Big Story. Can urban cooperative banks convert into small finance banks?

Depositors of Punjab and Maharashtra Bank (PMC) Bank have been left high and dry after RBI’s sudden cap on withdrawals. The massive frauds and malpractices at PMC Bank that have come to light have brought the focus back on the lacunae in the regulations of cooperative banks. The dual regulation by the RBI — concerning banking functions such as prudential and capital requirements, and by the Registrar of Co-operative Societies — for incorporation, management constitution, audits etc., has led to huge regulatory gaps in cooperative banks.

Fixing the regulatory imbroglio can help ease the pain for depositors in many other cooperative banks from such crisis in the future. The big question is, how do we bring in more stringent regulations for cooperative banks. One way would be to convert them into small finance banks (SFB), which are much better regulated. But, can these banks — at least the urban co-operative banks (UCBs) — get converted into small finance banks?

According to an RBI report released last December, scheduled UCBs compare well with small finance banks in terms of net worth and gross loans (as of March 2018). RBI data suggests that among the 54 scheduled UCBs, 45 already have a net worth of ₹100 crore or more. Also, 1,450 non-scheduled UCBs (NSUCBs), out of a total of 1497, have a capital to risk-weighted assets ratio (CRAR) of more than 9 per cent. Many of these cooperative banks could consider converting into SFBs.

In September last year, the RBI had announced a scheme for voluntary transition of eligible UCBs into small finance banks (SFBs). UCBs with a minimum net worth of ₹50 crore and a capital to risk-weighted assets ratio (CRAR) of 9 per cent and above, are eligible for the voluntary transition. Upon commencement of business, the converted entity must have a minimum net worth of ₹100 crore and the promoters should hold at least 26 per cent of the paid-up equity capital. They also need to maintain a CRAR of 15 per cent on a continuous basis.

Recently, the RBI had laid down the guidelines for on-tap licencing of SFBs, facilitating the conversion of existing NBFCs, MFIs, local area banks and payments banks into SFBs. Under this, there is a higher capital requirement of ₹200 crore. However, primary UCBs can voluntarily convert into small finance banks, with a minimum net worth of ₹100 crore from the date of commencement of business. They will have to increase their minimum net worth to ₹200 crore within five years from the date of commencement of business.

Meeting capital requirements

According to data provided by RBI on balance sheets of the 54 scheduled UCBs, 45 of them have a capital of over ₹100 crore as of March 2018. However, only 25 UCBs have a capital of over ₹200 crore, the threshold they will have to reach after five years of commencement of SFB business, if they convert.

It is important to note that there are nine UCBs that have a capital of less than ₹100 crore as of March 2018, of which four have a negative net worth — Amanath Co-operative Bank Limited, Bangalore, Rupee Co-operative Bank Limited, Kapol Co-operative Bank Limited, Mumbai and Mapusa Urban Co-operative Bank of Goa Limited, Mapusa.

As far the CRAR requirement goes, while 50 scheduled UCBs have a CRAR of over 9 per cent, a lower 46 of them have CRAR of over 12 per cent.

Falling short

Apart from the capital and net worth requirement, SFBs also have to comply with the norm of extending 75 per cent of loans to the priority sector and must have at least 50 per cent of loans up to ₹25 lakh. They also have to comply with cash reserve ratio (CRR) and statutory liquidity (SLR) requirements. UCBs too have to adhere to CRR and SLR norms.

As far priority sector lending (PSL) requirement is concerned, as of March 2018, UCBs PSL lending stood at 46.6 per cent of credit. The mandated target for UCBs lending to total priority sector is 40 per cent. To meet the 75 per cent norm for SFBs, UCBs will have to up their lending significantly to the priority sector. In May 2018, the RBI revised guidelines for PSL that offers more scope to scale up lending to such segments (for instance, distinction between direct and indirect agriculture was dispensed with). However, how far UCBs can meet the 75 per cent PSL mandate has to be seen. Over 60 per cent of the PSL advances (including to the weaker section) pertains to micro and small enterprises. Agriculture is only 7 per cent of the PSL advances.

On the other mandate — at least 50 per cent of loans of SFBs to be up to ₹25 lakh — scheduled UCBs may need to significantly review their existing business mix and strategy. According to an RBI report, as of March 2015, about 67 per cent of loans by scheduled UCBs were more than ₹50 lakhs.

The detailed break-up of loans under the ₹10 crore category is not available for March 2018. But as per the information available, 50 per cent of the advances of UCBs were with a ticket size of over ₹1000 crore. Only 0.5 per cent of the total loans belonged in the less than ₹10 crore category.

Hence it would appear that the lending structure and models of UCBs (mainly scheduled UCBs) will have to undergo a drastic change to comply with SFB lending norms.

Overall performance

Since converting into an SFB would entail near-term challenges, UCBs with good profitability metrics and sound business models can make the transition better. However, a look at the financial performance of scheduled UCBs as of March 2018 suggests that there is a need for significant improvement in the metrics of many of these banks.

Overall, the return on asset (ROA) and return on equity (ROE) for all scheduled UCBs put together stood at just 0.55 per cent and 7 per cent respectively, as of March 2018. In fact, 19 of the 54 scheduled UCBs, for which information is available, have an ROA of less than 0.5 per cent. In fact, UCBs such as Kapol Co-operative Bank (Mumbai), Mapusa Urban Co-operative Bank of Goa, Shikshak Sahakari Bank (Nagpur), Karad Urban Co-operative Bank, Cosmos Co-operative Bank (Pune) and Bombay Mercantile Co-operative Bank — reported negative ROA, as of March 2018.

The core net interest income growth for the 54 UCBs stood at 12.6 per cent in 2017-18. While this growth figure is decent, 15 of the 54 scheduled UCBs saw a net interest income (NII) growth of below 10 per cent, six witnessed a decline in NII. At an aggregate level, scheduled UCBs saw net profit decline by nearly 9 per cent — six of them reported loss. Four of the scheduled UCBs saw a steep decline in net profit of 40-90 per cent in 2017-18 — New India Co-operative Bank, Rupee Co-operative Bank, Solapur Janata Sahakari Bank, and Thane Bharat Sahakari Bank.

On the balance sheet front, while loans and advances expanded, they grew by a modest 6 per cent for scheduled UCBs in 2017-18. Deposits also grew by a subdued 2.3 per cent, but there was a sharp 43 per cent jump in borrowings. As far as individual banks performance is concerned, 17 of the 54 scheduled UCBs saw their loan books shrink in 2017-18.

The GNPA ratio of scheduled UCBs stood at 6.2 per cent as of March 2018, with a provision cover of 61 per cent.

Skewed distribution

UCBs distribution in the country is highly skewed in terms of region and states. Their high levels of concentration in one region/state could be a key factor that the RBI would consider before granting approval to convert into an SFB. For instance, about 75 per cent of deposits and advances in 2017-18 pertained to the western region, wherein Maharashtra alone constituted about 62 per cent of the total advances. Of the 1551 UCBs (both scheduled and non-scheduled), 498 are from Maharashtra and 220 are from Gujarat. After the western region, southern region constitutes about 17 per cent of deposits/advances, of which Karnataka’s share is nearly 50 per cent.

The RBI has undertaken merger/amalgamation measures for weak, but viable UCBs and closure of unviable ones, over the years. Maharashtra accounted for the largest number of mergers (72 between 2004 and 2018), followed by Gujarat (31).

COMMENT NOW