Financial Markets & Institutions

Q2 What is Urban Cooperative Bank. Discuss the a) Objectives, b) RBI

Guidelines & c) reasons for failures? Is it meeting the objectives for which it was
set up?
Introduction to Urban Cooperative Banks:

UCBs are cooperative banks serving urban areas, providing banking services and promoting
financial inclusion. Urban Cooperative Banks (UCBs) are financial institutions that operate in
urban and semi-urban areas in India. They are registered under the Cooperative Societies Act
and function as cooperative entities owned and operated by their members.

As per Section 56 of the Banking Regulation Act, 1949, a primary co-operative bank
(Urban Co-operative Bank or UCB) means a co-operative society, other than a
primary agricultural credit society, whose,

(i) Primary or principal business is a transaction of banking business.

(ii) Paid-up share capital and reserves of which are not less than one lakh of rupees:

The UCBs are diverse in terms of their size and operations. Given this heterogeneity,
a differentiated regulatory regime is followed by RBI and thus, the UCBs are
categorized under two Tiers (Tier I and II). Tier II UCBs has a larger depositor base
and a wider geographical presence compared to the Tier I UCBs. Tier I UCBs is
defined as (i) Banks with deposits below 100 crore operating in a single district, (ii)
Banks with deposits below 100 crore operating in more than one district provided the
branches are in contiguous districts and deposits and advances of branches in one
district along with constitute at least 95 per cent of the total deposits and advances
respectively of the bank and (iii) Banks with deposits below ` 100 crore, whose
branches were originally in a single district but subsequently became multi-district
due to reorganization of the district. All other UCBs are categorized as Tier-II UCBs.
This categorization is based on their branch network, area of operation and the level
of deposits. The Banking Regulation Act, 1949, instructs the submission of periodical
returns by UCBs to the Reserve Bank of India.

UCBs are governed by a board of directors elected by their members and operate on a
cooperative principle, where each member has equal voting rights. They are regulated and
supervised by the Reserve Bank of India (RBI) under the Banking Regulation Act, of 1949,
and are subject to various prudential norms, regulations, and guidelines issued by the RBI to
ensure their stability and soundness

Urban Cooperative Banks (UCBs) in India have a history that dates back to the early 20th
century. Here is a brief overview of the history of UCBs in India:

Early Development (1904-1966)

The first urban cooperative bank, The Cooperative Credit Society of Haryana, was established
in 1904 in Haryana. The Cooperative Credit Movement gained momentum in the 1920s, with
the formation of various cooperative credit societies across the country. The cooperative
banking sector witnessed significant growth during the 1950s and 1960s, primarily driven by
rural and agricultural credit needs.

The Banking Regulation Act, 1949 was amended in 1965 to bring cooperative banks under
the regulatory purview of the Reserve Bank of India (RBI). The Banking Laws (Application to
Cooperative Societies) Act was enacted in 1965, granting regulatory powers to the RBI over
UCBs. The UCBs started expanding their operations, offering various banking services to
urban areas, including deposit-taking, lending, and other financial services.

Reforms and Consolidation (1991-Present)

Following the liberalization of the Indian economy in 1991, significant reforms were introduced
to strengthen the cooperative banking sector. The Narasimham Committee Report in 1998
recommended reforms to improve the governance, capitalization, and regulation of UCBs. The
Multi-State Cooperative Societies Act was enacted in 2002 to facilitate the formation and
functioning of multi-state cooperative banks. RBI has taken several measures to enhance the
regulatory framework and improve the financial health of UCBs, including capital adequacy
norms, risk management guidelines, and periodic inspections.

Objectives of UCBs

UCBs are formed with the primary objective of promoting the economic and social betterment
of their members by providing banking services. UCBs provide a wide range of banking
services to their members and customers, including deposit accounts, loans, remittances, and
other financial products and services. They primarily serve the banking needs of small
businesses, individuals, and communities in urban areas.

