4.1 The co-operative 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.

4.2 The structure of co-operative banking¹ 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 (Chart IV.1). 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 co-operative credit system is

Under the Banking Regulation Act, 1949 only Urban Co-operative Banks (UCBs), State Co-operative Banks (StCBs) and Central Co-operative Banks (CCBs) are qualified to be called as banks in the co-operative sector. The discussion in this Chapter also covers issues relating to other credit co-operatives viz., Primary Agricultural Credit Societies (PACS) and the long-term structure of rural credit co-operatives. Data on scheduled urban co-operative banks relate to 2003-04, while those for others pertain to 2002-03.

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 Societies (PACSs) which are not banks but only societies. The long-term co-operative credit institutions have generally a two tier structure comprising the State Co-operative 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 not having long-term co-operative credit entities are served by the State Co-operative Banks apart from being serviced by the branches of Regional Rural Banks (RRBs) and the rural/semi-urban branches of commercial banks. However, in the State of Andhra Pradesh, the co-operative structure is integrated combining both short-term and long-term structures.

4.3 The regulation and supervision of co-operative banks poses several challenges in view of the large number of such banks, as also the multiple controls by supervisors, including the Reserve Bank, the State Governments and NABARD. The co-operatives are at present under the control of State Governments in all matters relating to registration, membership, election, financial assistance, loaning powers, business operations, loan recovery and audit. Some aspects relating to banking activities are regulated and supervised by the Reserve Bank of India/NABARD. While urban co-operative banks come under the supervisory jurisdiction of the Reserve Bank, rural co-operatives are regulated by the NABARD. There is thus no clear demarcation of regulatory powers, which at times has resulted in cross directives from the controlling agencies, thereby undermining the working of co-operatives.

4.4 Despite several years of operational experience, financial performance of a number of co-operative banks is still below their potential (Appendix Table IV.1). The infusion of elements of good corporate governance, sound investment policy, appropriate internal control systems, better credit risk management, commitment to better customer service, and focus on newly-emerging business areas like micro finance, is expected to strengthen the co-operative banks The Reserve Bank is in favour of a consultative approach to developing a regulatory framework and a revival plan in order to ensure a vibrant future for the co-operative sector, and thus encouraging systemic stability of the overall financial sector.

2. Urban Co-operative Banks

4.5 Urban Co-operative Banks (UCBs) play an important role as financial intermediaries in urban and semi-urban areas catering to the needs of the non-agricultural sector, particularly small borrowers. In the context of the current economic scenario and problems faced by the co-operative banking sector, several initiatives were taken in consultation with the federations and associations of co-operative banks. These include: deferring the application of 90 day NPA norm for small loans and gold loans up to Rs.1 lakh by two years, giving additional time for meeting the prescribed provisioning requirements for assets classified in doubtful category and permission to transfer Government and other approved securities up to 25 per cent to held to maturity (HTM) category. The Reserve Bank has taken several initiatives to address the procedural and regulatory issues. The consultative process has already been put in place with respect to the UCBs in the form of a Standing Advisory Committee. As stated in the mid-term Review of annual policy 2004-05, a vision document for the future role of UCBs is being evolved to ensure depositors’ interests and avoid contagion, while providing useful service to local communities. In regard to structural issues, the Reserve Bank would be encouraging growth of strong and viable entities within the sector through consolidation. Further, the Reserve Bank would continue to pursue with the State and Central Governments regarding the issues that arise in their jurisdiction.

4.6 The number of UCBs increased to 2,105 including 179 banks under liquidation at end-June 2004 compared with 1,106 in 1966 – the year in which the UCBs were brought under the purview of Banking Regulation Act 1949 (As Applicable to Co-operative Societies (AACS)). These include 80 salary earners banks, 112 Mahila banks and 25 SC/ST banks. State-wise

distribution of branches shows that around 80 per cent of the UCBs are concentrated in five States viz., Maharashtra, Gujarat, Karnataka, Andhra Pradesh and Tamil Nadu (Table IV.1). Only nine UCBs had a deposit size of more than Rs.1,000 crore, while most of the UCBs (about 60 per cent) had a deposit size of less than Rs.25 crore (Table IV.2)

4.7 Of the 8,166 branches of UCBs, 883 were unit banks i.e., banks which function as Head

Office-cum-Branches. The Centre-wise distribution shows that Ahmedabad, Bangalore, Hyderabad and Nagpur had the highest number of unit banks (Table IV.3).

4.8 The minimum demand and time liabilities that a co-operative bank should have, to qualify for inclusion in Second Schedule has been enhanced to Rs.250 crore from Rs.100 crore through the Government of India Notification dated October 30, 2003. During 2003-04 (July-June), one UCB viz., Pravara Sahakari Co-operative Bank Limited, Loni, Dist. Ahmednagar was included in the Second Schedule, while two UCBs from Gujarat viz., Charotar Nagarik Sahakari Bank Limited, Anand and Visnagar Nagarik Sahakari Bank Limited, Visnagar, Gujarat were excluded consequent upon their liquidation. As a result, at end-March 2004, there were 55 scheduled UCBs spread over Andhra Pradesh, Goa, Gujarat, Karnataka, Maharashtra and Uttar Pradesh.

