March 1, 2024

Banking laws and regulations governing co-operative banks in India

This article has been written by Ms. Aanchal Rawat, a 5th year student of R N Patel Ipcowala School of Law and Justice, Vallabh Vidhyanagar. 

ABSTRACT:

This article aims to provide a comprehensive overview of the laws and regulations governing cooperative banks in India. It will delve into the historical context, the current legal framework, and the role of various regulatory bodies. The article will also discuss the challenges faced by these banks and the impact of recent regulatory changes.

  • INTRODUCTION

Cooperative banks, an integral component of India’s banking sector, have a rich history that dates back to the early 20th century. These banks, founded on the principles of cooperation, mutual help, and self-help, have been instrumental in providing essential financial services to millions of Indians, particularly in rural and semi-urban areas. They have played a significant role in promoting financial inclusion, rural development, and socio-economic progress.

However, the governance and operation of cooperative banks in India are subject to a complex legal framework. This framework involves both central and state laws, making the regulatory landscape multifaceted. The Banking Regulation Act, 1949, amended over time, provides the central legal structure governing these banks. Additionally, various state laws and the role of the Reserve Bank of India (RBI) add layers of complexity to this framework.

This article aims to provide a comprehensive overview of the laws and regulations governing cooperative banks in India. It will delve into the historical context, tracing the evolution of these banks and the legislative changes over time. The article will also shed light on the current legal framework, discussing the role of the RBI and its regulatory powers, as well as the impact of state laws on the functioning of cooperative banks.

Furthermore, the article will discuss the challenges faced by cooperative banks in India. These challenges range from governance issues and financial health to regulatory compliance. The article will also analyze the impact of recent regulatory changes on the functioning of cooperative banks. These changes, brought about by amendments to the Banking Regulation Act, have significant implications for the governance and operations of cooperative banks.

  • ORIGIN AND EVOLUTION OF COOPERATIVE BANKS IN INDIA

The cooperative banking movement in India traces its origins back to the early 20th century. The first significant step was the passing of the Cooperative Societies Act in 1904, which laid the groundwork for cooperative societies, including cooperative banks. The first credit cooperative society was established in Bengal in 1903. These cooperative banks were established on a cooperative basis and primarily dealt with ordinary banking business. Their main focus was on rural credit, providing financial assistance for agricultural and rural activities. The structure of cooperative banking in India is federal, with primary credit societies forming the base, central cooperative banks at the district level, and state cooperative banks at the state level. Over the years, there have been several key legislative changes. The Cooperative Societies Act of 1912 was enacted to rectify some of the drawbacks of the 1904 Act. In 1919, cooperation became a State subject. More recently, the Banking Regulation (Amendment) Bill, 2020 brought the regulation of cooperative banks under the Act in line with that of commercial banks. This amendment eased capital raising constraints of urban cooperative banks (UCBs). The Reserve Bank of India (RBI) has also been initiating reforms to strengthen the cooperative banking structure. This evolution of cooperative banks in India represents a significant aspect of the country’s banking and financial history.

