Banking
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This article is written by Nikuj Mehta, pursuing a Certificate Course in Banking & Finance Practice: Contracts, Disputes & Recovery from LawSikho.

Introduction 

The Banking Regulation (Amendment) Bill 2020 (Bill) was recently passed by the Rajya Sabha in its session dated 22nd September 2020. The Bill has several provisions which will have a long-standing impact on the Banking industry. It endeavors to amend the Banking Regulations Act (Act) and extend its boundaries over the conduct of cooperative banks. Finance Minister Nirmala Sitharaman, while introducing the Bill in the parliament mentioned that after the failure of notable Punjab and Maharashtra Cooperative Bank and other cooperative banks in the recent past, it was a need of the hour to regulate the conduct of such cooperative banks whose failure had severely affected the financial market and disrupted the trust of depositors over the banking industry. (i)

This article initially discusses the lacunas in the existing framework to regulate the conduct of the co-operative banks, the newly enacted framework under the new bill, and the implications it would have on the effective resolution of stressed co-operative banks.

Muddled regulatory framework governing the Cooperative Banks 

Major reasons for the failure of cooperative banks in India is the vague and unclear distribution of regulatory powers over the Cooperative banks amongst the Registrar of Cooperative Societies (ROCS) and the Reserve Bank of India (RBI).  While the Registrar of Cooperative Societies regulate the administrative aspects of these banks, which include the control of management elections and audit related matters, the RBI is empowered with regulating the aspects pertaining to liquidity like license, maintaining cash reserve, statutory liquidity and capital adequacy ratios, and inspection. This bifurcation of powers amongst two regulatory bodies is termed as the problem of dual regulatory framework for regulating the conduct of cooperative banks.

History of dual regulatory framework in India

The problem of dual regulation originates from the division of legislative powers amongst the Centre and State legislature provided under Schedule 7 of the Indian Constitution.(ii) In the said Schedule, though the legislative powers to regulate the banking activities (iii) are provided under the Union list, the legislative powers pertaining to the management of cooperative societies vests with the state governments. For this reason, the regulatory mechanism for cooperative banks is bifurcated into two segments. 

The problem initiated from the 1966 amendment to the Banking Regulation Act, which inserted Part V, specifically dealing with provisions pertaining to the Act’s applicability over certain categories of Co-operative Banks provided under the Second Schedule of the Reserve Bank of India Act. By virtue of this amendment, following actions of the Scheduled Cooperative banks were brought under the supervision of the RBI:

  • Requirement pertaining to minimum paid up capital and reserves 

Section 11 of the Act was amended to include the value of its paid-up capital and reserves is not less than one lakh of rupees.

  • Requirement pertaining to Cash Reserve Ratio (CRR)

The Section 18 of the Act of amended to include the mandate for the Cooperative Banks to maintain a cash reserve ratio with itself, or by way of current account with the RBI, or the State Co-operative bank of the state concerned, and in case of primary co-operative banks with the central co-operative bank of the concerned district. The rate of CRR, as provided under the statute must be decided by the Reserve Bank of India from by way of an official gazette. 

  • Restrictions on holding hare in other co-operative societies

Section 19 of the Act was amended to prevent the cooperatives holding shares amongst other cooperative societies.

  • Restrictions on making certain loans and advances 

Section 20 of the Act was amended to prevent making of certain loans and advances by the cooperative banks on security of their own shares. It further restricts the cooperative banks from giving unsecured loans to any of its directors, firms or private companies Directors is interested as partner of Managing agent or guarantor, or to any other company in which the Chairman of the Board of Directors of the co-operative bank (where the appointment of a Chairman is for a fixed term) is interested as its Managing agent, or where there is no Managing agent, as its Chairman or Managing Director.

  • Requirement of licence for primary cooperative banks

Section 22 of the Act was amended to mandate the primary cooperative banks to get a licence from the Reserve Bank of India for performing the Banking business defined under the Act. 

  • Restriction on changing the place of business

Section 23 of the Act was amended to prohibit the cooperative banks from opening a new place of business or change its existing place of business without prior permission of the Reserve Bank.

  • Requirements of preparing a balance sheet and profit and loss statement

The amendment prescribes every cooperative bank to prepare a balance sheet and profit and loss on 30th June every year in the. Format of the forms prescribed by the Central Government in the Schedule to the Act.

  • Power of RBI to conduct Audit

Section 30 of the Act was amended to empower the RBI to conduct an additional audit of the Cooperative Bank, when it deems necessary in the interest of the public, cooperative bank, or its depositors. 

