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Wednesday, Jun 26, 2002

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What ails co-operative banking?

N. A. Mujumdar

Anxious depositors outside a Charminar Cooperative Urban Bank branch in Hyderabad... After the 2001 scam, the RBI put a stop to UCBs lending against the security of stocks. But other loopholes were left unplugged.

CO-OPERATIVE banks are in the news again, but not for the right reasons. It may be recalled that during March 2001, some urban co-operative banks (UCBs) faced liquidity and insolvency problems. A major underlying factor was non-adherence by these UCBs to prudential norms prescribed by Reserve bank of India (RBI). These included lending to stock brokers exceeding prudential exposure norms to single party/group and the limit on unsecured advances.

At the centre of the problem was what the RBI calls a multi-state scheduled UCB, which witnessed a sudden withdrawal of deposits. If the share market was the theatre of the scam in 2001, it is the government debt market which is the theatre of the present scam. An intermediary was successful in inducing some co-operative banks to part with large sums on the pretext of buying government securities for them, without really purchasing such securities. What is disturbing is that not only UCBs but some district central co-operative banks were also involved in this disastrous affair. Why this new-found love for government securities, even by district co-operative banks? The RBI seems to be content with merely ad hoc responses.

For instance, in the aftermath of the 2001 scam, the RBI put a stop to lending by UCBs, directly or indirectly, against security of stocks. Such ad hoc responses no doubt plug the loopholes but they cannot stop the system from opening up other loopholes. This is what perhaps happened in 2002. The point is that the infirmities of the co-operative system are more serious that what these periodic scams seem to expose. The co-operative credit structure today is direction-less, with the RBI having diluted its earlier commitment by transferring the subject of rural credit to Nabard. The intellectual leadership for shaping the future of the co-operative credit system can come only from the RBI while, no doubt, Nabard can discharge its responsibilities regarding the routine operating. The central bank can have a vision about the nature of the future growth of the economy and shape the financial system as to support the anticipated pattern of growth. Only on the basis of such a macro picture could the relative roles of different segments of the financial system be defined. For instance, what sub-sectors of the economy are co-operatives expected to support? What is the role of the regional rural banks (RRBs)? How do the micro-credit institutions, which we are more recently attempting to build, fit into the whole business of rural development? The RBI should have a broad idea of the relative roles of the financial segments and guide their development accordingly. Various committees conducted in-depth studies recently of different aspects of the co-operative credit structure: Madhavarao Committee on UCBs (1999); Jagdish Capour Task force on Co-operative credit system (2000), and U. S Vyas Group on Rural Credit (2001). Unfortunately, none of these groups addressed the basic issue. It is time that the RBI takes up the task of providing a blueprint of the future shape of the rural credit delivery system.

Today, the co-operative credit system neither has the leadership of men such as Vaikunth Lal Mehta or D. R. Gadgil; nor the guidelines of the RBI. It is in this sense that the co-operative system remains directionless and falls an easy victim to rapacious elements which are on the look out for such a prey.

Super-imposed on this fact is the impact of the new banking culture, nurtured by banking sector reforms co-operative managers who want to imitate public sector banks (PSBs) which, in turn, want to cast themselves in the image of foreign banks. The emphasis now is on a "quick kill'' rather than on extending to medium and long-term credit to productive sectors. For instance, banks had enough resources to extend bridge loans to enterprises such as M. S. Shoes, but they had no funds to support the production of sugar in Maharashtra. No wonder this culture has also percolated to the management of the co-operative financial institutions. Bereft of the co-operative ideology of yesteryears, corrupted by the hard banking culture, it is no wonder that scams are manifesting themselves in the co-operative banking institutions with regular frequency. It is a matter of grave concern that the financial health of a large number of co-operative credit institutions is extremely `fragile', to borrow a phrase from the RBI. It is time that the co-operative financial system reinvents itself in terms of what it could do to promote employment expansion, especially for the small man, promote broad-based growth and reduce poverty. The exaggerated emphasis placed by both Government of India and the RBI on the development of the capital market during the reform phase, seems to be at the root of many recent scams:

The mushrooming growth of non-banking financial companies (NBFCs) and their eventual collapse, the Harshad Mehta episode, and the recent stock market disturbances.

Goading PSBs to involve themselves increasingly in the stock market, fiscal concession for investors — in equity and in mutual funds — are some of the artificial props given to boost the capital market. Today, even the RRBs are allowed to invest in bonds of the public sector units (PSUs). Facilitating the reserve flow of funds from the rural to the urban areas is the most retrograde step that policy-makers have taken. Priority sectors — including agriculture, small industry, retail trade, the whole range of non-form activities in the rural sector — have no access to the capital market and hence the emphasis should be to promote flow of resources from the urban to the rural areas. The RBI itself admits that "The objective of co-operative banking is to create enduring and sustainable financial institutions which remain responsive to the credit needs of weaker sections'' (Report on Trend and Progress of Banking in India, 2000-01). In spite of the artificial props, the attempt to develop the capital market has been a dismal failure, as the phenomenal growth of the private placement market clearly demonstrates.

On the other hand, the capital market has become the incubator for financial scams. It is, therefore, necessary to keep the co-operative banking system as far away as possible from the capital market.

It is not adequately appreciated that the co-operative financial segment occupies a crucial position in the financial system in terms of its reach and volume of business. Credit co-operatives account for 70 per cent of the rural credit outlets. Rural co-operative banks account for about 30 per cent of total rural deposits and 44 per cent of outstanding loans and advances of the banking system in respect of agriculture and rural development. UCBs are expected to mobilise savings from the middle- and low-income groups and extend credit to priority sectors and weaker sections.

While we have failed to reduce poverty levels during the last 50 years since the inception of planning in 1950s, China was able to reduce its poverty levels to a minimal of 6 per cent of the rural population in just two decades. Two features of such an astonishing performance need to be highlighted — faster agricultural growth of 5.2 per cent per annum and an explosion in non-farm employment. Rural industry grew rapidly employing about 25 per cent of the rural labour force. Town and village enterprises (TVE) have expanded at a fast rate, contributing about 40 per cent to the total industrial output.

The architects of the Tenth Plan recognise the imperative need of broad-based, decentralised growth as is clear in the following statement. "It is important to emphasise that the equity-related objectives of the Plan, which are extremely important, are linked to the growth objectives, and the attainment of one may not be possible without the attainment of the other.

For example, high rates of growth are essential if we want to provide a sufficient expansion of sustainable high quality employment opportunities to the expanding labour force and ensure a sufficient increase in income of the poor and the disadvantaged.'' (Draft Approach Paper to the Tenth Plan — 2002-2007)

Empirical experience of the Asian tigers has shown that shared growth is sustainable growth. This is especially so in India where expansion of employment opportunities has to necessarily come from sources other than the organised large-scale sector. If thus decentralised, broad-based growth is the desired objective, it is important to facilitate such growth through appropriate financial mechanisms in this task; PSBs, RRBs, the whole range of co-operative credit institutions and micro credit institutions would all have to participate. It is the business of the RBI to broadly earmark the respective areas on which each of these institutions could focus and also devise ways and means of establishing appropriate links among the institutions.

(The author is former Principal Adviser to the RBI.)

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