  • CURRENT LEGAL FRAMEWORK
  • Overview of the Banking Regulation Act, 1949: The Banking Regulation Act of 1949 is crucial legislation governing the banking sector in India. Originally enacted as the Banking Companies Act 1949, it commenced on 16 March 1949 and was renamed to the Banking Regulation Act 1949 from 1 March 1966. The Act sets forth regulations on management, operations, governance, capital requirements, lending norms, and investment policies of banks. Its main objective is to promote a sound banking environment, ensuring financial stability and protecting the interests of depositors.
  • Role of the Reserve Bank of India and its Regulatory Powers: The Reserve Bank of India, established under the Reserve Bank of India Act of 1934, is the central banking institution responsible for regulating the monetary and financial system of India. Its comprehensive regulatory powers include oversight of monetary policy, foreign exchange management, as well as functioning as the supervisor for the banking system, with a focus on ensuring public confidence, maintaining stable interest rates, and providing a framework for a secure and efficient financial environment.
  • State Laws Governing Cooperative Banks: Cooperative banks in India are registered under the States Cooperative Societies Act. They also come under the regulatory ambit of the Reserve Bank of India (RBI) under two laws, namely, the Banking Regulations Act, 1949, and the Banking Laws (Co-operative Societies) Act, 1955. The incorporation, regulation, and winding up of co-operative societies (other than those operating in more than one State) is a State subject and is governed by the State laws on co-operative societies. In the case of co-operatives with objects not confined to one State, their incorporation, regulation, and winding up fall in the central domain and are governed by the Multi-State Co-operative Societies Act, 2002.
  • REGULATORY BODIES
  • Role of the RBI in Regulation and Supervision: The Reserve Bank of India is the principal regulatory authority for the banking system in India. It oversees not just the banking sector but also non-banking financial institutions. Responsibilities include managing the nation’s currency, defining monetary policy, and ensuring economic stability. The RBI employs a regulatory approach based on three main principles: promoting sound governance, addressing vulnerabilities at their core, and enhancing the resilience of the banking sector in terms of finance, operations, and organization.
  • Role of the Central Registrar of Cooperative Societies: The Central Registrar of Cooperative Societies is responsible for administering the Multi-State Cooperative Societies Act. The office manages the registration, regulation, and supervision of cooperative societies that operate across state lines, overseeing their governance, including annual filings, bylaw amendments, and election matters. It also analyzes annual returns and audit reports of these cooperatives.
  • Role of State Cooperative Societies: State Cooperative Societies are governed under the State Cooperative Societies Act and are overseen by the respective state governments. These societies act as conduits for state programs, promoting economic and social development at the regional level through cooperative efforts. They function with state support, assuming roles similar to those of public sector units, helping in the socio-economic upliftment within their operational states.
  • CHALLENGES FACED BY COOPERATIVE BANKS
  1. Governance Issues: Cooperative banks in India encounter governance challenges due to their unique ownership structures, which sometimes lead to suboptimal governance practices and increased occurrences of fraud. Their ability to expand and enhance their operations is constrained by their structure, which limits capital accessibility. Additionally, the oversight responsibilities are not always clear, with both the RBI and state governments involved, leading to potential governance ambiguities.
  2. Financial Health and Stability: In the fiscal year 2021-22, the financial status of urban cooperative banks improved, marked by stronger capital reserves, a reduction in the ratio of gross non-performing assets, and elevated profit levels. Despite these improvements, the sector has struggled with substantial loan defaults and weakened trust from depositors due to fraud incidents. In the year 2019- 20, the growth of UCBs was restrained, with a slowdown in deposit collection impacting the liability side, and a subdued increase in lending activities affecting the asset side.
  3. Regulatory Compliance: Cooperative banks are dealing with challenges that stem from being overseen by both the Reserve Bank of India and governmental bodies. This dual regulation can create challenges, including legal obstacles and unique factors that can delay the resolution of issues. Following the legislative amendments to the Banking Regulation Act in September of the previous year, the cooperative banks have become subject to stricter RBI supervision.
  4. Other Challenges: In addition to internal challenges, cooperative banks face external competitive pressures from better-resourced banks. Many State Cooperative Banks and District Central Cooperative Banks continue to struggle with inadequate technological infrastructure and digital literacy, which challenges their competitive edge and service delivery. Primary Agricultural Credit Societies and long-term rural credit cooperatives play a crucial role in the rural credit landscape yet remain outside the RBI’s regulatory framework. These entities have a mixed record in terms of profitability and maintaining asset quality
  • IMPACT OF RECENT REGULATORY CHANGES
  • Analysis of the Recent Amendments to the Banking Regulation Act: The 2020 amendment to the Banking Regulation Act was proposed to broaden the Reserve Bank of India’s oversight over cooperative banks. The objectives of these amendments are to enhance the governance of these banks, secure the savings of depositors, and bolster the financial robustness of the cooperative banking sector. The legislation allows cooperative banks to seek external capital through equity or unsecured debt, pending RBI’s approval. It also grants the RBI the authority to dismiss a Chairman who falls short of the ‘fit and proper’ criteria and to replace a chairman with someone who meets the required standards. Additionally, the RBI has been given the power to disband a cooperative bank’s Board of Directors with the state government’s input. Another significant shift is the RBI’s ability to initiate the restructuring or merger of a bank without enforcing a moratorium, enhancing the bank’s ability to recover without halting its operations.
  • Impact on the Governance and Operations of Cooperative Banks: The revisions to the Banking Regulation Act focus on reinforcing the governance framework of cooperative banks while ensuring the security of depositor funds. The amendments permit the RBI to proceed with the consolidation of banks seamlessly, without the need for a moratorium, ensuring that cooperative banks are subject to the same stringent governance and sound banking standards under RBI directives. Furthermore, the amendments facilitate cooperative banks in raising capital by issuing shares to members and individuals within their service area, although the restrictions on share capital redemption could limit member exit options. The incorporation of cooperative banks under RBI supervision has fortified the banking system and enhanced depositor protection by subjecting these banks to rigorous oversight and regulatory standards.
  • CASE STUDIES
  1. Saraswat Co-operative Bank: This bank has experienced continuous business growth over the last two decades and has adopted various strategic initiatives, including Business Process Reengineering. It has emerged as the largest Urban Co-operative Bank in India and even in Asia. The notable performance of Saraswat Bank, its comparative success against other banks, and the factors contributing to its success have seen it transition from a cooperative entity towards a more comprehensive private bank model.

