A REPORT ON

STUDY ON SPECIFIC ISSUES CONCERNING UCBs IN GUJARAT

CREATED BYBABU LAL MEENA RBI YOUNG SCHOLAR

RESERVE BANK OF INDIA AHMEDABAD

CONTENTS

ACKNOWLEDGEMENTS EXECUTIVE SUMMARY Part-1 1.Introduction 1.1 The Objectives of the study 1.2 The layout of the study 2. Reserve Bank of India 2.1 About RBI 2.2 Urban Bank Department Part-11 3. Urban Co-operative Bank 3.1 Definition of Urban Cooperative Banks 3.2 History And Development UCBs 3.3 Function of UCBs 3.3.UCBs in Gujarat Part-111 4. main issues in UCB in Gujarat 4.1 Governance Issues Dual Control and Borrower driven structure 4.2 Management and HR Issues 4.3 Issues relating to Finance 4.4 Issues relating to computerization

1.Introduction This report is based on my training at Reserve Bank of India, Ahmedabad. As a young scholar Award-2011,the student are expected to undergo training for a period2to3 months in RBI regional office to knew about its organization, function and role in economic development and financial system . I underwent training in Urban Bank Department (UBD).The report study on specific issues concerning UCBs in Gujarat is based in data collected by way of discussion with key personnel in UBD, intranet, internal circulars, RBI reports and internet. The scope of the study is restricted to Urban Co-operative Banks. Objective and the need for study Urban co-operative banks is the most important part of the Indian banking system. They play a major role in development of our country but they have many problem And issues in Gujarat .

2. Reserve Bank of India

2.1 About RBI The Reserve Bank of India is the central bank of India, was established on April 1,1935 in accordance with the provisions of the Reserve Bank of India Act, 1934 . Its Central Office is located at Mumbai since inception. Though originally privately owned, since nationalisation in 1949, RBI is fully owned by the Government of India . RBI is governed by a central board ( board headed by a governor ) appointed by the central Government of India. According to the Preamble of the Reserve Bank of India Act, 1934, the main function of the Bank is: .to regulate the issue of Bank Notes and keeping of reserves with a a view to securing monetary stability in India and generally to operate the currency and credit system of the country to its advantage. This is regarded as the traditional banking function . With economic development assuming new urgency in the fifties in the wake of the five year plans, the range of Reserve Banks functions has steadily widened. The Bank now performs a variety of developmental and promotional functions which in the past were regarded as being outside the normal purview of central banking. The various functions being performed presently by the Reserve Bank can be classified as follows :

Monetary Authority: o Formulates implements and monitors the monetary policy. o Objective: maintaining price stability and ensuring adequate flow of credit to productive sectors. Regulator and supervisor of the financial system o Prescribes broad parameters of banking operations within which the countrys banking and financial system functions. o Objective: maintain public confidence in the banking system, protect depositors interest and provide cost-effective banking services to the public .

Manager of Exchange Control : o Manages the Foreign Exchange management Act , 1999. o Objective: to facilitate external trade and payment and promote orderly development and maintenance of foreign market in India. Issuer of currency : o Issues and exchanges or destroys currency and coins not fit for circulation. o Objective: to give the public adequate quantity of supplies of currency notes and coins and in good quality. Developmental role : o Performs a wide range of promotional function to support national objectives. Related Functions : o Banker to the Government: performs merchant banking function for the central and the state Governments; also acts as their banker . o Banker to banks : maintains banking accounts of all scheduled banks.

2.2 Urban Banks Department Consequent upon the establishment of National Bank for Agriculture and Rural Development on July 12, 1982, the work relating to the supervision of primary (urban) co-operative banks, was till then the responsibility of the Agriculture Credit Department, was entrusted to the Urban Bank Division Of the Department of Banking Operations and Development . Subsequently, on February 1, 1984 the Urban Banks Division was constituted as a separate department to look after the regulation and supervision of urban co-operative banks. The regulation and supervision of primary co-operative banks, popular known as urban co-operative banks is performed by the Urban Banks Department of the RBI in coordination with the Registrars of Co-operative Societies of the State Governments. The RBI earlier had practically no statutory powers over the organization and management of urban cooperative banks. By the enactment of the banking laws (As applicable to cooperative Societies) Act , 1965, certain provisions of the Banking Regulation Act, 1949 were made applicable to cooperative banks with effect from March 1, 1966 . The activities of the Department can be broadly divided into 4 areas, viz. regulatory, supervisory, operational and developmental.

