Developments in Co-operative Banking

4.1 Co-operative banking has passed through many phases since the enactment of the Agricultural Credit Co-operative Societies Act in 1904. Co-operative banks, developed largely as an offshoot of official policy, expanded rapidly in the post-independence era and played an important role in implementation of various Government schemes. Their business is now being re-engineered to strengthen their role in contributing to financial inclusion and deepening banking penetration in an increasingly competitive financial landscape.

4.2 The co-operative banking structure in India is complex. It comprises urban co-operative banks and rural co-operative credit institutions. Urban co-operative financial institutions consist of a single tier, viz., primary co-operative banks, commonly referred to as urban co-operative banks (UCBs). However, they are classified according to their scheduled status, operational outreach and purpose/clientele. Out of the 1,853 UCBs, 55 enjoyed scheduled status, of which 24 had multi-State presence as on March 31, 2006. Of the non-scheduled UCBs, 117 were Mahila (women) UCBs and another 6 were Scheduled Caste (SC)/Scheduled Tribe (ST) banks. In addition, there were 79 salary earnersí UCBs. Out of the 1,853 banks, 914 UCBs were unit banks i.e., having a single Head office/branch set up.

4.3 Historically, rural co-operative credit institutions have played an important role in providing institutional credit to the agricultural and the rural sectors. These credit institutions have typically been divided into two distinct structures, commonly known as the short-term co-operative credit structure (STCCS) and the long-term co-operative credit structure (LTCCS). The STCCS, comprising primary agricultural credit societies (PACS) at the village level, district central co-operative banks (DCCBs) at the intermediate level, and the state co-operative banks (StCBs) at the apex level, provides crop and other working capital loans primarily for short-term purposes to farmers and rural artisans. The LTCCS, comprising state co-operative agriculture and rural development banks (SCARDBs) at the State level and primary co-operative agriculture and rural development banks (PCARDBs) at the district or block level, has been providing typically medium and long-term loans for making investments in agriculture, rural industries and, in the recent period, housing. However, the structure of rural co-operative banks is not uniform across all States of the country. Some States have a unitary structure with the State level banks operating through their own branches, while others have a mixed structure incorporating both unitary and federal systems (Chart IV.1).

4.4 Several measures have been initiated in recent years with the primary objective of evolving a turnaround in the financial health of the cooperative sector. As announced in the Mid-Term Review of the Annual Policy 2004-2005, a draft ëVision Document for Urban Co-operative Banksí was formulated and placed in the public domain in March 2005. As UCBs are subject to dual control by the Reserve Bank and the State Governments, the Vision Document envisaged greater convergence in the approach towards regulation and supervision over UCBs for facilitating the development of the sector. For strengthening the rural co-operative credit institutions, the Government of India constituted the ëTask Force on Revival of Rural Co-operative Credit Institutionsí (Chairman: Prof. A. Vaidyanathan) in August 2004 to formulate a practical and implementable action plan for revival of rural co-operative banking institutions. In view of the multi-tier regulatory structure, heterogeneous nature of operations and problems of incentives faced by the co-operative sector, consultative process of policy formulation guided the approach of reform in this important segment of the financial sector. Prudential regulatory standards were designed keeping in view the nature of their business with an overall objective of improving their financial health.

4.5 Business operations of  UCBs (scheduled and unscheduled), on the whole, expanded at a moderate rate, though scheduled UCBs grew at a relatively higher rate during the year. The asset quality of UCBs also improved significantly. Profits of scheduled UCBs increased during 2005-06.

4.6 All segments of the rural co-operative sector were able to expand their business operations during 2004-05, the latest period for which data were available (Appendix Table IV.1). However, their financial performance varied across the institutions. Within the short-term structure, while the StCBs earned lower profits, on account of a sharp decline in income, as compared with 2003-04, DCCBs earned higher profits over the same period due to a significant rise in income. PACS, on the whole, continued to make overall losses, although a sizable number of them earned profit. In the case of long-term structure, while the SCARDBs continued to incur net losses during 2004-05 on account of rise in expenditure, especially in provisions and contingencies, PCARDBs staged a turnaround over the same period, facilitated by a sharp increase in non-interest income and expenditure containment. Asset quality of short-term structure of rural co-operative banks improved, while NPAs of long-term institutions increased. Improvement in the recovery performance of the PACS also brought down their overdues ratio.

4.7 The SHG-Bank linkage programme and extension of financial assistance to micro-finance institutions (MFIs) continued with their high growth. NABARD continued to play a pivotal role in refinancing, monitoring project implementation, administering various Government schemes and capacity building of rural co-operative credit institutions.

