Why in the news?

The RBI has imposed a six-month moratorium on New India Co-operative Bank Limited, restricting loans, deposits, and withdrawals.

More on the news

• According to the RBI, these measures have been taken due to concerns over the bank's financial stability and liquidity situation. 

• The RBI also superseded its Board of Directors for 12 months, citing "poor governance standards".

About Urban Cooperative Banks

• Urban Cooperative Banks (UCBs) are a subset of cooperative banks in India that operate primarily in urban and semi-urban areas.
• History:  The Cooperative Credit Societies Act of 1904 (during Lord Curzon's tenure) and its 1912 amendment laid the legal foundation for these institutions.
  • The first urban cooperative credit society was established in 1889 in Baroda (Anyonya Sahakari Mandali).
• Currently, they are registered as cooperative societies under the respective State Cooperative Societies Acts (for single-state operations) or the Multi-State Cooperative Societies Act, 2002 (for operations across multiple states).
• Control and Regulation: UCBs function under a dual regulatory framework:
  • Banking Regulation Act, 1949:  Since 1966, RBI has been supervising UCBs regarding licensing, capital adequacy, loan policies, and financial stability.
    • The Banking Regulation (Amendment) Act, 2020 has given RBI more control over UCBs, allowing it to intervene in their management and governance.
  •  Registrar of Cooperative Societies (RCS): The respective state governments or the central government control administrative functions through the RCS.

Significance of UCBs

• Financial Inclusion: UCBs primarily cater to small borrowers, micro-businesses, and lower-income groups in urban and semi-urban areas.
• Local Focus: UCBs operate within specific communities, allowing them to understand local needs and provide tailored financial services.
• Priority Sector Lending: UCBs have to allocate 65% to PSL in FY 2024-25 but increasing it to 75% by March 2026. 
• Developmental Support: UCBs are catering the needs of the non-agricultural sector, particularly small borrowers in urban and semi-urban areas.
  • UCBs, till 1996, were allowed to lend money only for non-agricultural purposes. This distinction does not hold today.

Challenges Faced by UCBs

• Weak Governance and Fraud Risks: Many UCBs suffer from political interference, nepotism, and financial mismanagement, leading to fraud and operational inefficiencies.
  • During 2023-24, licenses of 24 UCBs were cancelled.            
• Competition from Commercial Banks and Fintechs: UCBs share in the banking sector declined to 2.5% of total banking assets in March 2024, down from 3.8% in 2017.
• High Non-Performing Assets (NPAs):  High levels of NPAs erode profitability and weaken the financial health of UCBs.
  • Gross NPAs of UCBs were 8.8 per cent at the end of March 2024.
• Capital Adequacy Shortfalls: Limited access to capital markets restricts their ability to meet regulatory capital requirements and expand operations.
• Regulatory Non-Compliance: Dual regulation by RBI and state cooperative bodies leads to compliance challenges and operational inefficiencies.
• Technological Obsolescence: Many UCBs lag in adopting digital banking technologies, impacting efficiency and customer experience.

Recent measures taken Banking Regulation Amendment Act, 2020: The amendment empowered the RBI to supersede boards, restructure managements and formulate resolution plans. Revised Prompt Corrective Action (PCA) Framework: In 2024, the RBI extended the PCA framework to UCBs, setting thresholds for capital adequacy, asset quality, and profitability. PCA is a mechanism that allows the RBI to intervene early when a bank shows signs of financial distress. Liquidity Support via Umbrella Organization (UO): Established National Urban Co-operative Finance and Development Corporation as UO for UCBs. Tiered Regulatory Framework: The RBI introduced a four-tiered regulatory framework for UCBs based on deposit size to tailor regulatory approaches effectively. Other steps UCBs can now open new branches up to 10% (maximum 5 branches) of the existing number of branches in the previous financial year without prior approval of RBI. UCBs have been allowed by RBI to offer doorstep services to their customers. Cooperative banks have been allowed to make one-time settlement of outstanding loans, like Commercial Banks.

Way forward

• Strengthening Governance and Supervision: Mandate professionalization of UCB boards by requiring at least 50% of directors to have expertise in banking, finance, or law.
• Consolidation and Mergers: Encourage voluntary mergers of weak UCBs with stronger ones to create financially resilient entities.
•  ⁠Independent Audits:  Conduct regular audits by autonomous bodies for all UCBs to ensure financial discipline.
• ⁠Technology Adoption: Cooperative banks are encouraged to adopt modern technology for efficient operations and better customer service.
• Social Audits:  Enable stakeholder-led audits to assess policies and fund allocation.