Part-11 3.Urban co-operative bank 3.1 Co-operative Banking in India Co-operative banks came into existence with the enactment of the Cooperative Credit Societies Act of 1904, which provided for the formation of cooperative credit societies. Subsequently, in 1912, a new Act was passed which provided for the establishment of cooperative central banks. Cooperative credit institutions play a pivotal role in the financial system of the economy in term of their reach, volume of operations, and the purpose they serve . Categories of co-operative Banks There are two main categories of the co-operative banks. (a) Short term lending oriented co-operative Banks- within this category there are three subcategories of banks viz. state co-operative banks, District co-operative banks and Primary Agricultural co-operative societies. (b) Long term lending oriented co-operative Banks - within the second category there are land development banks at three levels state level, district level and village level. The cooperative banking system, with two broad segments of Urban and Rural co-operatives, forms an integral part of the Indian financial system. With a wide network and extensive coverage, these institutions have played an important developmental role in enlarging the ambit of institutional credit by way of inculcating banking habits among the poor and those in remote areas. In recent times, co-operative banks have tried to improve credit delivery through some financial innovations. Structure of co-operative banking system The structure of co-operative banking that has evolved over more than fifty years Highlights the dual role of members as lenders and borrowers. The co-operative Credit structure in the country can be divided into two broad segments: the urban Co-operative banks and the rural co-operative credit institutions. While the urban Co-operative banking system has a single tier comprising the primary co-operative Banks ( commonly known as urban co-operative banks UCBs ) , the rural cooperative credit system is divided into long-term and short-term co-operative Credit institutions, which have a multi-tier structure. The short-term co-operative Credit institutions have a three-tier structure comprising State Co-operative Banks (StCBs), Central Co-operative Banks (CCBs), and primary Agricultural Credit
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Societies (PACSs), which are not banks, but only societies. The long-term cooperative credit institutions have generally a two-tier structure comprising the State Co0operative Agriculture and Rural Development Banks (SCARDBs) and The primary Co-operative Agriculture and Rural Development Banks (PCARDBs). Long-term co-operative credit institutions have a unitary structure in some states , While in other states they have a mixed structure (unitary and two-tier). The states operative banks apart from being serviced by the branches of Regional Rural Banks Not aving long-term co-operative credit entities are served by the state co- (RRBs) and the rural/semi-urban branches of commercial banks. However, In the state of Andhra Pradesh, the cooperative structure is integrated combining both short-term and long-term structures. Structure of cooperative credit institutions

3.2 Definition of Urban Co-operative Banks; The urban co-operative banks constitute an important segment of the Indian banking system. The term urban co-operative banks, though not formally defined, refers to primary cooperative banks located in urban and semi-urban areas. They have an important role play in mobilization of small saving and purveying of credit to the weaker section of the society. Cooperative societies are based on the principal of cooperation,- mutual help, democratic decision making and open membership. They function with the rule of one member, one vote function on no profit, on loss basis. These banks, till 1996 , were allowed to lend money only for non agricultural purposes. This distinction does not hold today . co-operative banks now provide housing loans also. These banks were traditionally centred around communities, localities work place groups . the essentially lent to small borrowers and businesses. Today , their scope of operations has widened considerably 3.2 History and Development of Urban Cooperative Banks in India ; Origin of the urban credit movement in India can be traced to the close of the nineteenth century. Following the success of the urban credit institutions organized by Hermann Schultz in Germany and Luigi Suzette in Italy during the period 1855-1885, some middle class Maharashtrian families settled in the erstwhile Baroda State started a mutual aid society in Baroda on 5 February 1889 under the guidance of Shri Vithal Laxman Kavthekar. The Cooperative Credit Societies Act, 1904 was amended in 1912, with a view to broad basing it to enable organization of non-credit societies. The Maclagan Committee of 1915 was appointed to review their performance and suggest measures for strengthening them. The committee also felt that the urban cooperative credit movement was more viable than agricultural credit societies. The constitutional reforms which led to the passing of the Government of India Act in 1919 transferred the subject of Cooperation from Government of India to the Provincial Governments. The Government of Bombay passed the first State Cooperative Societies Act in 1925 which not only gave the movement its size and shape but was a pace setter of cooperative activities and stressed the basic concept of thrift, self help and mutual aid. This marked the beginning of the second phase in the history of Cooperative Credit Institutions. The first study of Urban Co-operative Banks was taken up by RBI in the year 1958-59. The Report published in 1961 acknowledged the widespread and financially sound framework of urban co-operative banks; emphasized the need to establish primary urban cooperative banks in new centers and suggested that State Governments lend active support to their development. In 1963,
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Varde Committee recommended that such banks should be organized at all Urban Centers with a population of 1 lakh or more and not by any single community or caste. The committee introduced the concept of minimum capital requirement and the criteria of population for defining the urban centre where UCBs were incorporated. 3.3 Function of UCBs The RBI appointed a high power committee in May 1999 under the chairmanship of Shri.K. Madhava Rao, Ex-Chief Secretary, Government of Andhra Pradesh to review. The performance of Urban Co-operative Banks (UCBs) and to suggest necessary measures to strengthen this sector. With reference to the terms given to the committee, the committee identified five broad objectives: To preserve the co-operative character of UCBs To protect the depositors interest To reduce financial risk To put in place strong regulatory norms at the entry level to sustain the operational efficiency of UCBs in a competitive environment and evolve Measures to strengthen the existing UCB structure particularly in the context of ever increasing number of weak banks To align urban banking sector with the other segments of banking sector . 3.4 Urban Co-operative Banks in Gujarat The co-operative movement in Gujarat is playing vital role in the social and economic development of the state , particularly in rural and urban areas. Initially, this movement was confined to agricultural credit, later on, it rapidly spread to other fields like agro-processing, agro-marketing, milk production and distribution, urban industries, consumer stores, social services etc. There are 389 urban co-operative banks in Gujarat in March 2011. the total turnover of Gujarat UCBsAll data in lakh ( as on March 31, 2010) 1. Total paid up share capital 18369.03d) 20556.8 3. Total provision etc.(including liabilities) 10101.24 4. Total term deposit
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230178.48 (source: Annual report of urban bank department(UBD) in RBI Ahmedabad)