4.8 A significant number of co-operative banks are covered under the deposit insurance scheme of Deposit Insurance and Credit Guarantee Corporation (DICGC). As on March 31, 2006, the number of insured co-operative banks were 2,245. The insurance premium received from co-operative banks amounted to Rs.190 crore during 2005-06 as against Rs.143 crore during the previous year. During the year, the DICGC settled claims for 43 co-operative banks for an aggregate amount of Rs.565 crore, an amount much higher than the premium received. The aggregate amount of claims paid and provided for 147 co-operative banks, since the inception of the Scheme, amounted to Rs.1,760 crore. Repayment received by DICGC out of the recoveries since inception amounted to Rs.28 crore (including Rs.8 crore during 2005-06). Together with the strengthening of the prudential standards, deposit insurance also has played a significant role in enhancing stability of this sector.

4.9 The Chapter is organised into six sections. Section 2 details the policy measures, the operations and performance of the urban cooperative banks, followed by a discussion on rural co-operative banks in Section 3. An account of the developments in the area of micro credit is undertaken in Section 4. Section 5 delineates the role of NABARD in the rural co-operative sector. Section 6 outlines the measures initiated for revival of the rural co-operative banking sector.

2. Urban Co-operative Banks

4.10 UCBs are unique in terms of their clientele mix and channels of credit delivery. UCBs are organised with the objective of promoting thrift and self-help among the middle class/lower middle class population and providing credit facilities to the people with small means in the urban/semi-urban centers. On account of their local feel and familiarity, UCBs are important for achieving greater financial inclusion. In recent times, however, UCBs have shown several weaknesses, particularly related to their financial health. Recognising their important role in the financial system, it has been the endeavor of the Reserve Bank to promote their healthy growth. However, the heterogeneous nature of the sector has called for a differentiated regime of regulation. In recent years, therefore, the Reserve Bank has provided regulatory support to small and weak UCBs, while at the same time strengthening their supervision (Box IV.1).

Box IV.1: Two-Tier Framework for Regulation and Supervision of Urban Co-operative Banks

In order to address the problems faced by UCBs, a draft Vision Document for UCBs was prepared by the Reserve Bank and placed in the public domain in March 2005. The Vision Document highlighted that the UCB sector was characterised by a high degree of heterogeneity in terms of geographical spread, size, strength, levels of professionalism and performance.

Notwithstanding the varied nature of UCBs, they were subjected to uniform regulations, as in principle, it was considered appropriate to apply uniform regulatory standards within the same sector. However, the application of uniform regulations on all UCBs affected the performance of several banks, specially the smaller ones, which incidentally also operated more closely on the lines of cooperative principles. In the context of supervision also, the adoption of same supervisory approach towards all UCBs increased the cost of supervision for banks in terms of on-site inspections and returns to be submitted even by the smaller banks. This also led to inefficient allocation of supervisory resources, thereby reducing supervisory focus on the larger and riskier banks.

Keeping in view the heterogeneous character of entities in the sector and the need for adopting a differentiated approach, the Vision Document set out the objective of rationalising the regulatory and supervisory framework for UCBs to enable the smaller UCBs to gain in strength. In order to achieve this objective, smaller UCBs whose operations are limited to a single district and have deposits of less than Rs.100 crore have been allowed to adopt 180-day delinquency norm for classification of assets as non-performing, instead of the 90-day norm which is applicable to the larger UCBs and all commercial banks. This is intended to provide a measure of relief to the smaller UCBs as they are required to make lower provisioning, which, in turn, translates into higher profits that could be used to shore up the capital base of these banks. Further, in view of the market risks associated with investments made in Government securities, smaller UCBs have been given exemption from maintaining SLR in Government securities (up to 15 per cent of NDTL) to the extent of funds placed in interest bearing deposits with the public sector banks. These banks have also not been subjected to the provisioning norms of 0.40 per cent of ëstandard advancesí which, have recently been applied to the larger UCBs.

As part of rationalisation of supervision, while the larger UCBs are placed under a composite off-site surveillance (OSS) reporting system comprising a set of eight prudential supervisory returns, a simplified reporting system consisting of five returns has been introduced for the smaller banks having deposits between Rs.50 crore and Rs.100 crore and whose branches are limited to a single district. The simplified OSS reporting framework would be extended to banks with deposits below Rs.50 crore in the near future.

Policy Developments

4.11 The policy initiatives during the year, inter alia, sought to address issues relating to dual control by establishing greater convergence of views through the process of consultation between the Reserve Bank, State Governments and representatives of the urban co-operative banking sector. In this context, Memoranda of Understanding (MoU) have been signed with eight States so far. In order to strengthen the sector through consolidation, attention is being paid to restructuring of weak UCBs as also on their non-disruptive exit through mergers and amalgamations, and by seeking to create the environment for augmenting the capital of UCBs. This, inter alia, would enhance the ability of the stronger UCBs to take over the weaker ones. 4.12 Prudential norms were also fine-tuned to the evolving circumstances and newer business opportunities were opened for UCBs to enhance their fee based and other non-interest income. Several important measures relating to improvement in credit delivery, customer service, financial inclusion and financial markets, taken for the commercial banks were extended to UCBs with suitable adaptations.