4.9 During 2003-04, scheduled UCBs witnessed several positive developments pertaining to balance sheet, profit and income, and asset quality (Table IV.4). The deposits and advances of scheduled UCBs continued to grow during 2003-04. The policy induced changes in the composition of assets of UCBs, especially, the growth of investments in Government securities, led to a significant improvement in both the asset quality and profitability of scheduled UCBs. The net profit of the scheduled UCBs showed a substantial growth of 40.4 per cent, while the net loss of UCBs declined by 69.1 per cent. Tier I capital of scheduled UCBs as a group increased considerably to Rs.297 crore in 2003-04 from a negative Rs.10 crore in 2002-03. It may be noted that the negative Tier I capital shown for the year ended March 2003 was on account of the combined effect of negative Tier I capital in respect of (i) Madhavpura Mercantile Co-operative Bank Ltd., (ii) Charminar Co-operative Urban Bank Ltd., (iii) Vasavi Co-operative Urban Bank Ltd., (iv) Bombay Mercantile Co-operative Bank Ltd., (v) Janata Sahakari Bank Ltd., (vi) Mapusa Urban Co-operative Bank Ltd. and (vii) Rupee Co-operative Bank Ltd. on the aggregate position. Tier II capital also recorded a modest increase of 21.7 per cent. Non-performing assets declined both in absolute as well as percentage terms. The decline in net NPAs was higher due to increased provisioning.

4.10 UCBs are registered as societies under the Co-operative Societies Act of the respective State Governments, and UCBs that have a multi State presence are registered under the Multi State Co-operative Societies Act administered by the Government of India. While registration, administration, amalgamation and liquidation of UCBs are governed by the provisions of the

State Co-operative Societies Acts, banking related functions are governed by the provisions of Banking Regulation Act, 1949 (AACS).

4.11 An Ordinance to amend the Banking Regulation Act, 1949 and DICGC Act, 1961 was promulgated on September 24, 2004 to enable the Reserve Bank to issue licence to Multi State Co-operative Societies to carry on banking business. This was in response to developments following the Supreme Court judgement dated October 29, 2003 that the Reserve Bank could not issue banking licences to a society registered under the Multi State Co-operative Societies Act (MSCS Act), 2002. The Supreme Court ruling raised doubts about the legality of the licences issued to the existing multi State UCBs by the Reserve Bank under the Banking Regulation Act, 1949. This amendment would enable the Reserve Bank to issue licences to co-operative societies registered under the Multi State Co-operative Societies Act, 2002. The multi State co-operative banks have also become ‘eligible banks’ under Section 2(gg) of the DICGC Act so that their deposits can be insured by the Deposit Insurance Credit Guarantee Corporation in the interest of the small depositors.

4.12 The Reserve Bank since 2000-01 has sought to align the regulatory regime for the UCBs with that of commercial banks by introducing several measures relating to prudential norms, capital adequacy, asset classification, provisioning norms, individual and group exposure norms, ALM framework, etc.

4.13 The Reserve Bank constituted a Screening Committee of eminent external experts in June 2001 to examine the various factors influencing the viability of proposed banks including the background and credit-worthiness of promoters of proposed new UCBs, and the environment/ business projections submitted by the promoters. During 2003-04, 118 proposals for setting up of new UCBs were placed before the Committee for consideration. Three UCBs, which were granted ‘in principle’ approval during 2002-03, were issued banking licences during 2003-04. However, the Committee recommended that for all newly proposed UCBs, it should be made mandatory to come into being through a process of graduation on the strength of demonstrated and verifiable track record. Subsequently, it has been decided to consider issuance of fresh licences only after a comprehensive policy on UCBs is put in place.

4.14 During 2003-04, 104 licences were issued for opening new branches to 86 UCBs. According to the detailed guidelines issued by the Reserve Bank to UCBs on opening of Extension Counters (ECs), only those UCBs which are not classified as Grade III/IV can open ECs within the premises of educational institutions, big offices, factories and hospitals, of which the UCB is the principal banker provided the nearest branch of the bank is beyond 10 kms from the concerned institution. The eligibility for opening ECs for UCBs in Grade I/II requires that the own funds should not be less than the minimum required for opening of new branch at the place where the proposed EC is to be opened, and also subject to compliance with CRR/SLR, priority sector lending targets, other provisions of Banking Regulation Act, 1949 (AACS) and other instructions issued by the Reserve Bank. Further, only those UCBs that show net profits for the last three years and have net NPAs below 7 per cent can offer safe deposit locker facility subject to provisions of adequate security arrangements. While scheduled UCBs, which satisfy the eligibility criteria have been permitted to open ECs and obtain post facto approval from the Reserve Bank, non-scheduled UCBs require prior permission of the Reserve Bank for opening an EC.

4.15 The Board for Financial Supervision (BFS) of the Reserve Bank has been playing a critical role in enhancing the quality of regulation of urban co-operative banks on the basis of its deliberations and guidance while considering the inspection summaries of scheduled UCBs placed before the Board as well as other matters referred to it (Box IV.1).

