Revitalizing Cooperative Banking: Why Mergers May And May Not Catalyse The Industry Towards Better Profits

Update: 2025-01-23 05:48 GMT
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When the world observed 2012 as the international year of cooperatives, India witnessed the failure of 13 cooperatives. Back then, RBI's credit insurance arm – DICGC had to step in to repay Rs 160 crores to depositors. Thirteen years later it is not unreasonable to introspect whether maintaining cooperatives is worth our time and effort? In fact, there is more scrutiny on cooperative banks and any failure is a blow to the faith of the average banking depositor.

Before we venture into estimating the relevance of cooperatives, it is worth ascertaining whether this exercise merits our attention. The cooperative banking industry according to estimates has a lending portfolio of Rs 3.33 lakh crores and a deposit base of Rs 5.33 lakh crores. This asset base is operated by 1,500 scheduled and non-scheduled UCBs exceeding 11,000 branches. The numbers could increase since they may not accurately depict the value provided by 2.64 lakh primary agricultural credit societies (PACS).

When cooperatives were founded in India, they seemed practical – they were integral in providing banking services across the length and breadth of the country. Today, however, lack of technological tools and expansion opportunities have caused cooperative banks to cease and have financial woes. The Reserve Bank of India (RBI), notes that nearly half (48%) of UCBs (urban cooperative banks) reported losses in FY23 and another 14% of rural cooperatives were in a financial distress. Weak governance, inadequate capitalization, lack of technology and rising non-performing assets (NPAs) are plaguing the industry. Can we save this industry which has had a novel use-case and may go on to do well in providing necessary credit to the unbanked?

MERGERS: WHY THEY MAY WORK

Mergers of unviable entities could provide a range of benefits - improved financial stability, access to capital, NPA reduction, balance sheet augmentation, operational efficiency, economies of scale, reduced redundancy, and even strengthening governance mechanisms. Countries such as Germany and Canada have revitalized their cooperatives with mergers - Germany's Volksbanken Raiffeisenbanken, for instance.

In India, the Kerala state government's merger of 14 district cooperative banks into the Kerala Bank, has not only improved financial stability but also enhanced service delivery in rural areas. In the words of Kerala's former state finance minister, Dr. Thomas Isaac, the model resulted in, “a big bank with a strong presence in rural areas (that) can offer an alternative model of banking.”

Regulation in cooperatives is duopolistic – managed by RBI as well as the state cooperative department. Section 44A of the Banking Regulation Act, 1949 provides the framework for voluntary amalgamation of cooperative banks, subject to approval by the RBI and the respective state government. Meanwhile, Section 230 of the Companies Act, 2013 offers an additional mechanism for restructuring through schemes of arrangement, although its application to cooperative banks remains limited.

While the RBI's role has been questioned in many cases, it has served a very critical function – one that even courts have acknowledged. The RBI's role in mergers of larger banks suggests that it could emulate similar strategies in cooperative banks. In 2021, for instance, the United Western Bank was merged with IDBI Bank after facing insolvency. While this involved a commercial bank, a similar principle may be applied to cooperative banks.

In landmark cases like Madurai District Central Cooperative Bank vs. RBI (2019), the courts have upheld the RBI's authority to supervise mergers, highlighting its role in ensuring financial stability. While the legal framework exists, simplifying and harmonizing such laws is essential for promoting seamless mergers. A unified legislative approach would empower cooperative banks to adopt merger strategies more effectively.

WHY MERGERS MAY FAIL

Although mergers are appealing, they are not a magical pill. Take the case of Rupee Cooperative bank for instance. The RBI placed it under restrictions as early as 2013, a year after the international year of cooperatives. And nine years later, the RBI cancelled its license; investors, depositors, and the general media were uneasily speculating whether the bank would merge with Cosmos or with Saraswat Bank or any other larger bank.

Surprisingly none of the merger proposals or speculations worked. In fact, Saraswat Bank officials raised the right question about loss of business to the tune of Rs 700 crores by proceeding with that merger proposal. In summary, mergers of cooperative banks could face resistance despite potential benefits. This resistance could stem from multiple stakeholder entities, employees, regulatory complexities, management, and even local communities who may derail merger plans. Additionally, there's the dual oversight from state governments which necessitates a careful harmonization of legal frameworks.

REFORM OR RESILIENCE?

The question ideally should not be whether to choose between reform or resilience; rather how do achieve both. As such the merger of loss-making cooperative banks in India is not merely a financial imperative but a strategic move to strengthen cooperative federalism. By pooling resources, improving governance, and enhancing financial stability, mergers can transform cooperative banks into robust, profit-oriented institutions. As former RBI Governor Raghuram Rajan once noted, “Reforms should preserve the essential purpose of institutions while making them resilient to change.”

There are many who have questioned the viability of cooperative banking industry in the contemporary times. In the words of Dr. B.R. Ambedkar, “Cooperation is not a mere policy. It is a social and economic necessity for the survival of the community.” Embracing mergers as a solution will revitalize cooperative banks, and reaffirm India's commitment to inclusive and sustainable economic growth. But, more importantly, mergers need to be done with craft and finesse and not perceived as a quick-pill. 

Author: Akshat Khetan is a corporate and legal advisor (Twitter @akshat_khetan). Views are personal.


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