Hyderabad: Strengthening banking system to cope with the emerging challenges is a journey in perpetuity. The government and regulators have been innovating methods to provide a safe, secured and stable financial system to ensure its active role in funding economic growth.
Due to many external and internal factors, the banking and financial system has been experiencing turbulence, notably the failure of Infrastructure Leasing & Financial Services Limited (IL&FS), Punjab and Maharashtra Cooperative (PMC) Bank fiasco and near failure of Yes Bank.
Similar failures in multi state cooperative banks and cooperative banks have hurt the interest of large number of retail customers whose life and livelihood is linked to their smooth functioning. Cooperative banks have been anchoring prime role in financial inclusion for over a century serving effectively the lower and middle strata of the society.
The collateral damage due to these adversities in the financial system caused immense damage to the prospects of growth and enterprise. Consequently, many innocent stakeholders were exposed to untold sufferings eroding systemic confidence.
Tightening corporate governance, enhancing statutory and regulatory grip on the financial intermediaries and adequately empowering regulators for drastic intervention is felt essential.
Impact of ordinance on Private Banks
Keeping these expedient factors, government has amended Banking Regulation Act (BRA) 1949 through an ordinance to further empower RBI to intervene in time to and apprehend and prevent crisis, if any in private banks. A significant reform comes from amendment to Section 45 of BRA 1949 that enables RBI to work out a reconstruction or amalgamation scheme for any ailing private bank without necessarily putting it under moratorium and imposing restrictions for withdrawal of deposits.
Earlier, RBI was required to invoke section 45 against a private bank in distress only after putting customers/borrowers in distress due to moratorium bringing ignominy of the underlying entity under public glare. RBI has to first impose moratorium, appoint an administrator, limit withdrawal of deposits and then can draw up a rescue plan like what was recently done in Yes Bank.
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Imposing moratorium disrupts the banking operations, limits access to deposits and stop credit flow with its huge collateral damage. Even the maintenance of day today activities of bank customers and businesses of small traders are adversely impacted forcing panic reactions and social distress.
The current step a good move to enable RBI to restructure, amalgamate or recast private banks in distress before it impacts customers. With catastrophic developments from the ongoing pandemic and uncertainty looming large, more closer surveillance and systemic regulatory controls will be able to prevent collapse of vulnerable financial entities.
Post the amendment; banks in the knowledge of RBI powers to invoke section 45 of BRA may mend their governance so as to avert a crisis inviting drastic regulatory intervention.
Impact on Cooperative banks
The Second leg of Banking Regulation (Amendment) ordinance has amended section 56 of BRA 1949 to empower RBI to gain supervisory control on the cooperative banking sector. It will benefit grass root level bank customers with better management and sound regulation of cooperative banks.
The new rules will be applicable to both 1,482 urban cooperative banks and 58 multi-state cooperative banks, assuring estimated 86 million depositors that their deposits working out close to Rs 4.84 lakh crore (market share 3.5 percent) out of total banking industry deposits of Rs.138 lakh crore will stay safe.
Hitherto, weak corporate governance has been one of the major factors that is plaguing the cooperative banking sector and have led to bank failures/unsatisfactory growth. Co-operation being a State subject, RBI does not have adequate control on the management of these banks.
The provisions of Section 10A of the B. R. Act, 1949 are not applicable to them. The fit and proper criteria for CEO / Board members as envisaged in Section 10B of the Act are also not prescribed.
However, the new ordinance will not affect the existing powers of the state registrars of cooperative societies and the amendments do not apply to close to 90,000 Primary Agricultural Credit Societies (PACS) or cooperative societies whose primary object and principal business is long-term finance for agricultural development. They will continue to be governed under Cooperative Societies Act 1904.
It will be contextual to refer to a ‘Report of high-powered committee on Urban Cooperative Banks (Chairman R. Gandhi) in June 2015 identified several weaknesses and made recommendations to resurrect the sector.
Among them, there was an option for Urban Cooperative banks to get converted into Small Finance bank. After this amendment, some, stronger of them can offer to transform into SFBs shaping like mini commercial banks that will be in the larger interest of stakeholders.
Way forward
The ordinance route when seen together with the recent discussion paper of RBI on ‘Governance in commercial banks in India’ is set to make banking sector more robust and prepared to meet the near term challenges due to pandemic and geopolitical risks. It can prepare to meet long-term challenges to tow the economy towards the target of US $ 5 lakh crore.
But the ordinance passed on the challenge to the central bank. Presently looking after 141 banks has to scale up to oversee small but large number of cooperative banks that have connect with the diverse range of customers at the bottom of the pyramid.
The social impact of their suffering reverberates the micro economy more prominently. The challenges will be more daunting as the cooperative banking sector is not technologically well equipped to provide an ecosystem for off-site surveillance.
Enhancing on site scrutiny of such large number of geographically diverse entities would require huge scaling up of trained human resources. But from the customers’ perspective, amid enhanced deposit insurance of Rs. 5 lakh, better comfort and assurance is waiting as the bank reforms begin to improve the day today banking operations at the branches of cooperative banks too.
(Article by Dr K. Srinivasa Rao. He is Adjunct Professor, Institute of Insurance and Risk Management – IIRM, Hyderabad. Views expressed above are his own.)