Structural Initiatives

Vision Document/Medium-Term Framework

4.13 The most significant initiative by the Reserve Bank to revive UCBs has been the preparation of the Vision Document for the Urban Co-operative Banks which, inter alia, envisages a State-specific strategy for addressing the issues relating to UCBs. As part of this strategy, Memoranda of Understanding are being signed between the Reserve Bank and the respective State Governments. Till October 2006, MoU were signed with eight State Governments, viz., Andhra Pradesh, Gujarat, Karnataka, Madhya Pradesh, Uttaranchal, Rajasthan, Chattisgarh and Goa. The MoU, envisages constitution of a State level Task Force for Co-operative Urban Banks (TAFCUB) that would, inter alia, identify viable and non-viable UCBs in the State and suggest time bound plans for revival of the viable UCBs and non-disruptive exit for others (Box IV.2).

Restructuring of Scheduled UCBs with Negative Net Worth

4.14 Keeping in view the importance of scheduled UCBs, the Reserve Bank initiated a consultative process with the concerned State Governments for revitalising and rehabilitating the scheduled UCBs with negative net worth. The emphasis was on a time bound programme for restructuring of UCBs by demarcating the contours of their rehabilitation plan and setting up monitorable milestones. During the year, 10 scheduled UCBs were placed under restructuring. The Reserve Bank has been closely monitoring their progress with a view to protecting depositorsí interests and avoiding systemic problems.

Guidelines on Mergers/Amalgamations

4.15 As part of the endeavour towards strengthening UCBs, the Reserve Bank issued guidelines on mergers/amalgamations in February 2005. The protection of depositorsí interests and financial soundness of the merged entity are the two major thrust areas of the guidelines. In order to smoothen the process of merger for UCBs, general permission was given to acquirer UCBs to amortise the losses taken over from the acquired UCBs over a period of not more than five years, including the year of merger (Box IV.3).

Innovative Options for Augmenting Capital

4.16 Share capital and retained earnings constitute the owned funds of urban co-operative banks. Share capital can be withdrawn by members after the minimum lock-in period. Therefore, the shares of UCBs do not have all the characteristics of equity. Co-operative banks are also not permitted to issue shares at a premium. In order to explore various options for raising capital, a Working Group was constituted (Chairman: Shri N.S. Vishwanathan) comprising representatives of the Reserve Bank, State Governments and the urban co-operative banking sector to examine the issues involved and to identify alternate instruments/avenues for augmenting the capital funds of UCBs. The Group has since submitted its report which would be placed in the public domain for feedback.

Regulatory Initiatives

4.17 To strengthen the urban co-operative banking sector, the Reserve Bank took several policy initiatives during the year relating to prudential norms, credit delivery, improvement in customer service and enhancement of business opportunities, and financial inclusion.

Box IV.2: Task Force for Urban Co-operative Banks

Urban co-operative banks are regulated and supervised by State Registrars of Co-operative Societies (RCS) in case of single-State co-operative banks, Central Registrar of Co-operative Societies (CRCS) in case of multi-State co-operative banks and by the Reserve Bank. The RCS exercises powers under the respective Co-operative Societies Act of the States with regard to incorporation, registration, management, amalgamation, reconstruction or liquidation. Such powers in case of UCBs, that have multi-State presence, are exercised by the CRCS. The banking related functions such as issue of license to start new banks/branches, matters relating to interest rates, loan policies, investments and prudential exposure norms are regulated and supervised by the Reserve Bank under the provisions of the Banking Regulation Act, 1949 (aACS). The draft vision document identified this duality of command as the main cause of difficulties in implementing regulatory measures with the required speed and urgency, and as an impediment to effective supervision. In order to develop greater coordination between the agencies responsible for regulation and supervision of UCBs, it was proposed in the Vision Document to have a working arrangement in the form of a Memorandum of Understanding (MoU) between the Reserve Bank and the respective State Governments. As per the commitment made in the MoU with the respective States, the Reserve Bank forms a State level Task Force for Co-operative Urban Banks (TAFCUB) comprising the Regional Director of the Reserve Bank for the concerned State as the Chairman, Registrar of Co-operative Societies as co-Chairman, an official each from the Reserve Bank, National Federation of Co-operative Urban Banks (NAFCUB) and the State Federation of the UCBs as its members.

TAFCUBs, as per their terms of reference, identify the potentially viable and unviable weak banks in the State and suggest revival plans for the potentially viable banks and a non-disruptive exit route for unviable/weak banks. The non-disruptive exit route could include merger/amalgamation with strong banks, conversion into society or, as a last resort, liquidation. TAFCUBs also make recommendations on the future set up of unlicensed banks in the State, based on the assessment of their financial position and strength. MoU have already been signed with eight States, viz., Andhra Pradesh, Gujarat, Karnataka, Madhya Pradesh, Rajasthan, Uttaranchal, Chhattisgarh and Goa. In each of these States, a Task Force has also been constituted. These States together account for 45.5 per cent of the total number of UCBs and about 22.0 per cent of deposits of all UCBs.