The Urban co-operative bank is established with an objective to fulfil financial need to urban
and semi – urban areas. The urban co-operative bank has created important place in the mind
of urban peoples. Due to easy operation and quick fulfilment of members and non – members
need these banks have become popular in urban areas. Following are the functions of Urban
co-operative bank:

Accepting Deposits: The main functions of Urban co-operative bank are accepting deposits
from public. The deposits are collected from members and non-members of urban and semi-
urban areas. This bank accepts deposits in the form of Saving deposit, Current deposit, Fixed
deposit and Recurring deposit, Pygmy deposits, etc.
Granting Loan: Urban co-operative banks provide short-term and medium-term loan to
the members and non-members against security. The loan is provided to the businessmen,
merchants, craftsmen, salary earners, etc. considering their needs. The loan is provided to
the members for children education, housing, purchasing consumers product like television,
refrigerator, computer, etc. Overdraft facility is also provided to the business on current
account.
To act as an Agent: Urban co-operative bank provides all banking functions. As an agent of
accountholder, the bank makes payment of telephone bill, electric bill, LIC premium, children
educational fees, house rent, housing loan installment, purchase and sale of shares and
debentures, etc. for these functions nominal bank charges are charged by the bank. And also
provides guidance to the members for proper investment.
Discounting bill of exchange: When the credit transaction takes place between two
parties, the creditor draws bill of exchange for a specific period which is accepted by
debtor this bill of exchange is discounted by the bank for this interest is charged which is
known as discount.
To provide Safe Deposit Locker: Urban co-operative banks provide safe deposit lockers
to its customers means depositors. The depositor can keep safely their valuables like gold
and silver ornaments, important documents in such locker. This service or facility is
provided by the bank for the safe custody of valuables of its customers. Bank charges rent,
as per the size of lockers.
Modern banking services: Urban co-operative Banks also provides modern banking
services likes 24 hours ATM services to the members. This service is provided by the ATM
centers located nearby market, railway station, bus stand, etc. The bank also provides
other modern banking services like Electronic money transfer, core banking, e-banking,
mobile banking, Credit card, Debit card, etc. In Telebanking system, a specific phone
number is allotted to the members through which they can get all information regarding
their accounts like transaction, balance of their account, current rate of interest, foreign
exchange rate, etc.
Helping for self- employment: Urban co-operative banks provide loan for self
employment in urban and semi-urban areas for the persons want to start their own
business. Self-employed persons like work-shop owner, machinery repairer, tailor,
weaver, truck transporter, auto rickshaw driver, etc. These persons get the financial help
from Urban cooperative bank for self-employment which helps to solve the problem of
unemployment.
Quick banking services: Due to globalization competition is increasing in all sector. The
Urban co-operative society provides quick banking services as per the needs of the
customers by charging reasonable charges. Members pay service charges to the bank. The
bank maintains good relation with customers and provide quick services to the
customers.
Financial management: Urban co-operative bank makes proper investment o funds.
The bank invests surplus fund as per the provisions and instructions of Reserve Bank of
India. After taking into consideration the cash requirement security (safety) and return
on investment.
Training to staff and officers: The Urban co-operative bank provide professional
training to the staff, officers and employees of the bank. For this they arrange various
workshops to improve the quality of banking services. The success of bank is dependent
on the services provided by the bank.

Regulation and Supervision of UCBs by the RBI

The RBI, as the central bank, is known for its prudent regulation and supervision of financial
institutions including commercial banks, NBFCs, UCBs etc. In the case of UCBs, the central
bank regulates and supervises them to ensure that the institutions are financially fit to deliver
their functions. Regulatory norms related to UCBs are there regarding licensing, maintenance
of CRR, SLR, CRAR, Minimum net owned fund requirements etc. Following are the main
regulatory measures for UCBs:

 Licensing of New Primary (Urban) Cooperative Banks: For starting the banking business,
a primary (urban) cooperative bank, as in the case of a commercial bank, is required to
obtain a licence from the RBI as per the BR Act.
 Licensing of Existing Primary (Urban) Co-operative Banks: A primary credit society which
would like to become a primary (urban) cooperative bank (by fulfilling the share capital
and reserve norms) should avail a license from the RBI.
  Branch Licensing: Primary (urban) cooperative banks are required to obtain permission
from the RBI for opening branches.
 Statutory Provisions: Some of the statutory provisions under the BR Act is also applicable
for UCBs, and they will be monitored on the basis of these provisions:

(a) Minimum Share Capital: Minimum paid-up capital of Rs 1 lakh.

(b) Maintenance of CRR and SLR: The UCBs have to keep the SLR as per the RBI
requirements.

Previously, the RBI adopted differential SLR norm in accordance with the asset size of UCBs.
Several prudential norms were applied on UCBs since March 1993. These prudential norms
include:

 Applying capital adequacy standards,

 Prescribing an asset-liability management framework,
 Enhancing the proportion of holding of Government and other approved securities for the
purpose of SLR stipulation,
 Restriction on bank finance against the security of corporate shares and debentures, and
 Limiting the exposure to capital market investment.