4.16 UCBs have also been subjected to ‘Know Your Customer’ (KYC) norms. These guidelines relate to identification of depositors, and require the banks to put in place systems and procedures to help control financial frauds, identify money laundering and suspicious activities, and scrutiny/monitoring of large value cash transactions. UCBs were advised that the information collected from customers as part of KYC guidelines was confidential and not to be used for cross selling of services of various products by the banks. UCBs desirous of collecting information about customers for purposes other than KYC requirements could do so separately by obtaining customers’ approval for making use of such information.

The Board for Financial Supervision (BFS) suggested in March 2004 that till such time that appropriate regulatory/legislative framework be put in place, no fresh licences for setting up of UCBs should be issued. The suggestion was accepted and incorporated in the annual policy Statement 2004-05 announced on May 18, 2004.

Apart from this, the BFS has proposed a graded response to the issue of granting banking licences to existing unlicensed banks based on their eligibility criteria. Further BFS directed that only financially strong scheduled UCBs should be allowed to keep the deposits of non-scheduled UCBs to avoid contagion effect of failure of one UCB on other UCBs. The need for framing a 'Prompt Corrective Action' mechanism based on certain financial trigger points was also underscored by the Board, and as

directed by the Board, a paper on Escalatory Framework of Supervisory Action is under preparation. In case of several scheduled UCBs whose financials were weak, the Board directed that the concerned State Governments be advised to infuse capital in the banks to the extent required to meet the prescribed CRAR level. If capital funds are not infused within the prescribed time, the banks which had placed deposits with these banks (having solvency problem) would require to treat these deposits as NPAs.

Supervisory ratings based on CAMELS ratings, as applicable to commercial banks was introduced, initially for the scheduled UCBs with effect from March 2003, on an experimental basis. Simplified rating model for large non-scheduled urban co-operative banks based on CAEL parameters has been introduced from March 2004.

4.17 According to the targets prescribed, the UCBs are required to extend 60 per cent of total loans and advances for lending to the priority sector and of the total priority sector advances, at least 25 per cent (or 15 per cent of the total loans and advances) should be extended to weaker sections. In order to ensure that credit is available to all segments of the Small-Scale Industry (SSI) sector, (classified on the basis of investment in plant and machinery), certain sub-targets have also been specified (Table IV.5).

4.18 As at end-March 2003² , UCBs had extended Rs 42,633 crore to the priority sector constituting 62.1 per cent of total loans and advances (Table IV.6). Segment-wise break up shows that the highest percentage of priority sector advances was extended to cottage and small-scale industries followed by housing, and small business enterprises.

4.19 During 2003-04 (April-March), four UCBs were sanctioned refinance to the tune of Rs.466.89 lakh under Section 17(2)(bb) read with Section 17(4)(C) of the Reserve Bank of India Act, 1934.

4.20 Scheduled UCBs having a minimum net worth of Rs.100 crore and complying with exposure norms and connected lending have been allowed to act as corporate agents to undertake insurance business without risk participation after obtaining the approval of the Reserve Bank.

4.21 The Standing Advisory Committee on UCBs constituted by the Reserve Bank is a high

2 The data on priority sector advances of UCBs are available upto end-March 2003.

powered body chaired by a Deputy Governor and comprising members from Central and State Governments, IBA, DICGC, NABARD and federations of UCBs to give expert advice on policy matters pertaining to UCBs. The Committee had recommended in December 2002, that there should be representation of non-member depositors on the Board of UCBs so as to protect the interests of such depositors, as the proportion of non-member deposits to total deposits is very high in the UCBs. Accordingly, State Governments have been requested to consider amending their respective State Co-operative Societies Act so as to give representation to the non-member depositors on the Board of UCBs. With a view to reinforcing the consultative process in a more constructive manner, to address the structural/ regulatory and supervisory issues relating to UCBs and facilitating the process of formulating future approaches for this sector, it has been decided that the Committee would meet on a quarterly basis in future.

4.22 The overall ceiling on loans to directors, their relatives, and concerns in which they are interested was brought down to five per cent of bank’s demand and time liabilities in December 2002. A few instances, however, of an undue concentration of advances in the hands of a few borrowers, including directors and their relatives, were brought to the notice of the Reserve Bank. The Joint Parliamentary Committee (JPC), which probed the ‘stock market scam and matters relating thereto’ recommended that a complete ban be imposed on granting of loans and advances to the directors and their relatives or the concerns in which they are interested. Accordingly, a complete ban on sanction of loans and advances by UCBs to their directors and their relatives and the firms/ concerns in which they are interested has been imposed effective October 1, 2003.

4.23 UCBs have been advised to step up their SLR investments in Government securities and other approved securities. In order to mitigate the risk arising out of dealing in such securities, it has been prescribed that UCBs should build up Investment Fluctuation Reserve (IFR), out of realised gains on sale of investments and subject to available net profit, of a minimum of five per cent of the investment portfolio in available for sale and held to maturity categories within a period of five years.

