Tamal Bandyopadhyay: The fire in the circus tent

Cooperative bank burn-out is a crisis waiting to happen

On August 10, hundreds of people queued up at the branches of South Indian Co-operative Bank in Mumbai suburbs to withdraw money. As the day progressed, the queues got longer, forcing the Reserve Bank of India (RBI) to cap deposit withdrawals.

Two days later, panicky depositors of the Surat-based City Co-operative Bank thronged its branches to withdraw money after the Gujarat High Court superseded the bank's board and appointed the district registrar as the bank's administrator.

The very next day, yet another urban cooperative bank in Mumbai "" Maratha Mandir Co-operative Bank "" was put under the regulator's directives, ostensibly to stem a run on the bank.

A run on a bank is like a fire in a circus tent. When it breaks out, the spectators move only one way "" towards the exit gate. Similarly, at the faintest sign of financial weakness, depositors get panicky and rush only to one counter of the bank to withdraw their money.

No bank can deny the depositors their right to withdraw cash but when too many depositors demand their cash at the same time it leads to a bank run. This, in turn, could trigger a contagion and runs on other banks. Normally, what starts from a financial event in no time transforms into a psychological phenomenon.

But last week's sporadic run on a few small cooperative banks in Mumbai has again exposed the soft underbelly of cooperative banking "" a hybrid animal in the Indian financial system. It is regulated and supervised by the RBI and yet the central bank has no say in the directorial appointments nor can it dismantle their board for misdemeanours.

Caught between the regulator and the state government, the cooperative banks are political cesspools. An aspiring director who is denied a board berth can always play havoc on a bank by spreading rumour that it is not safe to keep money in its vault.

No wonder that with monotonous regularity, the cooperative banks steal the limelight for all the wrong reasons. In 2001, the Ahmedabad-based Madhavpura Mercantile Cooperative Bank went under following its Rs 977-crore exposure to stock broker Ketan Parekh which was deployed in stock markets.

The very next year, over a dozen cooperative banks in Gujarat and Maharashtra burnt their fingers playing in the bond market. Now, South Indian and Maratha Mandir cooperative banks are in trouble. What exactly has happened in these two banks? The trigger for the run on South Indian is its balance sheet that was made public ahead of its annual general meeting (AGM) due on August 16.

One big sticky exposure (around Rs 23 crore) to a group of companies raised its net non-performing asset (NPA) level to 51.76 per cent, wiping out its net worth. Its capital adequacy ratio was minus 17.52 per cent after posting a net loss of Rs 35.84 crore in 2003-2004.

A Bharatiya Janata Party leader is believed to have taken on the bank's chairman, Raghavan Sarathy, who owes allegiance to the Congress, and steered a whisper campaign to bring down the bank ahead of its AGM which was also expected to be a stormy one. This bank had total deposits of Rs 251 crore and advances of Rs 141 crore on March 31 this year.

Maratha Mandir Co-operative Bank, which has also been put under RBI "directives" freezing its all businesses, had actually reduced its net non-performing assets in March 2004 to 25.74 per cent from 33 per cent in the previous year. It also made a small net profit of Rs 24 lakh in 2003-2004. Its capital adequacy ratio was 9.91 per cent on March 31. Maratha Mandir has a deposit portfolio of Rs 278 crore and advances of Rs 139 crore. The regulator has two choices when a bank faces a run on its deposits.

It either restrains the bank from undertaking any activities and capping deposit withdrawals through a directive (in the case of cooperative banks) or a moratorium (in the case of private and public sector banks) or it issues an assurance to the depositors on the health of the bank.

While both South Indian and Maratha Mandir cooperative banks were put under directive, in the case of Punjab and Maharastra Co-operative Bank, which also faced sporadic deposit withdrawals last week, the RBI reassured the depositors that the bank was well managed and there was no reason to worry.

However, there is no end to the worry of the financial system for the cooperative banks as a group. There were 2,104 urban cooperative banks in March 2003 and of these 163 were under liquidation. Most of them are concentrated in Maharashtra (670), Gujarat (362), Karanataka (324), Andhra Pradesh (169) and Tamil Nadu (136).

Most are tiny, often with a single branch. Only one urban cooperative bank has a deposit base of over Rs 1,000 crore; 846 have a deposit base of less than Rs 10 crore.

The gross non-performing assets of these banks were 21 per cent of their aggregate advances in March 2003. In absolute term, the gross NPAs were Rs 13,647 crore.

The root of the problem is the dual control of the urban cooperative banks that are primarily cooperative societies. While the registration, administration, amalgamation and liquidation of urban cooperative banks are governed by the provisions of the State Cooperative Societies Acts, the RBI regulates and supervises their banking-related functions under the Banking Regulation Act, 1949.

The inevitable tension between the regulators and the other authorities came to the fore last year when some of the cooperative societies in Kerala started using the "bank" tag even though they were not licensed to do so by the RBI.

Things came to such a pass that the regulator had to fight a legal battle against the state registrar of cooperative societies to restrain these societies from functioning as banks.

Former RBI governor Bimal Jalan favoured setting up a separate supervisory body for urban cooperative banks consisting of representatives of the Centre, states and the RBI as well as independent experts.

At the same time Jalan strongly opposed any move to appoint a deputy governor exclusively for the cooperative sector. He probably feared that this would turn out to be a political appointment that would add to the mess that the cooperative banks have been making in the financial system.

The RBI and the finance ministry also quietly tried to bring these banks under the ambit of commercial banks by amending the Banking Regulation Act last year. But that move too was scuttled in face of stiff political opposition from certain quarters.

The RBI's attempt to rein in these banks by making policy changes on prudential norms, capital adequacy, income recognition, asset classification, asset-liability management and provisioning are pointless since the problem is essentially a political one.

The Madhava Rao and the Anant Geete committees on cooperative banking can at best brood over the problems but nothing will change unless either the government or the RBI gets the absolute power to control them.

South Indian and Maratha Mandir cooperative banks are only the tip of the proverbial iceberg that may rock the financial system if the government does not address the problems of 35 multi-state cooperative banks on a war footing. The position of these banks has become untenable following a Supreme Court judgement delivered last October.

The court categorically said that a cooperative society can either be a state cooperative bank or a central cooperative bank or a primary cooperative bank (at the urban level). It other words, the country's apex court does not recognise the Multi State Cooperative Act.

Following this, the RBI cancelled the licence of the Apex Urban Cooperative Bank of Maharashtra and Goa which has a deposit base of Rs 687 crore placed by 209 member banks.

The other 34 multi-state cooperative banks, which collectively have a deposit base of over Rs 20,000 crore, are still functioning but they are not qualified for deposit insurance cover.

Closure could wreak havoc in the system, pulling down hundreds of smaller urban cooperative banks. If that happens, it will be difficult to stem the contagion. The government must act fast.