  • Power of RBI to suppress the Board of Directors 

The RBI in may, in public interest, in the interest of depositors, or to preserve the business of the cooperative bank suppress the Board of Directors of the ‘primary cooperative’ Banks. This section excluded other cooperative banks from its ambit. Section 36AAA was amended to inculcate this power. It was amended to restrict the said power to supersede the Board for a period up to 5 years.

These points indicate the existing powers with the RBI under the Banking Regulation Act, to regulate the conduct of the Cooperative Banks. The amended provisions of the Banking Regulation Act, along with other state legislations constitute the dual regulatory framework for cooperative banks in India. This bifurcation of powers amongst RBI and ROCS of states has limited the RBI’s powers to efficiently regulate the distressed cooperative banks, and revive them without disrupting the financial market, and the interests of depositors.

Need for new regulations 

Failure of multiple cooperative banks in the recent past indicate the lacunae in the current regulatory framework to take adequate measures in resolving financial stress amongst the cooperative banks which have reached the stage of financial distress making them incapable of performing their regular functions. To name a few, the list of failed financially distressed co-operative banks include the Madhavpur Co-operative bank, for which the government had to implement a 10-year revival scheme, which could still not improve the financial situation of the bank, and its rising NPAs. (iv)

This was succeeded by the failure of Punjab and Maharashtra Cooperative Bank (PMC), in 2019 which compelled the RBI to issue directions under Section 35A(1), by virtue of which the RBI, while seizing the operations of the bank, had to put a cap on the daily withdrawals made by depositors. Recently the RBI, after the failure of a 10 year revival plan, cancelled the licence of the CKP Co-operative bank. (v)

Following the failure of Madhavpur Co-operative Bank, a committee was set up by the RBI under the chairmanship of K. Madhav Rao. The committee in its report submitted in the year 1999, primarily extended its concern regarding the scale of operations of Urban Commercial banks and the need for intervention of the RBI in their operations.(vi) The committee noted that as the bank extends its area of operation, there cooperative character tends to weaken and it assumes more and more the character of a commercial bank. Therefore, such extension must be accompanied by prescription of conditions under which commercial banks are allowed to operate. For these reasons, the committee proposed to enact norms to regulate management and the banking operations of the urban cooperative banks. It further proposed to take remedial actions for ensuring that any financially weak bank does not become a sick bank.

Amendments incorporated by the bill

The bill attempts to bring following amendments into force:

  • Applicability of Banking Regulation Act

The amendment extends the applicability of the Banking Regulation Act over the Primary cooperative banks defined under Section 56(ccv) of the Banking Regulations Act, Central co-operative bank, state co-operative banks. This eradicates the bifurcation made by the previous enactments which amongst the different co-operative societies incorporated under various state legislations. By doing this, a major line of bifurcation of roles between the RBI and the ROCS.

  • Power to make a scheme for reconstruction/amalgamation without imposing moratorium 

Section 45 of the Act was amended which has now enabled the RBI to enact a scheme for the purpose of protecting the interest of depositors, public at large, or to ensure the proper management, without imposing a moratorium on the functioning of the company.

This move is to avoid situations like the PMC bank, wherein the RBI imposed a moratorium on the functioning of the bank, with an aim to prevent the existing management of the bank to operate the bank against the interests of depositors. This has given a big blow to the depositors of the bank, who had to withdraw only up to a capped amount from their deposits with the bank. Since the banks under moratorium couldn’t discharge any of its liabilities or make any payments, the financial system at large would get disrupted while placing the distressed banks under moratorium. (vii)

  • Power to remove ceiling on issuance of shares and securities by co-operative banks

The bill purports that with prior approval of RBI, the co-operative banks regulate their paid up share capital and issue their securities to any of its members or any other person residing within its area of operation.  The bill further provides for a restriction on the banks from reducing their share capital, and withdrawal from share capital, unless it is specified by the RBI to do so.

This is in line with the recommendations provided by the working group formed by the RBI under the chairmanship of NS Vishwanathan examine augmenting capital of urban cooperative banks. The group raised concerns regarding non-existence of restrictions on the withdrawals from the share capital of UCBs, and limited avenues available to UCBs for raising their funds. (viii)

The bill is in contrast with the framework for raising additional funds from existing members proposed by the working group. The group discussed the ceilings prescribed under various state legislations regulating the individual shareholding of the UCBs. Before directly giving RBI the power to permit the UCBs from raising capitals from existing members, the working group prescribed for requesting the state governments to exempt the UCBs from the existing monetary ceiling on individual shareholding either through a notification or through amendment to the Act, where necessary.

Being a constitutional mandate, to enforce the provision would require the lifting of such restrictions and ceilings provided under the state legislations, before empowering the RBI  to provide for regulating such actions. 