4.24 Draft guidelines on UCBs’ investments in non-SLR debt securities was placed on the website for comments/suggestions from UCBs. Based on the feedback received, final guidelines were issued in April 2004. The guidelines cover investments in bonds issued by public sector undertakings, unsecured redeemable bonds floated by nationalised banks, bonds/shares issued by AIFIs and units of Unit Trust of India (UTI) and apply to both primary market and secondary market. As per the guidelines, UCBs are not permitted to invest in non-SLR debt securities of original maturity of less than one year. The Board of Directors should fix prudential limits in each category of investments and the aggregate investments in non-SLR debt securities including units of UTI should not exceed 10 per cent of the deposits as on March 31 of the previous year. UCBs’ investments in units of UTI should not exceed five per cent of the incremental deposits of the previous year.

4.25 UCBs have been issued detailed guidelines/safeguards on purchasing/ negotiating/discounting/rediscounting of genuine commercial bills. Banks have been advised to clearly lay down a bills discounting policy approved by their Board of Directors, which should be consistent with their policy of sanctioning of working capital limits.

4.26 All the scheduled UCBs and other UCBs that have deposits above Rs.50 crore were advised in December 1996 to introduce systems of concurrent audit. As recommended by the JPC on ‘Stock Market Scam and Matters Relating Thereto’, concurrent audit has been made mandatory for all the UCBs. UCBs have been advised to report serious irregularities, if any, pointed out by the Concurrent Auditors to the Reserve Bank together with details of the action taken to rectify the same.

4.27 In line with the international best practices and to ensure greater transparency, the period for recognition of loan impairment has been reduced from 180 days to 90 days with effect from March 31, 2004 except for gold loans and small loans up to Rs.1 lakh, which continue to be governed by 180 day loan impairment norm.

4.28 In view of representations received from UCBs/Federations, the time period for receiving and processing of applications for settlement of NPAs up to Rs.10 crore under one-time settlement has been extended up to July 2004 and October 2004, respectively. Registrar of Co-operative Societies of all the States have been advised to issue suitable instructions enabling UCBs to take recourse to Securitisation Act for recovery of NPAs.

4.29 In respect of NPAs included in ‘doubtful for more than three years’ category on or after April 1, 2004, a higher provisioning requirement of 100 per cent in place of 50 per cent earlier has been prescribed with effect from March 1, 2005. On receipt of requests from Federation/ Association of UCBs for granting more time to restructure their accounts and meet stricter prudential norms, it has been decided to grant more time to UCBs for: (i) adopting a graded higher provisioning according to the age of NPAs for the NPAs outstanding as on March 31, 2006, and (ii) a provisioning requirement of 100 per cent for NPAs classified as ‘doubtful for more than three years’ category.

4.30 It was observed that UCBs wait till the end of financial year to make provisions against NPAs which distorts the quantum of net NPAs as on any date other than the date of annual closure of accounts. UCBs have, therefore, been advised that apart from identifying NPAs on an ongoing basis, they should make provisions for the same at the end of each quarter.

4.31 A revised set of off-site surveillance returns were prescribed for scheduled UCBs effective from the quarter-ended March 2004 to obtain relevant information on areas of supervisory concern, strengthen MIS systems within the scheduled UCBs and to sensitise their managements about the prudential concerns of the supervisory authority and thereby help in self regulation. The content and structure of OSS returns have been modified to reduce the volume of data submission, while enlarging the breadth and depth of information being obtained from UCBs. The UCBs now have to submit eight returns including one annual return from the quarter ended April 2004.

4.32 The scope of OSS has been extended to cover non-scheduled UCBs with a deposit base of Rs.100 crore and above from the quarter-ended June 2004. The remaining non-scheduled UCBs would be brought under OSS in a phased manner. A revised application software developed by the Reserve Bank has been installed in all the UCBs covered under OSS enabling them to submit all the regulatory and supervisory returns in electronic format. The accuracy of data submission by UCBs is ensured through validation checks built in the application package. The application package also enables Regional Offices to capture the data received from UCBs electronically and the data gets replicated in the server installed in Central Office over the INFINET.

4.33 As a framework for initiating prompt corrective action, a system of gradation of UCBs based on critical financial parameters viz., capital adequacy, net non-performing advances and profitability has been introduced. Gradation is communicated to problem banks to enable them to formulate action plans for corrective action (Box IV.2). Only UCBs having strong financials are allowed to declare dividend.

4.34 Reserve Bank issues directions under Section 35A in respect of banks, which are in serious financial difficulty. The directions may be issued either as a consequence of findings of the inspection report or due to sudden developments like a run on the bank, etc. The directions may include restriction on deposit taking, withdrawal of deposits with or without a ceiling, further expansion of loans, restriction on incurring expenditure other than minimum establishment expenses required for day to day running of the bank, etc. The banks placed under directions are monitored and the restrictions may be gradually removed depending upon the ability of banks to rectify the inadequacies (Appendix Table IV.2).

4.35 The reconstruction schemes approved by the Reserve Bank in the recent past, in respect of a few UCBs, which landed into financial difficulty, have not been progressing as intended. Accordingly, it has been announced in the annual policy Statement for the year 2004-05 that only such reconstruction schemes would be considered, which envisage recapitalisation by the stakeholders viz., the shareholders/co-operative institutions/ Government to the extent of achieving the prescribed capital adequacy norms, without infusion of liquidity through settlement of insurance claims by DICGC, and schemes that lay a clear road map for reducing the NPA level to a tolerable limit within a stipulated time-frame.