4. The Main issues concerning UCBs in Gujarat

Recent Developments over the years, primary (urban) cooperative banks have registered a significant growth in number, size and volume of business handled. As on 31st March,2003 there were 2,104 UCBs of which 56 were scheduled banks. About 79percent of these are located in five states, - Andhra Pradesh,Gujarat,Karnataka, Maharashtra and TamilNadu. Recently the problems faced by a few large UCBs have highlighted some of the difficulties these banks face and policy endeavours are geared to consolidating and strengthening this sector and improving governance. Issues facing the cooperative banking segment in India Governance Issues Dual Control and Borrower driven structure Management and HR Issues Issues relating to Finance Issues relating to computerization Governance Issues Dual Control and Borrower driven structure Cooperation is a State subject under the Indian Constitution; hence all cooperative societies are governed by the Cooperative Societies Act of the State . Registration,
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incorporation, management, amalgamation etc are governed by the RCS of the particular State. At the same time, certain provisions of the Banking Regulation (BR) Act,1949, are applicable to the cooperative banks that accept public deposit. In the rural structure, StCBs and the DCCBs and in the urban structure, PCBs are covered by these provisions of the BR Act. This duality of control and regulation has given rise to serious problems in the governance structure ( such as interference by the State Govt. due to its combined role as dominant shareholder, manager, regulator, supervisor and auditor; further the precise demarcation of the powers between the two regulators is ambiguous.) The rural cooperative structure in India is focused mainly on credit. The upper tiers refinance the lower tiers hence the structure is driven by borrowers at all levels. Depositors are either non-members or nominal members without voting rights while the borrowers have full voting rights. This is inconsistent to the concept of mutuality (thrift and credit going hand in hand). This also prevents any incentive for good governance since the depositors, whose money is being intermediated, have no say in the management of their own money Management and HR Issues. Management problem arises due to the impairment of Governance. But following are also important Poor human capital leading generally ageing staff profile characterized by inadequate qualification and training. Issues relating to Finance. The poor recovery of outstanding credit by the rural cooperative banks makes the whole system unsustainable. Lack of standardized business model and risk management systems Over exposure to the agro sector and lack of diversification of the loan portfolios. For the LT structure, the loan portfolio consists of a single product long-term agro loan of > 5 years term.

