The Reserve Bank of India’s sudden direction last week capping withdrawals from Punjab and Maharashtra Co-operative (PMC) Bank has dealt a severe shock to many folks. Apart from retail depositors who had parked their life savings with the bank, small businesses complained of their business grinding to a halt with RBI directing the bank to stop all lending, investment and business operations for six months. Later reports digging into what went wrong at PMC Bank, one of the top five urban co-operative banks in the country, paint quite a scary picture of depositors’ money being put to risk by concentrated lending and undisclosed bad loans, which went undetected by regulators.

What is it?

Co-operative banks, which are distinct from commercial banks, were born out of the concept of co-operative credit societies where members from a community band together to extend loans to each other, at favourable terms. Credit co-operatives (or co-operative banks) are broadly classified into urban or rural co-operative banks based on their region of operation. Urban co-op banks are classified into scheduled and non-scheduled banks.

There are three key points of difference between scheduled commercial banks and co-operative banks. One, unlike commercial banks, UCBs are only partly regulated by the RBI. While their banking operations are regulated by the RBI, which lays down their capital adequacy, risk control and lending norms, their management and resolution in the case of distress is regulated by the Registrar of Co-operative Societies either under the State or Central government. Two, unlike commercial banks which are structured as joint stock companies, UCBs are structured as co-operatives, with their members carrying unlimited liability. Three, while there is a clear distinction between a commercial bank’s shareholders and its borrowers, in a UCB borrowers can double up as shareholders.

In the event UCBs fail, deposits with them are covered by the Deposit Insurance and Credit Guarantee Corporation of India up to a sum of ₹1 lakh per depositor, the same as for a commercial bank.

Why is it important?

After initially encouraging UCBs to spring up all over India for financial inclusion, the RBI began to wake up to their poor governance from 2005 when it stopped issuing new UCB licences. With many of these banks failing, and the RBI encouraging weak ones to merge, the number of UCBs operating in India has shrunk from 1,926 in 2005 to 1,551 by 2018. The RBI has also been trying to improve governance at these banks by putting up a Board of Management to oversee them. But the PMC Bank case reveals that a lot of shenanigans still escape RBI’s oversight.

While they may be unpopular with the RBI, UCBs remain quite a hit with retail savers and small businesses because they offer attractive interest rates on deposits, far higher than commercial banks. By end of FY18, UCBs managed ₹4.56 lakh crore in deposits, had advances of ₹2.80 lakh crore and managed total assets of ₹5.63 lakh crore. PMC Bank had ₹11,600 crore of deposits, with branches across seven States.

Why should I care?

If you’ve not been paying much attention to whether you are investing in a scheduled commercial bank or a co-operative bank, the PMC case highlights the possible risks you may be taking. Details leaking out about PMC Bank suggest that the bank lent over 70 per cent of its book, violating RBI limits, to distressed realty group HDIL and also had top management that was connected to HDIL. Nor is PMC Bank the first UCB to be hit by RBI directions. Past investigations have revealed instances of accounting fraud, funds diversion and politically motivated lending at UCBs.

The bottomline

All banks are not equal.

A weekly column that puts the fun into learning