In 2005-06, four TAFCUBs examined the position of over 250 UCBs and made various recommendations on the future course of action for these banks. Based on the recommendations of the TAFCUB, supervisory actions that have been taken include exiting banks through mergers with other UCBs, cancellations of license of unviable UCBs and rejections of license applications of unlicensed co-operative societies. The MoU signed between the Reserve Bank and the State Government also envisages signing of another MoU between the Registrar of Co-operative Societies of the State and the Regional Director of the Reserve Bank. This MoU stipulates the broad measures to be taken by the signatories for implementing the recommendations of the TAFCUB for each of the potentially viable/non-viable UCBs that are placed for consideration of TAFCUB (Table 1).

The salubrious impact of the consultative platform, i.e., TAFCUB is reflected in the decline in the number of weak and sick banks in the States, which were among the first to sign the MoU and where TAFCUBs were constituted, viz., Andhra Pradesh, Gujarat and Karnataka. In these States, while the number of UCBs in Grade I increased, the number of weak and sick UCBs in Grade III and IV declined (refer to Table IV.1).

Box IV.3: Mergers/Amalgamations of Urban Co-operative Banks

Pursuant to the issue of guidelines on merger of UCBs, the Reserve Bank received 36 proposals for merger in respect of 28 weak banks. The Reserve Bank has issued ëno objection certificateí (NOC) in 17 cases. Of these, 14 mergers have become effective upon the issue of statutory orders by the RCS concerned. Three proposals for merger were rejected by the Reserve Bank, while remaining are under consideration.

The process of merger and amalgamation is elaborate and intense. The merger proposal has to be submitted by the acquirer bank to RCS/CRCS and a copy of the proposal is also simultaneously forwarded to the Reserve Bank along with certain specified information. The Reserve Bank examines the proposals and places the same before an expert Group for screening and recommendations. On evaluation, if the proposal is found to be suitable, the Reserve Bank issues NOC to the RCS/CRCS and the banks concerned. RCS/ CRCS then issues the order of amalgamation of the target UCB in compliance with the provisions of the Co-operative Societies Act under which the bank is registered.

Most of the target banks were loss-making UCBs. In a few cases, mergers were permitted where the acquired banks, though not loss making, were not considered viable on a stand alone basis in the long-run. Out of the 28 target banks from which merger proposal was received, 10 banks were registered in Maharashtra, eight in Gujarat, four in Andhra Pradesh and one each in the States of Karnataka, Goa, Rajasthan, Delhi and Punjab. One merged bank was registered under the Multi-State Co-operative Societies Act, 2002. Out of the 17 merger proposals for which ëNOCsí were issued, six banks were registered in Maharashtra, six in Gujarat, three in Andhra Pradesh and one in Goa. One bank was registered under the Multi-State Co-operative Societies Act, 2002. UCBs registered under the Multi-State Co-operative Societies Act were the front-runner as acquirers having taken over 10 banks. The State-wise break up of the acquirer and the acquired banks are presented in Tables 1 and 2.

I. Prudential Norms

4.18 In line with the international best practices, the 180-day delinquency period for reckoning an advance as non-performing was brought down to 90-day with effect from March 31, 2004. However, the norm was relaxed and deferred for certain categories of UCBs considering their difficulty in meeting the norm. Accordingly, banks with deposits of less than Rs.100 crore and having branches within a single district (including unit banks, i.e., having single branch/head office) were permitted to classify their loan accounts as NPAs based on the 180-day delinquency norm instead of the 90-day norm. The relaxation would be operative up to end-March 2007 to enable UCBs concerned to build up adequate provisions and strengthen their procedures in order to transit to the 90-day delinquency norm.

4.19 Taking into account the recent trend in credit growth, general provisioning requirement for ëstandard advancesí in the case of scheduled commercial banks was increased in November 2005 to 0.40 per cent from 0.25 per cent on credit other than direct advances to agriculture and the SME sector. The higher provisioning requirement was made applicable to UCBs having branches within a single district (including unit banks) and those having deposits of Rs.100 crore and above, and for all other UCBs operating in more than one district. For other UCBs, i.e., banks having branches in only one district (including unit banks) and having deposits of less than Rs.100 crore, the existing requirement of provisioning of 0.25 per cent for standard assets continues. Such provisions are eligible for inclusion in Tier II capital for capital adequacy purposes up to the permitted extent as hitherto.

4.20 UCBs were advised in April 2001 to maintain certain percentage of their assets under Section 24 of the Banking Regulation Act, 1949 as Applicable to Co-operative Societies (aACS) in the form of Government and other approved securities. In view of the difficulty in making investments in Government securities,  UCBs with a deposit base of less than Rs.100 crore and having branches within a single district were given partial exemption (not exceeding 15.0 per cent) from the prescribed SLR of 25.0 per cent to the extent of funds placed in interest bearing deposits with public sector banks with a view to obviating market risks associated with investment in Government securities. The exemption would be in force up to March 31, 2008.

