by Radhika Pandey and Sumathi Chandrashekaran
The facts: A troubled decade for the Rupee Cooperative Bank (2002-2013)
It was a little over a decade ago when
Rupee Cooperative Bank (RCB)
began
to show signs of distress. In 2002, the bank faced a liquidity crisis
due to non-recovery of loans, prompting RBI to appoint
an administrator
for the bank. This involves the bank coming under
the supervision of the administrator, and is usually accompanied with
the bank losing the freedom to carry on certain basic functions, such
as accepting deposits or giving out loans.
In the case of RCB, after five years under the 'supervision' of
administrators, fresh elections were held and a new board of directors
was elected. The task at hand for the new board was to recover overdue
loans of Rs 360 crore. As things turned out, they could not recover
the full amount. Over the years, RBI's watchful eye on the bank did
not wane. In 2011, RBI imposed a fine of Rs 5 lakh
on RCB for violating its directives regarding the limits and scope of
business permitted to be carried out by cooperative banks. The
violations included discounting a cheque for an amount higher than Rs
25,000; and releasing a loan of over Rs 25 lakh for land purchase
which exceeded the general limits set by RBI for cooperative banks. In
2012, another similar fine was imposed because RCB had unauthorisedly
sanctioned cash credit facility exceeding Rs 1 lakh to four customers.
Anyone looking at the dateline of events would expect trouble to be
looming large ahead. Earlier this year, with effect from close of
business
on 22
February 2013, RBI placed RCB under harsh restrictions, under
the Banking Regulation Act, 1949. There were also
restrictions on banking activities - RCB would not be able to grant
or renew loans and advances, make investment, incur liability (i.e.,
borrow funds or accept fresh deposits), disburse or agree to disburse
payments, enter into compromise or arrangement and sell, transfer or
otherwise dispose of any of its properties or assets, and so on. RCB
has not as yet lost its license, according to the RBI, which issued a
clarification that the directions should not be construed as
cancellation of banking licence.
Before the directions were issued, six directors of RCB had
resigned in early February 2013 "over differences on loan
recovery". A day after the directions were issued, on February 24,
the six directors withdrew
their resignation "to work in the interest of the bank". RBI
would not have any of it, and dissolved the Board of Directors on 26
February. In its place, it appointed a two-member administrative
board, chaired by a career bureaucrat, and an experienced
administrator, who had earlier handled the merger of another bank with
a public sector entity.
Why is this a malady?
These events have been bad for the depositors. They are now allowed
to withdraw only upto Rs 1000 per account. Effectively, they have lost
their money (other than what is protected under deposit
insurance).
What is the source of this malady?
Cooperative banks, being cooperative societies that offer banking
services, have a peculiar status in India because of how the two
subjects are treated in the Constitution of India: 'cooperative
societies' are a subject of state governance; whereas 'banking' is a
subject of central interest.
There are legal arrangements that permit RBI to partially handle
cooperative banks, but managing the failure of cooperative banks has problems:
- Long delays before RBI takes serious action: The
administration of a bank is given multiple opportunities to salvage
its position. RCB, for instance, showed early signs of distress in
2002, but was permitted to stay alive for over a decade before final
directions were issued. The position of cooperative banks is perhaps
more problematic because of the political stake involved: some of
the more prominent cooperative banks failing in the recent past died
a slow death because high-ranking politicians were associated with
them. - Long delays to close down the failed bank: The process
of managing the failure of a bank is slow, and the tools available
to RBI are limited. This problem, in theory, is shared by
all failing banks. In practice, however, most failing banks have
been only cooperative banks, which are therefore at the receiving
end of procedural and administrative delays. - Long delays for claim settlement: Due to the frequent
failure of cooperative banks, combined with fixed deposit insurance
premiums, the DICGC invariably has to pay out claims of an order far
higher than premiums collected from these banks. This hits the
ordinary depositors the most, who, in the case of cooperative banks,
are more likely to be small depositors, from the unorganised sector,
farmers, or small traders.
The Centre is not entirely powerless when it comes to cooperative
banks. Under Part V of the Banking Regulation Act, RBI has some micro-prudential
powers with respect to cooperative banks, similar to but significantly
weaker than those it has with respect to commercial banks. But the
application of these powers is made difficult, particularly in the
context of winding up of cooperative banks, because of the
centre-state arrangement.