Regulatory trends for UCBs in recent years are in accordance with the challenges they are
facing. Earlier, in the context of the big challenges for UCBs, the RBI appointed High-Power
Committee (Chairman: K. Madhava Rao, 1999) to review the performance of UCBs. As a
follow-up, the RBI introduced further measures to strengthen the UCBs.

Failures of cooperative banks like the Madhavapura Mercantile Cooperative Bank brought
stringent regulatory control over the cooperative banking system. Recently, the failure of
Punjab and Maharashtra Cooperative Bank compelled RBI to tighten regulations along with
government efforts to give more powers to the RBI by amending the Banking Regulation Act
in September 2020.

Supervisory Action Framework for UCB

The Supervisory Action Framework (SAF) for Urban Co-operative Banks (UCBs) was
introduced by the Reserve Bank of India (RBI) in 2014 to better manage stressed UCBs and
ensure the timely resolution of financial stress. The SAF is similar to the Prompt Corrective
Action (PCA) framework imposed on scheduled commercial banks.

Under the SAF, the RBI assesses the financial position of UCBs and issues directions or
instructions based on the provisions of the Banking Regulation Act, of 1949. The framework
sets threshold limits for asset quality, profitability, and capital adequacy. In the early stage of
deterioration, UCB management is expected to take self-corrective action.

However, if the financial position of the UCB does not improve, the RBI initiates the SAF. Once
a UCB’s net non-performing assets (NPAs) exceed 6% of its net advances, it may be placed
under the framework. The regulator may then take multiple actions depending on the severity
of the stress.

In December 2019, the RBI proposed reducing the loan amounts UCBs can lend to a single
entity and a group of borrowers to 10% and 25%, respectively. This was aimed at preventing
large exposure to one group and avoiding scams similar to the Punjab and Maharashtra Co-
operative (PMC) Bank case.

The revision of the SAF in early 2020 further strengthened the supervisory framework for
UCBs, enabling the RBI to closely monitor and regulate UCBs to ensure their financial stability
and protect the interests of depositors and stakeholders

Reason for Failure by Urban Cooperative Banks

Unproductive loan: It is expected the Urban co-operative bank should provide loan for
productive purpose. But at present, these banks provide loan for unproductive purpose
likes to purchase furniture, television, refrigerator, festival loan, housing loan, etc. and
this loan is also not recovered within given period of time.
Lack of training facility: Bank employees and staff are not trained. Most of the staff does
not have sufficient knowledge of banking operation. They are not aware of the new
changes in banking sector. But the banks did not arrange workshops, seminars for the
training of the staff due to lack of funds which affects the day-to-day working of the bank.
Lack of fund: The area of Urban co-operative bank is limited upto particular city.
Therefore, there are limited number of members in Urban co-operative bank. Due to
which the share capital, deposits, membership fees, reserve fund is also very limited
which is insufficient for the development of the bank. The District central co-operative
bank also do not provide sufficient financial help to Urban co-operative bank. Due to
limited capital the bank faces difficulty for its development.
Inefficient management: The management of Urban co-operative bank is inefficient.
They lack in management abilities which effects the smooth and successful working of
the society. The management is not professional and trained.
Unbalanced development: The Urban co-operative banks are developed in the state like
Maharashtra, Gujarat, Tamil Nadu and Karnataka and remained undeveloped in
remaining states. The progress of these banks from geographical point of view is
unbalanced. So, the artisans and other people do not get financial help in those states.
Increasing overdue: There is large amount of overdue in Urban co-operative bank. The
loan is given without taking proper care, loan to unproductive purpose, low control on
use and recovery of loan due to which bank comes into financial problem. Due to
inefficient management and political pressure there is difficulty in recovery of loan.
Defective loan policy: The loan policy of Urban co-operative bank is defective. The
decision of granting loan is taken by managing committee. Loan demand, scrutiny of loan
application, use of loan, ability to repay the loan such important factors are not observed
and loan is given to the ineligible person under the influence of management. Provisions
of loan security is not followed hence bank has came into economical problem.
Dual control: Reserve Bank of India and Co-operative department, has joint control over
the Urban co-operative bank. Due to dual control there is problem in administration of
bank. When the bank has to start new projects like establishment of new branch,
investment of funds, recovery of loans, etc. bank finds difficulty in taking decision
according to Reserve bank or Co-operative department. The dual control creates
problems in their working.
Political interference: It is observed that a lot of political interference seen in the
working of urban co-operative bank. There is political pressure for granting loans,
recovery of loans, appointment of employees, etc. Due to which these banks have come
into economic problems.
Fail to provide Modern banking services: Due to lack of capital the Urban co-operative
bank has come into financial problems. Due to which they are not in the position to
provide modern banking services to its customers like commercial and nationalized bank
which results in decrease in number of customers.