  • Power to interfere with management of cooperative banks

The Bill empowers the RBI to supersede the Board of Directors of multi state cooperative banks for up to five years in i) Public interest, and ii) with an aim to protect the interests of depositors. It has restricted the RBI from exercising the said power only after consultation with the state government regulating the operations of the said bank. This power granted to the RBI is an extension to the provisions under Section 36ACA of the Act, which empowers them to suppress such the board of directors of ordinary banks.

Though empowering the RBI with powers to supersede the Board of Directors of financially distressed Cooperative banks, the bill doesn’t empower the regulator with the power to interfere with the management of Co-operative banks without suppressing its board of directors. 

An efficient way to interfere with the management of cooperative banks by the RBI was discussed by the working group set up by the Financial Sector Legislative Reforms Commission (FSLRC) on 1st March 2013.  In recommendation 36 of the said working group recommendation it was suggested to bifurcate the management of the co-operative banks in two parts. Where the Board of Directors, appointed by the Registrar of Co-operative Societies, would formally head the co-operative society registered under the state legislation, the banking segment of the society would be headed by a board of management whose oversight will be done by the RBI. This enactment of the said suggestion would be a more viable solution for effective regulation of the cooperative banks would be done by the RBI and Registrar of Cooperative Society. (ix)

  • Power to exempt cooperative banks

The bill elucidates that the RBI would be entitled to exclude the provisions relating to:

  1. Restrictions of certain types of employment
  2. Qualifications of the Board of Directors
  3. The appointment of Chairman

The exemption will be available to certain co-operative banks or any class of them as decided by the RBI.

The power to supersede board of directors, relax the ceiling on issuance of securities, and adopt a scheme of reviving cooperative banks without imposing a moratorium on its actions, are certain powers granted to the Registrar of Cooperative Societies of each state under state legislations. These have blurred the bifurcation of powers which currently exists between the RBI and the ROCS.

Comparison of the new and old framework 

 

Subject

Old framework

New framework 

 

Applicability of the Act

Only on primary cooperative banks and multi state cooperative banks.

On all the cooperative banks except primary agricultural credit societies. 

 

Power to make a scheme for reconstruction/amalgamation without imposing moratorium.

A moratorium had to be imposed on the business of a financially distressed cooperative bank, while implementing a scheme under Section 45 of the Act.

A reconstruction/amalgamation plan scheme under Section 45 can now be implemented without imposing a moratorium on the business of the bank.

 

Power to remove ceiling on issuance of shares and securities to existing members of cooperative society. 

RBI had no power to relax such a ceiling.

RBI granted with power to relax such ceiling on issuance of securities in consultation with the Central Government.

       
 

Power to supersede Board of Directors.

RBI had the power to supersede the BOD of only primary cooperative banks. 

RBI can supersede the BOD of primary and multi state cooperative banks. 

       

Conclusion and analysis

The introduced bill brings several well suggested and well discussed provisions into effect. These enactments now equip the regulator with sufficient power to efficiently resolve the financially distressed cooperative banks. Even while not considering recommendations of FSLRC, the current enactment is a step taken by the legislature in the right direction towards effective regulation of the conduct of the co-operative banks. 

References

  1. 17th Lok Sabha, winter session 2020, accessible from: http://loksabhaph.nic.in/Debates/Result17.aspx?dbsl=3504 
  2. Indian Constitution, Schedule 7, List II, Entry 32. 
  3. Indian Constitution, Schedule 7, List I, Entry 45.
  4. Evolution of Urban Co-operative Banks in India and their current status, IOSR Journal of Business and Management (IOSR-JBM), e-ISSN: 2278-487X, p-ISSN: 2319-7668. Volume 19, Issue 7. Ver. V. (July 2017), PP 17-21.
  5. Available at: https://lawschoolpolicyreview.com/2020/07/03/dual-regulation-of-co-operative-banks-a-constitutional-and-policy-analysis/
  6. Madhav Rao Committee Report, accessible from: https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?ID=130 
  7. Available at: https://www.thehindu.com/business/Industry/betrayed-by-a-bank-how-the-collapse-of-punjab-and-maharashtra-cooperative-bank-left-thousands-in-distress/article29986064.ece
  8. Working Committee, chaired by N.S. Vishwanathan, Available at: https://rbidocs.rbi.org.in/rdocs//PublicationReport/Pdfs/74324.pdf
  9. Report of the Working Group on Banking Financial Sector Legislative Reforms Commission (2013), Available at: https://macrofinance.nipfp.org.in/fslrc/documents/wg_banking_report.pdf

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