Additionally, the
Deposit Insurance and Credit Guarantee Corporation (DICGC), the RBI
subsidiary that pays out to depositors of failed insured banks, covers
cooperative banks'' under its deposit insurance scheme. Eligible
cooperative banks, according to the DICGC Act, are those functioning
in such states/union territories that have amended their Co-operative
Societies Act to incorporate two features: first, that RBI may order
the concerned Registrar of Cooperative Societies to wind up a
cooperative bank or to supersede its committee of management; and
second, that the Registrar may not take any action of its own accord
for winding up, amalgamation or reconstruction of a cooperative bank
without prior sanction from RBI.
The IFC solution
The Financial
Sector Legislative Reforms Commission (FSLRC), through
the draft
Indian Financial Code (IFC) offers a solution to this
malady. While other solutions are possible, the present
centre-state governance arrangement allows only limited room for
maneuver with regard to the resolvability of cooperative banks.
The IFC creates a Resolution Corporation, which will resolve
financial service providers that show signs of financial
distress. This would include those who offer banking services. The
Resolution Corporation will detect financial trouble at an early stage
and will be empowered with a significantly more robust set of tools to
close down a failing financial service provider than the RBI is
presently empowered with.
The IFC recognises that the process of resolving failed financial
institutions is closely intertwined with micro-prudential
regulation. Therefore, the IFC provides for a structured framework of
regulatory intervention and information-sharing between the
micro-prudential regulator and the Resolution Corporation. The
Resolution Corporation will have a wider mandate than the present
DICGC. It will be responsible for prompt resolution of trouble
financial service providers and for paying compensation to the
consumers of failed financial service providers.
Under the IFC, the Resolution Corporation has the duty to insure
(Section 260):
(a) each consumer of a specified category of covered obligations
with a covered service provider to the extent of a specified limit;
and
(b) each covered service provider to the extent of a specified
limit.
The IFC permits the Resolution Corporation to manage the failure of
only eligible financial service providers who fall within the ambit of
micro-prudential regulation. This narrower class of financial service
providers are referred to as ''Covered Service Providers'' i.e. those
who make covered obligations. How is this determined?
The ultimate goal of resolution is consumer protection. Keeping this
goal in mind, the specified categories of covered obligations, who
will fall within the ambit of the Resolution Corporation, will be
determined by the Regulator, in consultation with the Resolution
Corporation. The determination will be based on the following
principles Ssection 260(4)) :
(a) the detriment that may be caused to consumers if obligations
owed to them are not fulfilled by a covered service provider;
(b) the lack of ability of consumers to access and process
information relating to the safety and soundness of the covered
service provider; and
(c) the inherent difficulties that may arise for financial service
providers in fulfilling those obligations.
In addition to the financial service providers who make covered
obligations based on the above principles, the class of covered
service providers will also include systemically important financial
institutions (SIFIs).
These principles are in consonance with the test for the intensity of
micro-prudential regulation that is followed in the IFC. Applying
these tests on the activities of cooperative banks shows that similar
obligations are made by such banks to their consumers, and they would
logically be covered by the Resolution Corporation. By extension,
cooperative banks that make such obligations will have to apply for
Corporation insurance, and in order to do so, will have to first
submit to the micro-prudential regulatory conditions set by the
regulator.
Therefore, for cooperative banks, it will no longer be sufficient for
RBI to be empowered to order the State Registrar of Cooperative
Societies to liquidate, amalgamate or reconstruct a cooperative bank,
or to supersede management. Instead, in order to be eligible for
insurance from the Resolution Corporation), State governments will
have to co-opt RBI as the banking regulator of cooperative banks in
that state under law. Upon becoming eligible for Corporation
insurance, cooperative banks would be charged premia according to
their risk position. This is contrary to the present practice of
collecting fixed deposit insurance premia from all eligible banks.
If the State governments do not co-opt RBI as the banking regulator
under law, then banks such as RCB would not be eligible for insurance
cover from the Resolution Corporation, and by corollary, may not be
permitted to carry on certain types of activities that need
Corporation protection (refer to the discussion earlier on specified
obligations).
Cooperative banks that are regulated poorly, or not at all, because of
the present dual regulatory arrangement, will continue to pose
considerable risks to the soundness of the financial system until some
drastic changes occur. The IFC, being a central legislation, comes
with its challenges, because it is not able to directly impinge on
what is otherwise a subject of state supervision under the
Constitution of India. But through structural design, it is possible
to compel the State governments to embrace the well-defined regulatory
and supervisory expertise of an RBI and a Resolution Corporation as
laid out in the IFC.
The authors are grateful to Smriti Parsheera for useful inputs.
0 comments:
Post a Comment