Urban Cooperative Banks need Prompt Action

Context:  Urban Cooperative Banks (UCBs) in India face  various operational challenges like frequent license revocations and other regulatory actions. To address this, the Reserve Bank of India is set to replace the Supervisory Action Framework with the Prompt Corrective Action (PCA) Framework in 2025. 

What are Cooperative Banks?

• Cooperative Banks refer to financial institutions under the Banking System in India that operate on the principles of cooperation and mutual benefit for their members.
• Their members are both the owners and customers of the bank.
• They operate on the principle of “one person, one vote” in decision making and are managed on the basis of cooperation, self-help, and no profit no loss.
• Along with lending, these banks also accept deposits.
• They are incorporated and registered under the States’ Cooperative Societies Act passed by the concerned state.

What are Urban Cooperative Banks?

• Urban Cooperative Banks (UCBs) are financial institutions that operate in urban and semi-urban areas in India. 
• They primarily serve the banking needs of small businesses, individuals, and communities in urban areas.
• UCBs were brought under the purview of the Banking Regulation Act, 1949 through an amendment in 1966.
• Until 1996, these banks were allowed to lend money only for non-agricultural purposes. This distinction does not hold today.

Regulation of Urban Cooperative Banks:

• UCBs are registered as societies under the Co-operative Societies Acts of the respective State Governments.
• UCBs that have a multi-State presence are registered under the Multi State Co-operative Societies Act administered by the Government of India.
• Previously, the UCBs were under dual regulation by the state registrar of societies and the RBI.
  • Registration, administration, amalgamation and liquidation of UCBs were governed by the provisions of the State Co-operative Societies Acts.
  • Banking related functions were governed by the provisions of Banking Regulation Act, 1949 (AACS).
• This dual regulation resulted in ambiguity and a lack of clarity, creating additional impediments to effective governance of UCBs.
• In 2020, all UCBs and multi-state cooperatives were brought under the supervision of RBI for banking-related functions through the Banking Regulation (Amendment) Act, 2020.

Banking Regulation Amendment Act, 2020:

Applicability	- Applicable to Scheduled Cooperative banks which include Urban Cooperative Banks, District Cooperative Banks and State Cooperative Banks.  - Not applicable to Non-Scheduled Cooperative Banks.
Enhanced Regulatory Powers of the RBI	- Empowers RBI to remove the chairperson of the Cooperative Banks.  - Extends RBI’s power to supersede the Board of Directors of all the Scheduled Cooperative Banks. (Earlier, RBI was only empowered to supersede the Board of Directors of the Multi-State Cooperative Banks) - RBI can order a special audit of Cooperative Banks.
Issue of Shares	- Cooperative Banks are allowed to issue shares to members or persons residing within Banks’ area of operation.

Challenges Associated with Urban Cooperative Banks:

• Board members as borrowers:
  • Cooperative bank board members can borrow from the banks, unlike the commercial bank board members. 
  • The board members in several cases have misused their borrowing powers to siphon off large sums of money, resulting in major cooperative bank failures. E.g., PMC Bank Failure due to misuse of power by board.
• Financial Challenges: Such as low capitalisation, high levels of Non Performing Assets (NPA), inadequate Capital Adequacy Ratio (CAR).
• Technological Limitations: Many UCBs lag in adopting technologies like Core Banking Solutions (CBS). 
• Decline in number of UCBs: Due to various reasons like unsafe operations to the interests of depositors and the general public, insufficient capital, low earnings, etc. 

RBI’s Prompt Corrective Action: 

• To strengthen UCBs in India, RBI will implement the Prompt Corrective Action (PCA) Framework for UCBs starting April 1, 2025. This will replace the current Supervisory Action Framework (SAF).
• The PCA framework will be applied based on different tiers of UCBs.
  • Tier 1 UCBs: deposits up to ₹100 crore
  • Tier 2 UCBs: deposits b/w ₹100 crore - ₹1,000 crore
  • Tier 3 UCBs: deposits b/w ₹1000 crore - ₹10,000 crore
  • Tier 4 UCBs: deposits above ₹10,000 crore
• Tier 1 UCBs are excluded from PCA Framework for now.
• PCA framework applies to UCBs in Tier 2, Tier 3 and Tier 4.
  • The framework establishes risk thresholds for capital adequacy, asset quality, and profitability.
  • For capital adequacy, breaches are categorised based on the extent to which the levels fall below the regulatory minimum — by up to 250 basis points, 250-400 basis points, or exceeding 400 basis points.
  • In terms of asset quality, thresholds are determined by the level of net non-performing assets (NNPAs), with categories set at 6-9 per cent, 9-12 per cent, and 12 per cent or higher.
• A UCB may exit the PCA framework if it reports no breaches in risk parameters for four consecutive quarters.

Way Forward

• Strict diligence practices through credit assessments, proper documentation, and compliance with legal and regulatory standards. 
• Regular compliance checks: A well-designed compliance programme with a dedicated Chief Compliance Officer (CCO) can help UCBs to adhere to regulatory complexities and maintain operational stability.
• Enhance risk management through risk management committees to oversee activities related to credit and operational risks. 
• Upskilling staff: Regular staff training on compliance and risk management is essential for effective functioning of UCBs.
• Strengthening Audit mechanisms to help meet regulatory standards and restore depositor confidence.

The PCA framework emphasises the need for UCBs to manage credit and concentration risks effectively. This involves diversifying loan portfolios, reducing exposure to risky sectors, and maintaining healthy asset quality.