4.36 Keeping a constant vigil on the UCBs, the Reserve Bank took measures as cancellation of licences and rejection of licence applications to eliminate financially unviable entities from the urban banking sector. Also, the Registrars of Co-operative Societies (RCS) were asked to initiate liquidation proceedings in a few banks (Appendix Table IV.3). Further, the liquidators appointed by the RCS in a few banks were found to be directly linked with other UCBs in the area. It was also noticed by DICGC that the claim list submitted in respect of UCBs under liquidation contained several inadequacies. In order to overcome such shortcomings, RCS of all the States were requested to frame criteria for appointment of liquidators with suitable qualifications. Further, certification by a Chartered Accountant of the deposit claim list forwarded by UCBs under liquidation/amalgamation/merger/restructure has been introduced.

4.37 In order to reduce UCBs’ exposure to the capital market, the margin requirement on

For regulatory purposes, a system of grading has been adopted under which UCBs are being classified into four categories (Grade I/II/III/IV). The criteria for classification is as follows.

Sound banks having no supervisory concerns are classified as Grade I. Banks meeting any one of the following parameters are classified under Grade II (problem banks): (i) CRAR of one per cent below the prescribed norms, or (ii) net NPAs of 10 per cent or more, but below 15 per cent, or (iii) incurred a net loss for the previous financial year, or (iv) defaults in the maintenance of CRR/SLR in the previous financial year and/ or there is more or less a continuous default in maintenance of CRR/SLR during the current year.

Banks meeting any two of the following conditions are classified under Grade III: (i) CRAR of less than below 75 per cent of the minimum prescribed but 50 per cent or above the level required; (ii) net NPA of 10 per cent or more, but less than 15 per cent; (iii) incurred net losses for two years out of the last three years. Banks meeting the following conditions are classified under Grade IV: (i) CRAR of less than 50 per cent of the prescribed limit and (ii) net NPA at 15 per cent or more or incurred net losses for the last three consecutive years.

As at end-June 2004, the financial position of 732 UCBs were not considered satisfactory and were categorised under Grade III/IV (Table). While, 307 banks have been classified as Grade II (where slight deterioration in the financial condition is noticed), 529 banks are in Grade III (where the financial condition has deteriorated requiring supervisory action viz., ban on declaration of dividend, ban on opening of branches, etc.), and 203 banks in Grade IV (where the financial condition has worsened to such an extent requiring drastic supervisory action viz., imposition of directives, amalgamation, reconstruction, liquidation, etc.).

advances against shares/debentures has been increased to 50 per cent with effect from January 5, 2004.

4.38 UCBs have been advised not to open Constituents’ Subsidiary General Ledger (CSGL) Accounts of other UCBs, and to settle all their Government securities transactions compulsorily through Clearing Corporation of India Limited (CCIL). UCBs are advised to open demat account with a depository participant for holding public sector undertakings’ (PSU) securities.

4.39 It has been the endeavour of the Reserve Bank to develop the urban co-operative banking sector on sound lines in order to provide security to depositors as well as bridge the financing gaps for SSIs, SMEs and small borrowers. Though the supervisory standards of these banks have been streamlined in recent years to bring them on par with the commercial banks, it is sometimes argued that these standards which are designed primarily for the commercial banks may not be suitable for the co-operative credit structure. International comparison of the existing regulatory framework for co-operative banking sector in a few major countries also indicates that in order to ensure overall smooth functioning of the financial system, it may be necessary to inculcate sound financial discipline in these institutions (Box IV.3).

The origin of co-operative principles can be traced to 1800 -the early stage of Europe’s industrial revolution. At first, the philosophy of equality, equity and self-help was confined mainly to the area of retail trade. The ideas of self-help, self-responsibility and self-administration deployed by a few men of vision like Raiffeisen and Schulze in Germany, spread very rapidly through Europe and rest of the world with the result that there are now more than 60,000 credit co-operatives operating in more than 100 countries.

At present, a majority of co-operative banks in Europe have acquired universal bank status, providing a full range of financial services to all types of customers (members and clients alike) as opposed to focusing on serving members with a specific product range. In some member states of the European Community, co-operative banks have been eminently successful viz., the Credit Agricole in France, Raiffeisen and People’s Banks in Germany, Rabobank Nederland in the Netherlands and Austrian Raiffeisen banks. Co-operative banks with the universal bank status are subject to banking supervisory legislation in common with their commercial and savings bank competitors. The universal bank status accorded to co-operative banks entails that they are the only players in the banking market to have expanded their global market share in most European countries during the past two decades. The European Association of Co-operative Banks, created in 1970, functions as spokesperson for co-operative banks to the European Community (EC) authorities and comprises of member organisations from all the EC member states, Austria, the Czech Republic, Finland, Hungary, Sweden and Poland.