4.21 Based on the representations received, relaxation was allowed to UCBs to shift their securities to ëheld to maturityí (HTM) category once more before March 31, 2006. Where the market value of the security was lower than the face value, the provision required would be the difference between book value and the face value which could be amortised during the remaining period of maturity, instead of five years as advised earlier to scheduled UCBs. These revised valuation norms were applicable only in respect of transfers to HTM made during 2005-06.

4.22 The Reserve Bank had permitted UCBs in November 1996 to extend unsecured advances without surety against purchase/discount/ withdrawal of third party cheques within a limit of up to Rs.5,000. As the limit was fixed long back, the State Federations of UCBs and NAFCUB had represented for an enhancement of the limit to provide UCBs with a competitive edge. After considering the representation, it was decided to enhance the limit on unsecured advances without surety from Rs.5,000 to Rs.50,000 on a graded scale in respect of purchase/discount/ withdrawal against third party cheques for a temporary period of 30 days in emergent cases. The ceiling on temporary unsecured advances without sureties up to a period of 30 days would, however, continue to be limited to a maximum of Rs.5,000 for other class of unsecured advances, viz., clean bills and multani hundis. The total unsecured advances granted by a bank to its members should not exceed 15.0 per cent of its demand and time liabilities (DTL) as against the extant limit of 33.3 per cent. However, banks were permitted to conform to the lower limit in a gradual manner, i.e., 20.0 per cent of DTL by March 31, 2006 and further to 15.0 per cent of DTL by March 31, 2007.

4.23 As a follow up to the announcement made in the Annual Policy Statement for 2006-07 and to achieve greater regulatory convergence with the scheduled commercial banks, the risk weight for loans extended against primary/collateral security of shares/debentures was increased to 125.0 per cent and that of investment in equities of AIFIs/ units of UTI to 127.5 per cent from the present level of 100.0 per cent and 102.5 per cent, respectively. 4.24 In July 2005, the Reserve Bank increased the risk weight on exposures to commercial real estate from 100.0 per cent to 125.0 per cent. In view of the increasing exposure to this sensitive sector, the risk weight was increased further to 150.0 per cent.

4.25 Income recognition and asset classification requirements in respect of State Government guaranteed advances and investments, which were earlier linked to invocation of the State Government guarantee, was reviewed and it was decided to de-link the above requirements, from the year ended March 31, 2006.

4.26 UCBs were prohibited in April 2003 from extending any loans and advances to the directors, their relatives and the firms/concerns/companies in which they have business interests. On reconsideration, in October 2005, it was decided to exclude the following categories of director related loans from the purview of this directive: (a) regular employee - related loans to staff directors on the Boards of UCBs; (b) normal loans as available to members to the directors on the Boards of salary earnersí co-operative banks; and (c) normal employee - related loans to Managing Directors of multi-State co-operative banks. 4.27 With a view to protecting UCBs from being burdened with liabilities arising out of unauthorised collections, and in the interest of integrity and soundness of the payment and banking systems, they were prohibited, in January 2006, from crediting ëaccount payeeí cheques to the account of any person other than the payee named therein.

II. Credit Delivery

4.28 In order to smoothen the flow of credit to the small scale industries (SSIs), a scheme of strategic alliance between branches of banks and SIDBI, located in the clusters of SSI units was worked out in consultation with the Government of India (Ministry of SSI and Ministry of Finance), SIDBI, IBA and select banks. The scheme is called ëSmall Enterprises Financial Centres (SEFCs)í and UCBs were advised to take benefit of the scheme on such terms and conditions as mutually agreed to between them and SIDBI.

4.29 The investment limit in plant and machinery of seven items reserved for manufacturing in the SSI sector was enhanced in May 2005 from Rs.1 crore to Rs.5 crore. The advances given to these units by UCBs were treated as priority sector lending.

4.30 As a part of announcement made by Honíble Finance Minister for improving flow of credit to small and medium enterprises (SMEs), certain guidelines were issued for restructuring of debt of SMEs (also refer to Chapter II). UCBs were advised to formulate the debt restructuring scheme with the approval of concerned State/Central Registrar of Co-operative Societies and give adequate publicity to the scheme among the customers so as to bring it to the notice of all beneficiaries.

III. Improving Customer Service and Enhancing Business Opportunities

4.31 A number of measures were initiated during the year to improve customer service by UCBs and to improve their business opportunities. The Reserve Bank permitted UCBs in States, where MoU have been signed and those registered under the Multi-State Co-operative Societies Act, to offer mutual fund products, as agents, to their customers, subject to certain conditions. The Reserve Bank also allowed well managed scheduled and non-scheduled UCBs to open select off-site/on-site ATMs based on the recommendation of the TAFCUBs. In respect of UCBs that were placed under liquidation, the preparation, submission and settlement of claims and recoveries from assets for distribution were delayed due to the involvement of several agencies and stages in the process of liquidation. In order to ensure appropriate co-ordination among agencies and to expedite the process of settlement of claims and recovery of dues, committees comprising representatives of the State Government, the Reserve Bank and State Federation of UCBs were constituted in Andhra Pradesh, Karnataka and Madhya Pradesh to review the progress made by the liquidator in settlement of claims, recovery of dues and repayment to DICGC and other creditors, including depositors.