Challenge Faced by Urban Cooperative Banks

Urban Cooperative Banks (UCBs) face several challenges in their operations. Here are the
challenges faced by UCBs based on the provided information:

Capital Restriction

UCBs in India are not permitted to pay more than 15% dividend to their shareholders. This
limitation can hinder their ability to raise capital when needed, especially during times of
financial distress.

Difficulty in Raising Capital

Unlike commercial banks, UCBs have limited options for raising capital. They can only
increase their membership or ask existing members to buy more shares. This reliance on
members for capital infusion can be challenging, as members may not have the financial
capacity or incentive to contribute significant amounts of fresh capital.

Lack of Diversification

Small UCBs often lack diversification in their operations and have a high degree of overlap
between their members and clients. This can pose difficulties during financial difficulties, as
members may not be in a position to provide substantial amounts of additional capital.

Limited Alternatives for Funding

UCBs can face challenges in accessing alternative sources of funding. Issuing securities may
require high remuneration and decision-making procedures for raising new capital can be
cumbersome and time-consuming.

Low Incentives for Profit Distribution

In the absence of investment-driven shareholders, UCBs may have limited incentives to pay
out a significant share of profits as dividends. This can affect their ability to attract capital and
may impact their growth potential.

Pressure on Solvency and Liquidity

Expansionary policies and acquisitions can strain the solvency and liquidity of UCBs. Without
the ability to finance acquisitions through the issuance of new equity, UCBs often resort to
debt or liquidating assets, leading to a deterioration in their balance sheets.
These challenges highlight the unique financial constraints and operational limitations faced
by UCBs, requiring them to carefully manage their capital, liquidity, and expansion strategies
to ensure financial stability and sustainable growth.

Reforms Needed in Urban Cooperative Banks

The committee headed by N S Vishwanathan, former RBI Deputy Governor, made several
recommendations for reforms in Urban Cooperative Banks (UCBs). Here are the key reforms
suggested by the committee:

Functioning as Small Finance Banks (SFBs)

Well-governed large UCBs meeting certain parameters should be allowed to operate as SFBs
and universal banks, similar to commercial banks.

Four-Tiered Regulatory Structure

The committee proposed a four-tier structure for UCBs based on their deposit size. Each tier
would have different capital adequacy and regulatory norms, ranging from Tier-1 (up to Rs
100 crore deposits) to Tier-4 (over Rs 10,000 crore deposits).

Norms for Each Tier

The minimum Capital to Risk-Weighted Assets Ratio (CRAR) for UCBs would vary depending
on the tier. Tier-3 UCBs (Rs 1,000 crore to Rs 10,000 crore deposits) meeting a 15% capital
adequacy ratio could function like SFBs, while Tier-4 UCBs (over Rs 10,000 crore deposits)
meeting a 9% capital adequacy ratio could operate as universal banks.

Separate Ceilings and Stipulations

The committee recommended separate ceilings for home loans, loans against gold
ornaments, and unsecured loans for different categories of UCBs. It also suggested that the
loan portfolio of Tier-3 UCBs should align with the stipulations for SFBs.

All-Inclusive Directions (AID)

AID should be treated similarly to moratorium under Section 45 of the Banking Regulation Act,
and banks should not continue under AID beyond the specified time, which is three months
extendable by another three months.

Merger and Consolidation

The RBI should be neutral to voluntary consolidation of UCBs, but mandatory mergers can be
considered as a supervisory action if UCBs fail to meet prudential requirements.

Changes to Supervisory Action Framework (SAF)

The SAF should follow a twin-indicator approach, considering only asset quality and capital
(measured through net non-performing assets and CRAR) instead of the current triple
indicators. The objective of SAF should be to provide a time-bound remedy to the financial
stress of a UCB.

These recommendations aim to strengthen governance, enhance capital adequacy, improve

asset quality, and provide a framework for resolving financial stress in UCBs, ensuring their
stability and better regulation in line with the changing banking landscape.
Q3 What is Rural Cooperative Credit Institution. Discuss the a) Objectives, b) RBI
Guidelines, & reasons for failures? Is it meeting the objectives for which it was set up?