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Dual control leading to lack of control of co-op banks Dual control of co-operative banks by the reserve bank of India (rbi) and the state government's registrar of co-operative societies (rcs) has emerged as a major ploy by the two sides to shift the blame to the other agency whenever scams and frauds take place. in spite of dual control and dual audits, scams have taken place at madhavpura, ahmedabad urban, lakshmi, genco and charotar banks recently. most experts and co-operative bankers agree that dual control is unnecessary duplication, serves no purpose and does not stop scams from happening. but, the state governments are not willing to let go as the politicians in power would lose access to the large funds available with this sector as well as the reach that these banks have in smaller towns and major village clusters. this is what the rbi has to say in its annual report for 2000-01: "the existence of overlapping jurisdictions between the central/state government and the RBI hinders the speed of response to unforeseen developments. in the April 2001 monetary and credit policy statement, the RBI has mooted a proposal for setting up of a new apex supervisory body, which can take over the entire inspection/supervisory functions in relation to scheduled and nonscheduled urban co-operative banks (UCBs). this apex body could be under the control of a separate high-level supervisory board consisting of representatives of the central/state governments, the rbi as well as experts and may be given the responsibility of inspection and supervision of UCBs and ensuring their conformity with prudential, capital adequacy and risk-management norms as laid down by the rbi." natwarlal patel, vice-chairman of gujarat state urban co-operative banks federation, said that dual control of co-operative banks needs to be removed as it leads to a lot of unnecessary duplication and serves no purpose at all. "in spite of dual audits, scams have taken place at mmcb, laxshmi, genco and charotar. the state government is not willing to give away complete control to the rbi as their current
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hold over the operations of co-operative banks would be lost," said patel. y s punjawat, former general manager of nabard and administrator of bhavnagar district co-operative bank said that dual control allows the heads of co-operative banks to seek support of ministers whenever rbi forces them to clean their balance sheet. "it is not that if rbi were to become the sole supervisory body of co-operative banks all scams in this sector would stop. in fact, much larger scams, running into thousands of cores, have happened at big Indian and foreign banks in India which were solely under the RBI's supervision. but, rbi is a much lesser evil than the state government," said punjawat. "while dual control is certainly an obstacle to efficient management, it does not per se contribute to scams. if the rbi alone were more efficient, diligent and acted with greater alacrity, the scams could have been pre-empted," said m h jowher, former ceo of a co-operative bank. p s vyas, managing director of Gujarat state co-operative bank, also agreed that dual control only leads to more bureaucracy and serves no purpose in controlling frauds. "effective control and immediate action against discrepancies in functioning of co-operative banks by either agency is more important," said vyas.

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Issues related to computerization The questions that emerged out of the above discussions and presentations and the responses thereto are summarized below 1.what is the desired level if IT in a bank, irrespective if size, location &profits ? the group opined that the minimum level of IT infrastructure in a bank should be a computerized front office services , back office accounting , MIS and regulatory reporting. 2.what are the available solutions? Several solution providers from nig firms to middle range players and bank etc, existed in the market. Peer group banks working jointly for developing facilities like data centre for use by group members could also come together to provide solutions for the smaller banks. Even local developers were offering inexpensive solutions to banks which were workable in the short / medium term. However, choosing standardized products was essential for ensuring reliability and continued support. 3.What is the cost? Costs of the ASP models have been discussed earlier. However, the costs mentioned above were the 'list costs' of the firms and would be negotiable, particularly if banks got together and bulk orders were to be placed. Different payment terms were also available which included a small charge every month combined with per transaction fee which could possibly be of interest to the smaller banks. In addition to the ASP model, the outright purchase offering also existed 4.Which approach could be adopted for computerization of bank ? In respect of the small banks, particularly the unit banks, it was felt that the best method for computerization could be through the ASP model wherein a few software vendors could be short-listed by an agency like IDRBT and the banks could select the vendor from out of the list, based on their geographical location and convenience. There was another view, however, that the independent application model might also be considered, should a bank be capable and desirous.