 

    1. Urban Cooperative Banking in India: This study examines the principal challenges confronting the Urban Cooperative Banks sector and proposes directions for the future. It covers the difficulties associated with business models, governance, and the need for professional management within UCBs.
    2. Cooperative Bank Scams in India: This case study provides insights into various fraudulent activities and misconduct in India’s cooperative banking sector and the subsequent impact on the broader financial system.
  • RBI’s Interventions and Legal Framework: The Reserve Bank of India has been proactive in reinforcing the cooperative banking system through statutory reforms and regulatory assistance. The Banking Regulation Act amendment in 2020 has facilitated capital raising for urban cooperative banks, while also granting the RBI enhanced powers for restructuring or merging banks.

The RBI has formed an Expert Committee on Urban Co-operative Banks to investigate the sector’s issues, offer a roadmap for the medium-term, propose measures for quicker UCB resolutions, and recommend regulatory changes to capitalize on recent legislative updates to the Banking Regulation Act.

There is consideration by the RBI to include urban cooperative banks in the prompt corrective action framework, which aims to fortify the cooperative banking sector lenders.

An RBI appointed panel has advocated for the fast-tracking of the establishment of an umbrella organization. This would allow smaller urban cooperative banks to grow by joining a larger network. The panel has also recommended that the RBI should adopt a proactive approach regarding the mergers of cooperative banks, supporting voluntary mergers and intervening in mergers when necessary to address issues within the cooperative banking sector.

  • CONCLUSION

In conclusion, the regulatory framework and recent amendments have significantly impacted the governance, operations, and financial stability of cooperative banks in India. The amendments to the Banking Regulation Act have enhanced the oversight and governance of cooperative banks, allowing for the strengthening of their financial robustness and ensuring the security of depositor funds. With the Reserve Bank of India taking a more proactive role in regulating cooperative banks, there is potential for improved stability and trust in the sector. Nevertheless, cooperative banks still face challenges in governance, financial health, and regulatory compliance, which will require ongoing attention and strategic management.

Moving forward, it will be essential for cooperative banks to address governance issues, strengthen their financial health and stability, and effectively navigate the dual regulatory oversight. Embracing technological advancements and digital literacy will also be crucial in maintaining their competitiveness and service delivery. Furthermore, cooperative banks will need to adapt to the changing regulatory landscape and capitalize on the opportunities presented by the recent amendments to the Banking Regulation Act to ensure their long-term viability and success in the Indian banking sector.

  • REFERENCES
    1. This article “Three pillars of RBI’s regulation and supervision approach” was originally written by Riddhima Gupta published on ET BFSI website. The link for the same is herein. https://bfsi.economictimes.indiatimes.com/news/policy/three-pillars-of-rbis-regulation-and-supervision-approach/99817308 
  1. This article “Central Registrar of Cooperative Societies” was originally written by Ministry Of Cooperation published on Ministry Of Cooperation website. The link for the same is herein. https://www.cooperation.gov.in/central-registrar-cooperative-societies 
    1. This article “Features of Banking Regulation Act, 1949” was originally written by Law Aimers published on Law Aimers website. The link for the same is herein. https://lawaimers.com/features-of-banking-regulation-act-1949/ 
    2. This article “Urban Cooperative Banking in India: Key Issues and Way Forward” was originally written by Dr Ashish Srivastava published on The Indian Banker, Indian Bank Association, ISSN 2349-7483. Volume VIII, No 11, June 2021. pp 22-27. The link for the same is herein. https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3864948 
    3. This article “Co-operative Bank Turning to Private : A Case Study on Saraswat Co-operative Bank” was originally written by Anupam Mitra published on The Management Accountant |August 2012. The link for the same is herein. https://icmai.in/Knowledge-Bank/upload/case-study/2012/Co-operative-Bank.pdf 
    1. This article “RBI mulls PCA framework for cooperative banks” was originally written by ET BFSI published on ET BFSI website. The link for the same is herein. https://bfsi.economictimes.indiatimes.com/news/policy/rbi-mulls-pca-framework-for-cooperative-banks/100696842 

 

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