4.32 UCBs were advised in March 2006 to install dual display note-counting machines at the payment counters of their branches for the use of their customers towards building confidence in the minds of the public to accept note packets secured with paper bands.

4.33 In pursuance of the announcement made in the Mid-term Review of the Annual Policy Statement for the year 2005-06, the currency chest facility was extended to scheduled UCBs registered under the Multi-State Co-operative Societies Act, 2002 and under the respective State Acts where the State Governments have assured regulatory co-ordination by entering into MoU with the Reserve Bank. The main conditions of the eligibility norms were that the banks should have: (a) minimum net worth of Rs.200 crore; (b) CRAR of 12 per cent; (c) Net NPA at less than 10 per cent; (d) made profit in the preceding three years, net of accumulated losses; (e) complied with CRR and SLR requirements; and (f) elected board of management with at least two professionals.

4.34 The acceptance of non-resident ordinary (NRO) deposits by UCBs was phased out and the UCBs were advised in July 2005 not to accept any fresh deposits in the form of savings/current/ recurring/term deposits and not to renew the existing, recurring/term deposits on maturity. However, in the case of the existing current/savings deposits, UCBs were allowed to continue the accounts up to a period of six months. The accounts should be closed thereafter with advance notice to the deposit holders. It was also decided not to issue any fresh full-fledged money changer (FFMC) licence to UCBs.

4.35 UCBs were encouraged to participate in the Government securities market during the year. In order to further widen the repo market in Government securities as per the proposal in the Annual Policy Statement for the year 2005-06, the Reserve Bank permitted, besides the scheduled UCBs, non-scheduled UCBs having gilt account with an SGL account holder to participate in repo market. UCBs were not permitted to enter into ready forward contracts with non-banking financial companies. However, restriction would not be applicable in the case of repo transactions between UCBs and authorised primary dealers in Government securities.

IV. Financial Inclusion

4.36 With the objective of extending the reach of UCBs to vast sections of the population hitherto uncovered, all UCBs were advised to make available a basic banking ëno-frillsí account either with ënilí or very low minimum balance as well as charges. They were further advised that the nature and number of transactions in such accounts could be restricted, but be made known to the customer in advance in a transparent manner. UCBs were also advised to give wide publicity, including on their websites, to the facility of such a ëno-frillsí account and other facilities and charges in a transparent manner.

4.37 In spite of flexibility in the requirements of documents of identity and proof of address, it was decided to simplify the KYC procedure for opening accounts for those who intend to keep balances not exceeding Rs.50,000 in all their accounts taken together and where the total credits in all the accounts taken together are not expected to exceed Rs.1 lakh in a year. Banks could open accounts, subject to introduction from another account holder of at least six months standing, with satisfactory record of transactions and who has been subjected to full KYC procedure. The bank could accept any other evidence as to the identity and address of the customer to its satisfaction. While opening such accounts, the customer is required to be made aware that if at any point of time, the balances in all his/her accounts with the bank (taken together) exceed Rs.50,000 or total credits in the account exceed Rs.1 lakh, no further transactions would be permitted until the full KYC procedure is completed. In order not to cause inconvenience to the customer, the bank must notify the customer, when the balance reaches Rs.40,000 or the total credit in a year reaches Rs.80,000, that appropriate documents for conducting the KYC must be submitted.

4.38 The banks were also advised to open accounts with reduced KYC standards in respect of persons affected by floods to enable them to credit the grant received from the Government. However, the maximum balance in such accounts should not exceed the amount of grant received from the Government or Rs.50,000, whichever was more and the initial credit of the grant amount should not be counted towards the total credit.

Supervision of UCBs

On-site Supervision

4.39 As per the extant policy, the periodicity of inspection of UCBs varies according to the scheduled status of the UCB or the financial position as reflected by its grade. At present, while scheduled and Grade III and IV non-scheduled UCBs are inspected on an annual basis, the non-scheduled UCBs with healthier financial performance (classified under Grade I and II) are inspected once in two years. The Reserve Bank carried out statutory inspections of 1,096 UCBs during 2005-06, i.e., around 60 per cent of the UCBs, as against inspection of 848 UCBs conducted during the previous year. For action required to be initiated on the basis of the inspection report, a system of graded supervisory action (GSA) has been put in place. The GSA serves as a framework for deciding the nature of supervisory intervention based on financial position of UCBs as reflected in their grades arrived at through inspection. In the States where MoU have been signed, the inputs given by respective TAFCUBs are taken into consideration for deciding the nature of supervisory action for the UCBs.

UCBs with Weak Financials

4.40 UCBs are classified in various grades depending on their financial strength based on objective criteria. The gradation of UCBs has enabled the Reserve Bank to optimise supervisory resources and focus on the weaker UCBs to facilitate a turnaround (Box IV.4).

4.41 The number of UCBs classified as Grade III and IV stood at 677 at end-March 2006 (Table IV.1). Although grades of UCBs in most of the States improved, a marked deterioration was observed in Maharashtra.