In the United States, co-operative banks, known as credit unions (CUs), with certain unique characteristics have evolved as increasingly competitive and customer-oriented providers of financial services to more than 68 million people. Like banking companies, CUs in the United Sates have a dual charter system - Federal or State. State-chartered credit unions are examined and supervised by state agencies, while federally chartered credit unions are examined and supervised by the National Credit Union Administration (NCUA), an agency of the federal government. The NCUA also examines state-chartered, federally insured institutions. In addition to chartering, supervising, examining, and insuring federal credit unions, the NCUA insures the accounts of state-chartered credit unions that voluntarily exercise the option to be federally insured, or are required by state law to be so. The credit union industry in the US has many tiers: credit unions, local chapters and State leagues of CUs, corporate credit unions, a national credit union ‘bankers’ bank’, and national trade associations. Regulatory structures consist of a federal agency, a liquidity branch of that agency, and State regulators. A corporate credit union (CCU) is a credit union, providing investment, settlement, and liquidity services for its members. A CCU also serves as a bankers’ bank for credit unions, accepting deposits and lending to them when loan demand is high. CCUs also provide their members with cheque clearing, automated clearing house processing, and other services, and function as a credit union clearing house. Charters generally establish rules for application requirements, purpose, membership, branching, and regulatory supervision. State-chartered CUs are examined and supervised by State agencies, while federally chartered CUs are examined and supervised by the NCUA. NCUA aids in CUs’ insurance, liquidity and liquidation through its two operations National Credit Union Share Insurance Fund (NCUSIF) and the Central Liquidity Facility (CLF). The NCUA also examines State-chartered federally insured institutions. The strength of the US credit union system, both State and Federal, depends on preserving the basic principle of dual chartering. Dual chartering system means that credits unions should have a meaningful choice between two strong and distinct charters: State or Federal. Credit union’s ability to choose, to pass judgment on a charter by voting creates a healthy competition between charters creating an incentive for regulators (both State and Federal) to maximise efficiency in their examinations, reduce costs, and take innovative approaches to regulation while maintaining high standards for safety and soundness. These examination efficiencies and innovative approaches in turn, once proven successful, spread throughout the system. The concept of dual chartering also provides an invaluable safety valve for the credit union system.

Credit co-operatives of one form or another existed in some Australian states as far back as 1905. The first State Cooperative Act in Australia was passed in 1923 and was amended by a more flexible Small Loans Act in 1941. In 1946, the first of modern credit unions was registered in Sydney. During the formative period, most credit unions were parish or community oriented organisations. However, the co-operative concept of promoting thrift was quickly embraced by industry and employer groups, and the present movement is a mix of industry based credit unions, affinity based credit unions and community credit unions.

In Australia, it was decided to implement the recommendations of the Financial System Inquiry, ‘The Wallis Report’ which suggested a single prudential regulator for all deposit taking institutions including CUs, building societies and banks. The rationale was that all deposit taking institutions should provide the same level of safety to consumers. In July 1999, all Australian CUs moved from the State based Financial Institutions (FI) Scheme to the new national system of prudential and corporate regulation under the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC). Consequently, CUs are supervised on the same basis as all other financial institutions, including banks. Under the new corporate regulatory system, credit unions became companies limited by shares under the corporation law. Every member of a credit union became a shareholder with one vote. Credit unions are thus similar to companies limited by shares and bound by the principles of mutuality, developed by the Credit Union Movement. Since July 1999 all CUs became public companies governed by the Corporations Act and regulated by the ASIC. The CUs operate within the regulatory framework and prudential supervision of the APRA. This structure provides high prudential standards for risk management, capital adequacy and disclosure.

Ravoet, G. (1994), ‘The Challenge Facing European Co-operative Banks’, The World of Co-operative Enterprise, Plunkett Foundation.

Thomas, T. (1994), ‘The Future Development of Co-operative Banks’, The World of Co-operative Enterprise, Plunkett Foundation.

Official websites of National Credit Union Administration, USA, Australian Prudential Regulatory Authority, and Australian Institute of Credit Union Directors.

4.40 The deposits and advances of the UCBs in 2003-04 increased by 8 per cent and 3 per cent, respectively, over 2002-03 and stood at Rs.1,10,256 crore and Rs.67,930 crore, respectively, as at end-March 2004. The paid up capital at Rs.3,267 crore as on March 31, 2004 showed an increase of 11 per cent over that in end-March 2003 (Chart IV.2).

4.41 When the UCBs were brought under the purview of the Banking Regulation Act, 1949 (AACS) in 1966, there were 1,106 UCBs having own funds to the tune of Rs.58 crore, and their deposits and advances amounted to Rs.153 crore and Rs.167 crore, respectively. As on March 31, 2004, there were 1,924 banks whose own funds amounted to Rs.12,348 crore. Their deposits and advances registered a substantial rise and stood at Rs.1,10,256 crore and Rs.67,930 crore, respectively. The region-wise financial position of UCBs displayed wide regional diversity (Table IV.7).