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5.Who should be supported and How? The Group deliberated upon the need for mandating the minimum level of IT usage by UCBs. It was observed that so far, mandates had been given by the Reserve Bank for regulatory purposes only, but if necessary, Reserve Bank could explore the possibility of laying down prescriptions for business purposes too. Prima facie banks that were making losses or very meagre profits or those that are very small in size and therefore do not have the financial strength to acquire the IT infrastructure set by RBI, require support. However, in case support is extended only to the weak or small banks, the better performing or growing banks may tend to interpret that they were indirectly suffering because of their good performance or growth as RBI was not extending support to them for their IT efforts. Even though, in fact, the better performing banks may not be needing support, this approach of providing support to only those which are loss making or small may give a wrong and unintended signal to better performing banks. This dilemma can therefore be addressed by ensuring that the support is not seen as a grant from Reserve Bank which was suggested by NAFCUB, as the banks must feel importance of participating by owing what they get. In any case, interest free payment over a period of time itself provides the built-in subsidy element. Similarly, the Committee felt that 3 years' subsidy on monthly rentals, as proposed by NAFCUB, may not be required Instead it could be in the form of, say, an interest free conditional loan. The repayment could be structured for different categories of banks. For loss making banks, for example, there could be a moratorium on repayment till the bank turned around. RBI could also attach conditions and link declaration of dividend to the repayments . In such a case, while the loss making banks would not have any problem in accepting the loan, the profit making banks that avail of it would have an incentive to pay back quickly so that they can declare dividend. Another area of support that Reserve Bank may provide to all banks could be in the area of training which could range from PC application to purchase / sale of securities over the Negotiated Dealing System. Further, financial support may be needed for purchasing and / or leasing in adequate and benchmarked hardware, required for setting up the system envisaged by the Group. The terms of the loan could be the same as that for acquisition of software, discussed earlier, as the existence of appropriate hardware in every bank is a very important plank in the over-all proposal of ensuring a minimum standard of computerization in all UCBs
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6.How to route financial support? On the issue of strategy for routing financial support to UCBs, the options were as under 1. Providing funds directly to banks for outright purchase of customised software and hardware 2. Paying the vendors who provide the software, on behalf of the UCB 3. Funding a national-level institution like IDRBT and routing the support through it. In this context, it may be mentioned that in case of the first option i.e. providing finance to individual banks, it would be difficult to manage as effecting timely payment and monitoring the proper end use of the funds would be a major issue. RBI would also not be able to enforce the agreement between the vendor and the bank as RBI or its agency like IDRBT would not be a party to the agreement. Option 2 would mean a direct support to a vendor rather than to banks. Therefore, In Option 3, the ASP model, the agreement could be tripartite. In this option i.e. providing support through IDRBT, it needs to be mentioned that the institution was created by RBI for providing services to banking and financial sector in India and it is already providing applications such as SFMS to many banking entities on similar lines. Further, IDRBT's budgetary deficit is fully financed by the Reserve Bank and therefore it is very easy and logistically simple for the Reserve Bank to extend financial support to the UCBs through IDRBT. IDRBT could shortlist vendors for procuring the ASP model for urban cooperative banks, as IDRBT could provide IT consulting and could also monitor the implementation of the SLA. As such, the 3rd Option is considered to be very practical. Further, the ASP approach will make it easier to negotiate the price as consolidating the demand would provide economies of scale for both the vendor and the purchaser. ASP model would be a way of ensuring that even the smallest banks acquired standard software with continued support through reputed vendor. There was also a view that banks which decided to select vendors independently should also be supported by RBI. Representatives of the sector felt that banks that had already selected or were in advanced stage of vendor selection for acquiring Core Banking Solutions stood to benefit from the support provided by RBI and should not be limited in the choice of vendor for availing the support. The Group debated this and concluded that such an option
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can be considered only for those banks which are well capitalised and with good track record, on whom we have confidence and comfort that the end use of funds are assured, and that they have IT savvy personnel to implement / oversee and deal with the vendors and for whom investing in an outright purchase option is financially a preferable option. The group felt that only banks which have deposits of over Rs.100 crore and are making profits for the last 3 years and have CRAR of over 9% should be supported for such outright purchase.

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6.Development of UCBs * An outcome of the on-going consolidation of the urban cooperative banking (UCB) sector was the further decline in the number of UCBs in 2009-10. However, there were also signs of increasing concentration of banking business within the UCB sector with the share of banking business in the larger assetsize categories and business - size categories showing an increase (para 5.5 to 5.7; pages 104 to 106). * Unlike SCBs, the consolidated balance sheet of UCBs expanded at a higher rate in 2009-10 attributable to the growth in deposits on the liability side, and a growth in both investments, and loans and advances on the asset side (para 5.12; page 108). * There were emerging concerns with respect to profitability of the UCB sector as net profits posted a decline in 2009-10, due to the decline in the operating profits. Consequently, the RoA of the UCB sector registered a fall from 0.8 per cent in 2008-09 to 0.7 per cent in 2009-10 (para 5.17; page 110). * There was an improvement in the asset quality of the UCB sector with a decline in the gross NPA ratio from 13.0 per cent at end-March 2009 to 11.8 per cent at end-March 2010 (para 5.20; page 111). * More importantly, the capital adequacy of UCBs was reasonable, with 86.3 per cent of UCBs complying with the minimum CRAR norm of 9 per cent at end-March 2010 (para 5.22; page 112). * In line with their role in financial inclusion, about 65 per cent of total advances of UCBs was made towards priority sectors with more than 16 per cent of the total advances being provided to weaker sections in 2009-10 (para 5.27; page 115). * While State Cooperative Banks, District Central Cooperative Banks and State Cooperative Agriculture and Rural Development Banks earned net profits, the ground level institutions, viz., Primary Agricultural Credit Societies, and Primary Cooperative Agriculture and Rural Development Banks reported net losses in 2008-09 (para 5.32; page 116). * Despite the improved financial performance, the asset quality of rural cooperative credit institutions witnessed deterioration with the short-term rural cooperative credit institutions accounting for the major share of non-performing loans at end-March 2009 (para 5.32; page 116).

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