UCBs Under Directions

4.42 The Reserve Bank issues directions under Section 35A of the Banking Regulation Act, 1949 in respect of banks, which are in serious financial difficulties. The directions are issued either based on inspection findings or due to sudden developments such as a run on the bank. The directions mainly include restrictions on acceptance/withdrawal of deposits, restriction or ban on expansion of loans, and restraint on incurring of expenditure other than minimum establishment expenses required for day to day running of the bank. The banks placed under directions are monitored and decision on removing restrictions depends upon the ability of banks to rectify the inadequacies. Total number of 75 UCBs were functioning under directions at end-March 2006, of which 12 UCBs were placed under directions during 2005-06 (Appendix Table IV.2).

Box IV.4: Criteria for Gradation of Urban Co-operative Banks

Urban co-operative banks are classified into four grades, viz., Grade I, II, III and IV on the basis of certain broad prudential indicators in the following manner: (a) Grade I: Sound banks having no supervisory concerns. (b) Grade II: Banks meeting any one of the following parameters:

ï  Capital to risk-weighted asset ratio (CRAR) one per cent below the prescribed norms; or

ï  Net non-performing assets (NPAs) of 10 per cent or more but below 15 per cent; or

ï  Incurred net loss in the previous financial year; or

ï  Defaulted in the maintenance of cash reserve ratio (CRR)/ statutory liquidity ratio (SLR) in the previous financial year and/or there is more or less continuous default in maintenance of CRR/SLR during the current year.

(c) Grade III: Banks meeting any two of the following parameters:

ï  CRAR below 75 per cent of the minimum prescribed but 50 per cent or above the level required; or

ï  Net NPAs of 10 per cent or more but less than 15 per cent; or

ï  Incurred net losses for two years out of the last three years.
(d) Grade IV: Banks meeting the following conditions:

ï   CRAR less than 50 per cent of the prescribed limit; and

ï   Net NPAs of 15 per cent or more as on March 31 of the previous year.
Banks in Grade III and IV broadly correspond to ëweakí and ësickí category under the earlier norms.

UCBs Under Liquidation

4.43 Licences of 14 UCBs were cancelled during 2005-06 and placed under liquidation as compared with 39 during 2004-05. In all 226 UCBs were under liquidation at end-March 2006 (Appendix Table IV.3).

Off-site Surveillance

4.44 On-site inspection, which remains the main instrument of supervision over UCBs, has been strengthened through integration with off-site surveillance (OSS). A supervisory reporting system comprising 10 quarterly OSS returns was introduced for scheduled urban co-operatives banks (UCBs) in April 2001. These returns were rationalised and replaced by a set of one annual and seven quarterly OSS returns for the scheduled UCBs with effect from quarter/year ended March 2004. The rationalisation of the reporting system was done with the objective of reducing the volume of data required to be reported by banks while increasing the breadth and depth of information obtained from them (Box IV.5).

Box IV.5: Off-site Surveillance Systems for Urban Co-operative Banks

The off-site surveillance (OSS) statements are designed to monitor compliance and obtain information in the areas of prudential interest, including information on balance sheet and off-balance sheet exposures, profitability, asset quality, sector/ segment-wise concentration of advances, connected or related lending and capital adequacy. A collateral objective of OSS reporting system is to sensitise managements of banks to prudential concerns of the supervisory authority and thereby help in self-regulation. A set of eight OSS returns, introduced for scheduled UCBs from the quarter ended March 2004, were extended to non-scheduled banks with deposits of over Rs.100 crore from June 2004 and to UCBs having deposits of Rs.50 crore and above from March 2006. For banks that have deposits less than Rs.100 crore and whose branch network is limited to a single district, a simplified set of five (four quarterly and one annual) returns has been introduced. With this, about 450 banks have been covered by the OSS system, which together account for about 80 per cent of deposits of urban co-operative banks. The existence of computerised environment is a pre-requisite for the establishment of a successful off-site surveillance system. As such, the OSS project of the Reserve Bank envisaged the development of software for UCBs that enabled preparation of all regulatory/supervisory returns directly by banks and their submission to the Reserve Bank electronically. As envisaged, a software was developed, tested and implemented in Regional Offices (ROs) of the Reserve Bank and in about 450 UCBs that had deposits of over Rs.50 crore by March 2006. The system is being strengthened further by increasing its coverage of information and utility for the banks as a component of their management information system.

The database being maintained in the Reserve Bank contains all regulatory and supervisory returns submitted by UCBs, including the returns and on-site inspections data submitted by inspecting officers (IOs). The data submitted by UCBs to the respective Regional Offices are uploaded to the regional servers after validation checks to ensure integrity of data. The data from Regional Offices are then transmitted to the Central Office (CO) server of the Reserve Bank. The system, facilitates analysis both at the Regional Offices and the Central Office (Charts 1 and 2). The institution of OSS system has brought many benefits to UCBs and the Reserve Bank.

