loans extended to related parties, mainly of banks in Gujarat.
Among the urban cooperative banks, the most prevalent offense was the breach of RBI’s prudential norms, covering various offenses unrelated to lending, loan recovery or customer interactions. However, the second largest category, comprising almost 25% of fines, involved lending to the banks’ own directors, individuals connected to the directors, companies in which the directors had a financial interest, or cases where directors acted as guarantors for loans . This directly contradicts the RBI regulations issued in February 2021, expressly prohibiting such practices.
What is suffering?
Weaker asset quality, capital positions and limited profitability resulting from low credit-to-deposit ratios hindered their progress. The lack of adequate resources and manpower, as well as technological limitations, further compounded these difficulties.
Challenges faced by UCBs stem from structural obstacles arising from their localized operations and the dual regulatory oversight imposed by both the RBI and state governments. This dual regulation often leads to ambiguity and lack of clarity, creating additional obstacles to effective management.
The core problems include deficiencies in corporate governance standards and professionalism within UCBs. Concerns continue regarding compliance with banking regulations, with non-compliance posing potential risks to the stability and integrity of the banking system. Unlike commercial banks, UCBs operate under a “one-member, one-vote” policy, where majority voting determines decision-making. However, this member-driven structure can affect management and limit capital-raising capabilities. The limited access to capital sources beyond their members hinders the ability of UCBs to raise funds, limiting their growth potential.
The RBI reforms
In response to these challenges, the RBI has implemented a four-tier scale-based regulatory framework to strengthen the governance of cooperative banks. This framework introduces higher capital requirements for larger banks, aiming to strengthen their stability and improve risk management practices. Additionally, the RBI has revised upwards the priority sector lending targets for UCBs. By March 2026, UCBs are expected to achieve a priority sector lending target of 75%, aligning with broader socio-economic goals.
The RBI has intensified its scrutiny of cooperative banks, with several penalties and the cancellation of licenses for eight lenders in FY2023 alone. To address these problems, industry experts propose strict governance standards at the board level, the conversion of cooperative banks to small finance banks, and enhanced oversight by regulators and auditors. The trust deficit resulting from governance problems and regulatory actions led to increased loan defaults and deposit outflows to larger banks. Experts recommend a comprehensive review in the governance structure of cooperative banks to protect these institutions and protect customer interests.