In this article, Shruti Goel, pursuing B.L.S LLB from Government Law College, Mumbai discusses on the co-operative banking system in India.
The recent Punjab and Maharashtra Co-operative Bank’s (PMC Bank) crisis has created chaos among thousands of its depositors. PMC Bank is a multi-state scheduled urban cooperative bank with its operations in Gujarat, Maharashtra, Goa, Karnataka, Andhra Pradesh, Madhya Pradesh and New Delhi. With a network of 137 branches, it ranks among the top 10 cooperative banks in the country. Recently, due to some under-disclosed bad loans above the ceiling limit, the RBI has imposed lending restrictions on PMCB, at Rs 10,000 per customer for six months. The bank has also been brought under Directives which means it will be directly overseen by the RBI for this period. So to understand this scam and its intricacies we are going first to discuss what are cooperative banks, why are they needed and what reforms are needed to help prevent such scams and to gain depositor’s trust back.
History of Cooperative Banks in India
The genesis of the cooperative movement and its implementation in a modern technical sense can be traced after the Industrial Revolution in England during the period of 18th and 19th century. The idea of Hermann Schulze and Friedrich Wilhelm Raiffeisen during the economic meltdown to provide easy credit to small businesses and poor sections of the society took shape as cooperative banks of today across the world.
Pre-independence period (prior to 1947)
British India replicated this model and based on the recommendations of Sir Frederick Nicholson (1899) and Sir Edward Law (1901), the Co-operative Credit Societies Act, 1904 was passed. It tried to deal with the problems of rural indebtedness and consequent conditions of farmers in the country. The Act promoted the establishment of credit cooperative societies which led to the formation of first urban co-operative credit society, registered on October 1904 at Kanjeepuram now in Tamil Nadu State. It marked the beginning of the institutionalization of the Cooperative Banking system in India. But there were certain defects in the Act which restricted the reach of the expected benefits of cooperatives. The Act only permitted the registration of credit societies, and there was no provision for the protection of non-credit societies or federal societies. These shortcomings were recognised by the Government and to remedy it; more comprehensive legislation was introduced, known as the Cooperative Societies Act of 1912. It recognized the formation and organisation of non-credit societies and the central co-operative federations.
In 1919, after the end of the first world war under the Treaty of Versailles,1919, the Montague Chelmsford Reforms were introduced in India under which Cooperation becomes a transferred subject which was to be administered by the States. The need for separate acts for effective implementation and to widen the reach of the cooperative banks was felt by the States. The Bombay Provincial Government was the first to pass its own act which was known as Bombay Provincial Cooperative Societies Act, 1925. Other state governments like Madras, Bengal, Bihar and Punjab followed the Bombay Act and passed their own legislation in the following years.
In 1942, the British Government enacted the Multi-Unit Cooperative Societies Act, 1942, the ambit of which covered societies whose operations are extended to more than one state. The Act provided for the regulation of affairs of such society by the provisions of cooperative societies act of the state where the principal business of the society is located.
Post-independence period (after 1947)
After independence, the movement of cooperative societies maintained its pace even after facing several hardships during that phase and continued to be part of the economic development of the country. The First Five Year Plan recognised the importance of cooperatives in the implementation of development plans, particularly targeting the farmers and weaker section of the society. In 1954, Government of India appointed a committee called All India Rural Credit Survey Committee to remedy the problem of rural credit and other financial issues of the rural community. It recommended a well defined institutional framework for cooperative organizations, particularly for meeting the needs of rural India. The recommendations of the committee were recognised and were put into effect under the Second Five Year Plan. The Second Five Year Plan recommended expanding the scope of cooperative activities to other fields with special emphasis on the warehousing sector. The Third Five Year Plan emphasised on training personnel for the cooperative sector and to increase the reach of the cooperative movement. The Fourth Five Year Plan recommended the consolidation of a cooperative system for effective functioning. The Fifth Five Year Plan recommended the establishment of Farmers Service Societies. The Sixth Five Year Plan developed a point programme for a cooperative society to bring economic development and for expanding the scope of cooperative societies. The Seventh Five Year Plan also focussed on expansion and growth of the scope of cooperative societies so as to achieve greater employment and decrease poverty in the country.
What are cooperative banks?
A co-operative bank is a financial entity which belongs to its members, who are at the same time the owners and the customers of their bank. It is often established by people belonging to the same local or professional community having a common interest. It is formed to promote the upliftment of financially weaker sections of the society and to protect them from the clutches of money lenders who provide loans at an unreasonably high-interest rate to the needy. The co-operative structure is designed on the principles of cooperation, mutual help, democratic decision making and open membership. It follows the principle of ‘one shareholder, one vote’ and ‘no profit, no loss’.
Cooperatives Banks are registered under the Cooperative Societies Act, 1912. These are regulated by the Reserve Bank of India and National Bank for Agriculture and Rural Development (NABARD) under the Banking Regulation Act, 1949 and Banking Laws (Application to Cooperative Societies) Act, 1965.