Benefits for the Urban Co-operative Banks

ï    The application obviates the need for keying-in repetitive data since such data entered in the previous period automatically get populated in the returns of succeeding quarters.

ï    The facility also stores data at bank level that enables UCBs to analyse their financial position and improve their MIS.
ï    The OSS statements are designed to sensitise the management of UCBs to the concerns of the supervisory authority.

Benefits for the Reserve Bank

ï    Time for data entry of each tranche of eight OSS returns has reduced significantly. Similar reduction in time has been made possible for all 35 returns submitted by UCBs. The software facilitates instant tracking of banks for non-submission or delayed submission of returns.

ï    The software provides for cross checks within each return, across returns and across time to ensure integrity of data.

ï    The data uploaded by Regional Offices of the Reserve Bank during the day (including inspection data) get replicated to Central Office server overnight, via INFINET (refer Chart 2).

ï    The software provides for generation of over 140 standard reports that are instantly available at all locations of the Reserve Bank.

ï    The OSS database not only contains all regulatory and supervisory returns submitted by banks, but also the on-site inspection data submitted by inspecting officers, besides important internal registers like penalty and penal interest register.

ï    The software enables generation of early warning reports at monthly and quarterly intervals which indicate incipient stress in liquidity position, highlights decline in quality of assets, fall in profits/profitability as also any unfavorable change in capital adequacy of UCBs. This facilitates better and more responsive supervision over UCBs and thereby helps in optimal allocation of supervisory resources for banks that show incipient weaknesses.

Way Forward

ï    To enhance the use of early warning reports for planning and prioritising scrutiny/inspections of banks, based on their riskiness and thereby further improve supervisory responsiveness.

ï    Up to end-October 2006, 452 out of 1,853 UCBs have been provided with the software. By mid-2007, it is envisaged that approximately 1,000 UCBs would be covered under the OSS.

Operations and Financial Performance of Urban Co-operative Banks

A Profile of UCBs

4.45 The urban co-operative banking sector comprises a number of institutions which vary in terms of their size, nature of business and their geographical spread. The deposit size of most of UCBs, barring a few, is small and most of them have only a single branch. As at end-March 2006, 1,423 UCBs out of 1,853 (76.8 per cent) had a deposit base of less than Rs.50 crore and 1,633 (88.1 per cent) less than Rs.100 crore. The share of these two categories in total deposits held was 19.0 per cent and 32.5 per cent, respectively. On the other hand, 14 UCBs with deposit base of above Rs.1,000 crore accounted for about one-fourth of deposits of all UCBs (Table IV.2).

4.46 Fifty five UCBs which have been accorded scheduled status constitute a sizable part with their share in total assets being 44.0 per cent. The non-scheduled UCBs with deposit size of Rs.100 crore and above, which were brought under the off-site surveillance process of the Reserve Bank, constituted another significant share (28.2 per cent) of the sector (Table IV.3).

Operations, Financial Performance and Asset Quality of Urban Co-operative Banks

Operations of UCBs

4.47 As at end-March 2006, total assets/ liabilities of UCBs constituted about 5.0 per cent of assets of scheduled commercial banks.

Business operations of UCBs grew by 6.3 per cent during 2005-06. The broad composition of the assets and liabilities of UCBs remained the same as in the previous year. Deposits continued to be the mainstay of resources for UCBs, accounting for 79.9 per cent of total resources. During 2005-06, deposits and capital increased, while statutory reserves declined, albeit marginally. On the asset side, nearly one half of the assets of UCBs were deployed in the form of loans and advances, while investments constituted the second major avenue of deployment of funds. During 2005-06, while loans and advances, and investments grew at a moderate rate, cash in hand and balances in the call/notice money market increased sharply (Table IV.4).

Priority Sector Lending

4.48 Urban co-operative banks are required to lend 60.0 per cent of their total loans and advances to the priority sector and 25.0 per cent of priority sector lending should go towards weaker sections. Credit extended by UCBs to the priority sector and weaker sections increased significantly in recent years. A significant amount of credit was extended to cottage and small scale industries and for housing loans (Table IV.5).

4.49 SLR investments constituted a bulk of investment (94.4 per cent) of UCBs at end-March 2006. While SLR investments, on the whole, grew moderately (2.1 per cent) during 2005-06, investments in other approved securities (non-Government) and term-deposits with the State cooperative banks (StCBs) increased sharply. However, term deposits with district central cooperative banks (DCCBs) declined. Non-SLR investments comprising bonds of public sector institutions/AIFIs, shares of AIFIs and units of UTI witnessed a sharp growth during 2005-06 (Table IV.6).

Asset Quality

4.50 The asset quality of UCBs improved significantly during the year. This was reflected in sharp decline in NPAs (gross and net) in absolute as well as percentage terms. However, NPAs of UCBs at 19.7 per cent (gross) and 9.6 per cent (net) at end-March 2006 were high compared to the level at end-March 2001 (16.1 per cent gross NPAs) and in comparison with scheduled commercial banks (3.3 per cent gross and