4.42 The SLR investments of all the UCBs increased to Rs.45,299 crore from Rs.38,739 crore as at end-March 2004 registering an

4.43 The gross non-performing advances declined by 5 per cent to Rs.11,922 crore at end-March 2004 from Rs.12,509 crore as at end-March 2003. Net NPAs declined by 12 per cent to Rs.5,683 crore from Rs.6,428 crore during the same period (Table IV.8). In percentage terms, gross NPAs declined to 17.6 per cent from 19.0 per cent and net NPAs declined to 11.1 per cent from 13.0 per cent for the period under consideration. In absolute terms, however, the Gross and Net Non-Performing Investments have increased by 13 per cent and 14 per cent, respectively, i.e., to Rs.365 crore from Rs.324 crore and to Rs.276 crore from Rs.242 crore, respectively, for the same period.

4.44 The size of scheduled UCBs declined during 2003-04 reflecting contraction of the UCB sector and a moderate decline in their numbers. The composition of liabilities remained broadly the same with modest decline in the share of deposits (Table IV.9). On the asset side, the share of investments increased while the share of loans and advances declined. This was in line with the trend witnessed in 2002-03 and in consonance with developments in the other segments of the financial sector.

4.45 The scheduled UCBs registered an increase in net profit due to a sharper decline in expenditure vis-à-vis income (Table IV.10). Interest income continued to decline as a proportion of total income. This was reflective of the changing asset composition and was in

tune with the trends witnessed in the banking sector. The share of interest expenditure as well as operating expenditure increased while the provisions and contingencies nearly halved in absolute terms. Bank-wise details on the major indicators of financial performance of the scheduled UCBs are given in Appendix Table IV.4 and IV.5.

3. Rural Co-operatives

4.46 The short-term rural co-operative credit system in India comprising State co-operative banks (StCBs) at the apex (State) level, central co-operative banks (CCBs) at the intermediate (district) level and primary agricultural co-operative Societies (PACS) at the grassroot (village) level, is designed essentially to provide for short-term credit needs for production purposes. StCBs and CCBs have over the years grown substantially in terms of coverage and outreach, and at end-March 2003, their number stood at 30 and 367, respectively. Most of the StCBs and CCBs were established prior to March 1, 1966, the date from which the Banking Regulation Act, 1949 was made applicable to the co-operative banks. Of these, only 13 StCBs and 73 CCBs have been granted licence by the Reserve Bank since 1966. The financial position of most of the StCBs and CCBs does not show any perceptible improvement. The accumulated losses of CCBs have increased to Rs.4,442 crore in 2002-03 from Rs.3,217 crore in 2000-01. The percentage of recovery to demand for StCBs and CCBs declined to 79 per cent and 61 per cent, respectively, in 2002-03 from 84 per cent and 67 per cent, respectively, in 2000-01. As on March 31, 2003, the gross NPAs to gross credit of StCBs and CCBs increased to 18 per cent and 22 per cent, respectively, from 12.7 per cent and 18.3 per cent, respectively, as at end-March 2001. Many of these short term rural co-operatives did not meet the minimum capital and reserve requirements stipulated under Section 11(1) of the Banking Regulation Act, 1949 (AACS).

4.47 State co-operative agriculture and rural development banks (SCARDBs) and primary co-operative agriculture and rural development banks (PCARDBs) which constitute the long-term rural co-operative credit structure, have negligible resource base of their own, and mostly raise resources through borrowings. Their poor recovery performance has affected their ability particularly at the primary level to cater to the credit needs of new and non-defaulting members. This has also resulted in low paid-up share capital, which constrains their borrowing capacity, and the consequent limited resources have inevitably led to low business levels.

4.48 Subsequent to the announcement made in the Union Budget 2004-05, Government of India has appointed a Task Force on Co-operatives under the Chairmanship of Prof. A. Vaidyanathan. The terms of reference include (i) to recommend an implementable action plan for reviving the Rural Co-operative Banking Institutions, taking into consideration, inter alia, the main recommendations made by various committees in this regard; (ii) to suggest an appropriate regulatory framework and the amendments, which may be necessary for the purpose, in the relevant laws; (iii) to make an assessment of the financial assistance that the Co-operative Banking Institutions will require for revival, the mode of such assistance, its sharing pattern and phasing; and (iv) to suggest any other measures required for improving the efficiency and viability of Rural Co-operative Credit Institutions. The Task Force is expected to submit its report shortly.

4.49 In order to streamline the investments made by StCBs and the CCBs, and to contain the risk arising out of their non-SLR investment portfolio, prudential guidelines on investment in non-SLR debt securities were issued in February 2004 on similar lines as those issued to scheduled commercial banks.

4.50 It was observed from the various financial indicators of the StCBs and CCBs that the number and amount of outstanding debit entries in the Inter-Branch Adjustment Accounts and the amount involved thereunder were increasing over the years. In order to put in place the best international accounting standards, it was decided to prescribe prudential provisioning norms for net debit balances outstanding in their Inter Branch Accounts in a phased manner. These instructions were issued in January 2004.

4.51 No StCB or CCB has been granted licence during 2003-04 under Section 22 of the Banking Regulation Act, 1949 (AACS) and the total number of licensed StCBs and CCBs stood at 13 and 73, respectively.