Cooperative banks differ from commercial banks on the grounds of organisation, governance, interest rates, the scope of functioning, objectives and values.
Characteristics of Cooperative Bank
Some of the main features or characteristics of cooperative banks are:
The members of cooperative banks are both the owners and the customers of the bank. Thus, the aim of the cooperative bank is not to maximize profits but to provide the best possible services to its members. Some of the cooperative banks also admit non-members so as to provide them with banking services.
Democratic member control
Cooperative banks are owned and controlled by members, who democratically elect the board of directors. The basic principle of co-operatives “one man one vote” is followed, irrespective of the number of shares held by a member, which ensures that no member enjoys any arbitrary power over other members.
A specified portion of the profits are transferred to Statutory Reserve and other reserves, and then a fair rate of interest is paid on the capital subscribed by the members. A part of this profit can also be distributed to the co-operative members, with legal and statutory limitations in most cases.
Inclusion of rural masses
It plays a significant role in the financial inclusion of unbanked rural masses.
Functions of Cooperative Banks
- It provides financial assistance to people with small means and protects them from the latches of money lenders providing loans and other services at a higher rate at the expense of the needy.
- It supervises and guides affiliated societies.
- Rural financing- It provides financing to rural sectors like cattle farming, crop farming, hatching, etc. at comparatively lower rates.
- Urban financing- it provides financing for small scale industries, personal finance, home finance, etc.
- It mobilises funds from its members and provides interest on the invested capital.
Objectives of Cooperative Banks
- To provide rural financing and micro-financing.
- To remove the dominance of money lenders and middleman.
- To provide credit services to agriculturalists and weaker sections of the society at comparatively lower rates.
- To provide financial support and personal financial services to small scale industries, housing financial assistance, etc.
- To provide basic banking services to its members.
- To promote the overall development of rural areas.
Structure of Cooperative Banks in India
The co-operative banking structure in India is divided into Short term structure and Long-term structure.
Short term structure has three levels
- A State Co-operative Bank works at the apex level (i.e. works at the state level).
- The Central Co-operative Bank works at the Intermediate Level (i.e. works at district level).
- Primary Co-operative Credit Societies at a base level (i.e. works at village level).
Long term structure has two levels
- State Co-operative Agriculture and Rural Development Banks (SCARDBs) at the apex level.
- Primary Co-operative Agriculture and Rural Development Banks (PCARDBs) at the district level or block level.
Types of Cooperative Banks in India
The co-operative banking structure in India is divided into the following 5 categories:
1. Primary Co-operative Credit Society
- The Primary Co-operative Credit Society is an association of borrowers and non-borrowers residing in a particular locality.
- The funds of the society are derived from the share capital and deposits of members and loans from central co-operative banks.
- Borrowing constitutes the most important element of their working capital.
- The borrowing powers of the members as well as of the society are fixed but may differ from state to state.
- The loans are given to members for the purchase of cattle, fodder, fertilizers and pesticides.
2. Central Co-operative Banks
- These are the federations of primary credit societies in a district and are of two types:
- Those having a membership of primary societies only.
- Those are having a membership of societies as well as individuals.
- The funds of the bank consist of share capital, deposits, loans and overdrafts from state co-operative banks and joint stocks.
- These banks provide finance to member societies within the limits of the borrowing capacity of societies.
- They also conduct all the business of a joint-stock bank.
3. State Co-operative Banks
- The state co-operative bank is a federation of central co-operative bank and acts as a watchdog of the co-operative banking structure in the state.
- It procures funds from share capital, deposits, loans and overdrafts from the Reserve Bank of India.
- The state co-operative banks lend money to central co-operative banks and primary societies and not directly to the farmers.
4. Land Development Banks
- These are organized in 3 tiers, namely; state, central, and primary level with the objective to meet the long term credit requirements of the farmers for developmental purposes.
- National Bank for Agriculture and Rural Development (NABARD) supervises Land development banks.
- The sources of funds for these banks are the debentures subscribed by both Central and State government as these banks do not accept deposits from the general public.
5. Urban Co-operative Banks
- It refers to primary cooperative banks located in urban and semi-urban areas.
- Earlier the scope of these banks was restricted, which now has been considerably widened.
- They provide funds and services to small borrowers and small business.
Cooperative banks in India fund rural are as under:
- Personal finance
Cooperative banks in India finance urban areas by virtue of:
- Small-scale units
- Home finance
- Consumer finance
- Personal finance
Importance of Cooperative Banks
- It has an extensive branch network all over the country, making credit easily available even to rural areas. It accounts for 67 per cent of total rural credit.
- It is an integral source for credit to agriculturalists.
- It confirms to the requirements of democratic planning and economic progress.
- It provides support to small and marginal farmers for buying inputs, storage and marketing assistance.
Advantages of Cooperative Banks
Easy to form
Registration and legal requirements are comparatively easy compared to traditional banks. It takes a group of ten adults to form a cooperative bank. It needs a base capital of 25 lakhs only as compared to 100 crores of Small Finance Banks.
Alternative credit source
One of the objectives of the cooperative system is to provide easy accessibility to the rural section of the country so as to protect them from the clutches of greedy money lenders. These money lenders exploit the needy by providing credit facilities at higher rates and by manipulating their accounts. It acts as an effective alternative to this traditional money lending system.
It provides cheap credit to rural masses. It provides a high-interest rate to members for their investments and low lending interest rate. This also protects the rural masses from the exorbitant interest rate at which money lender provides credit, thus breaking their monopoly.
Encouragement of savings and investments
It has encouraged the habit of thrift among the masses. Instead of hoarding money or spending unnecessarily, masses tend to invest and save their money.
Advancement in farming
Cooperative societies provide credit to agriculturalists at cheaper rates to buy inputs, warehousing facilities, marketing assistance and other facilities. These banks often provide assistance for buying cheap products and services and help them by introducing them to modern technology and better farming methods to improve their output.
Case of Punjab and Maharashtra Cooperative Bank (PMC Bank)
- The PMC Bank had Rs 11,617 crore in deposits as on March 31, 2019. It had violated Reserve Bank of India (RBI) norms by lending heavily to one client-real-estate firm Housing Development and Infrastructure Limited (HDIL), which itself is facing bankruptcy proceedings. PMC Bank has extended 73 per cent of their assets to HDIL.
- The former chiefs of the bank and the promoters of HDIL have been booked for cheating, and lookout notices have also been issued against them.
- The PMC Bank crisis shows how the watchdogs -the bank’s auditors, the RBI and the government were lousy in doing their jobs and taking responsibility.
- An action was taken by RBI under sub-section (1) of Section 35A of the Banking Regulation Act,1949 read with Section 56 of the Act which deals with the power of RBI to give directions.
- PMC Bank cannot grant or renew any loans or advances or to make any investments or accept any new deposits without the prior approval of RBI for the next six months.
Problems faced in the Indian Cooperative Banking System
Small capital base
Cooperative banks have a small capital base as it can start with a capital base of 25 lakhs, making it difficult for them to account a portion of such capital as their working capital and raising working capital has been a major hurdle for almost all cooperative banks.
Politicians use them to increase their vote bank and usually get their representatives elected over the board of directors in order to gain undue advantages like sanctioning of loans which later gets written off.
The supervision of RBI is not as stringent on cooperative banks as compared to commercial banks. RBI inspects the books of these banks only once a year.
Cooperative banks are controlled under the dual system, i.e. by RBI and by their respective State government which poses a problem in coordination and management.
Professional management and technological advancement
Cooperative banks are often reluctant to adopt new technologies like computerised data management. Professional management in the banks is often missing due to lack of training of personnel because of lack of funds.
Dependence of finance
Cooperative banks depend heavily on RBI, NABARD and the government for refinancing facilities. It depends on the government for capital rather than on its members.
Overdue loans of cooperative banks are increasing yearly, restricting the recycling of funds which in turn affects the lending and borrowing capacity of the bank.
Measures to be taken
PMC Bank is not the first case of failure of the cooperative banking system in India. The Madhavpura Cooperative Bank scam in 2001-02 was a clear signal to bring certain changes in the regulatory and supervisory structure of cooperative banks. But no heed was given at that time. Since then, urban cooperative banks are failing with alarming regularity. Their numbers fell from 1,926 in 2004 to 1,551 in 2018, as per RBI data. These issues need to be addressed and remedied if the Government wants the public to place their trust in the country’s banking system.
In 2015, an RBI panel under R. Gandhi, a former deputy governor at the Central bank, had proposed several governance reforms for the cooperative banking sector, some of which are as follows:
- Greater control and supervision of RBI upon the cooperative banks.
- These banks and other financial institutions should be professionally managed, which means that the board of directors should be delegated power similar to those delegated under commercial banks. Board of directors should be able to conduct an independent assessment and supervise the bank’s functioning. They should be able to question the shareholder’s representation.
- The committee also recommended certain changes in Banking Regulation Act,1949, so as to increase the ambit of power of RBI to wind up and liquidate banks without involving other regulators under the cooperative societies’ laws.
- Conversion of UCBs into small finance banks by RBI should be allowed subject to fulfilment of certain conditions.
- Creation of umbrella organisation for supervising and coordinating the activities of all cooperatives. Such an organisation should be over and above the board of directors and should be reporting directly to RBI so as to bring it under better control.
Cooperative banks play an integral part in the implementation of development plans and are important for the effective functioning of the banking system in India. India is termed as an underbanked country, and after so many scams, it is need of the hour to take necessary measures to remedy the lucane and to boost the confidence and trust of the public in the banking system.
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