4.52 The licence applications of four CCBs, viz., Sibsagar DCCB Ltd. (Assam), Madhepura-Supaul DCCB Ltd., Darbhanga DCCB Ltd. (Bihar) and Raigad DCCB Ltd. (Chattisgarh) have been rejected during the year under review, taking the total number of such cases to seven.

4.53 No StCB was included during 2003-04 in the Second Schedule under Section 42 of the Reserve Bank of India Act, 1934. The total number of scheduled StCBs remained unchanged at 16 as on March 31, 2004.

4.54 The composition of the liabilities of the StCBs in terms of major components (viz., capital, reserves, deposits, borrowings and other liabilities) remained broadly unaltered between end-March 2002 and end-March 2003 (Table IV.11). The recovery performance of StCBs as a proportion of demand at the all-India level declined to 79 per cent in 2002-03 from 82 per cent in 2001-02. Among the various States/Union Territories, the recovery performance in Rajasthan and Sikkim improved considerably, while it declined significantly in Andhra Pradesh and Arunachal Pradesh. The States where StCBs achieved more than 90 per cent recovery during 2002-03 include Gujarat, Haryana, Kerala, Madhya Pradesh, Punjab, Rajasthan and Tamil Nadu.

4.55 There was a decline in overall income and expenditure of StCBs during 2002-03. However, the net profit increased mainly due to increase in miscellaneous income and reduction in wage bill (Table IV.12). Out of 24 reporting StCBs, 21 have earned profits aggregating to Rs.463 crore, while 3 made losses amounting to Rs.29 crore.

4.56 The composition of the liabilities of Central co-operative banks (CCBs) remained broadly unaltered between end-March 2002 and end-March 2003 (Table IV.13). Deposits

continued to account for nearly two-thirds of the total liabilities, while reserves recorded a growth of 19.7 per cent.

4.57 At the all-India level, recovery performance of CCBs declined to 61 per cent for the year 2002-03 from 66 per cent during 2001-02. A few States such as, Chattisgarh and Himachal Pradesh, registered improvement in recovery performance, while the recovery performance in Andhra Pradesh, Bihar, Jammu & Kashmir, Jharkhand, Karnataka, Orissa and Tamil Nadu declined considerably. Punjab and Uttaranchal achieved more than 80 per cent recovery during 2002-03 (Appendix Table IV.6).

4.58 CCBs as a whole continued to register losses during 2002-03 as well (Table IV.14 & IV.15). Interest income accounted for nearly 95 per cent of the total income, while interest expenditure accounted for nearly two-thirds of total expenditure. During 2002-03, out of 339 reporting CCBs, 234 made profits amounting to Rs.734 crore, while 105 CCBs made losses to the tune of Rs.859 crore. The deterioration in the overall profitability of CCBs could be attributed to higher expenses for provisions and contingencies.

4.59 PACS as the grassroot level arm of short-term co-operative credit, mediate directly with individual borrowers, grant short-term to medium-term loans and also undertake distribution and marketing functions. There were 1,12,309 PACS as on March 31, 2003 with about 120 million members. A large number of PACS, however, face severe financial problems primarily due to significant erosion of own funds, deposits, and low recovery rates. Various policies have been adopted to improve the financial health of the PACS. NABARD, in particular, has been extending funds to develop the infrastructure of PACS.

4.60 The NPAs assets of rural co-operative banks remained high. The asset quality of the higher tier, i.e., StCBs was, however, relatively better than that of the lower tier, i.e., CCBs (Table IV.16).

4.61 Poor recovery performance continues to be a growing area of concern in the case of cooperative credit structure. During 2002-03 both the short-term and long-term credit have witnessed a fall in the rate of recovery.

4.62 In order to address the problem of large NPAs being faced by the rural credit co-operatives, NABARD has issued guidelines to co-operative banks on One-Time Settlement (OTS) scheme for NPAs on the lines of Reserve Bank’s guidelines to commercial banks. The guidelines provide for a simplified non-discretionary and non-discriminatory mechanism for compromise settlement of NPAs of Rs.10 lakh and below for individual borrowers and Rs.10 crore and below in respect of institutions under all categories of loans and advances. The scheme remained operative initially till September 30, 2003 but was further extended up to July 31, 2004 for acceptance of cases for OTS for NPAs under all loans and up to October 31, 2004 for completion of process of settlement. Finally, co-operative banks were given discretion to formulate OTS scheme for amounts of NPAs beyond the above cut-off level and date with the approval of Board of Directors and the Registrar of Co-operative Societies.

4.63 The long-term co-operative credit structure consists of State Co-operative Agriculture and Rural Development Banks (SCARDBs) and Primary Co-operative Agriculture and Rural Development Banks (PCARDBs). Total number of SCARDBs is placed at 20, while that of PCARDBs is placed at 768.

4.64 Important performance parameters of SCARDBs and PCARDBs as on March 31, 2002 and March 31, 2003 are given in Table IV.17.

4.65 The share capital of SCARDBs increased at a higher rate of 8 per cent compared with the growth of 4 per cent for PCARDBs. The deposits of both the term-lending rural co-operatives declined during 2002-03 – the decline in deposits of PCARDBs (13.3 per cent) being steeper than that for SCARDBs (4.4 per