Cooperative banks now subject to regulation by Reserve Bank of India

As an offshoot to the unravelling of Punjab and Maharashtra Cooperative Bank debacle in 2019, the President, in exercise of the powers conferred by Clause (1) of Article 123 of the Constitution of India, promulgated the Banking Regulation (Amendment) Ordinance, 2020 (hereinafter referred to as the “Ordinance”) on 26.06.2020. 

The ordinance has primarily been promulgated for bringing cooperative banks under the supervisory powers of the Reserve Bank of India (hereinafter referred to as “RBI”), in order to protect the interest of depositors across the country and strengthen cooperative banks by improving governance and oversight. The said intention of the central government was first intimated to the public by the finance minister, Nirmala Sitharaman during the presentation of the annual budget of the current financial year.

The ordinance effectively amends the Banking Regulation Act, 1949 (hereinafter referred to as the “Principal Act”) by extending powers already available with the Reserve Bank of India, in respect of other banks, to co-operative Banks as well for better management, sound banking regulation, ensuring professionalism and enabling their access to capital. 

The ordinance does not take away the powers of the state registrars of co-operative societies under state co-operative laws. Furthermore, the ordinance does not affect Primary Agricultural Credit Societies or co-operative societies, having a primary object and principal business of long-term finance for agricultural development, and which do not use the words “bank”, “banker” or “banking” and do not act as drawees of cheques. The ordinance also amends Section 45 of the Principal Act, to enable making of a scheme of reconstruction or amalgamation of a banking company for protecting the interest of the public, depositors and the banking system and for securing its proper management, even without making an order of moratorium, so as to avoid disruption of the financial system.

Prior to the ordinance, the duty to regulate the cooperative banks was shared by the RBI and the respective state registrar’s of the cooperative societies. The role of the registrar was to have a statutory oversight over the incorporation, management, audit and liquidation of the such banks, while the role of the RBI was restricted to overlooking the mere maintenance of cash reserves and capital adequacy. 

It is pertinent to note herein that this is the general regulatory role that RBI usually plays with respect to banks, irrespective of the nature of functioning. Therefore, following the irregularities uncovered in relation to such cooperative banks and with the intention to protect the hard earned money of approximately 8.6 crore depositors panning across 1,540 urban and multi-state cooperative banks, amounting to a total of up to Rs.4.84 lakh crores, the aforementioned ordinance was promulgated by the President of India. The Banking Regulation (Amendment) Bill, 2020 was previously introduced in the House of People on 03.03.2020 but could not be taken for consideration by the House of People due to the coronavirus pandemic.

Most cooperative banks, on account of the mismanagement prevalent therein, led to undercapitalisation and poor management and supervision thereby, leading to losses suffered by the innocent depositors. 

In the past many years, the RBI has been seen to impose restrictions on lending and withdrawals on such banks, that are able to continue to operate with the explicit or implicit support from the government for years. However, subsequently they are wound up and their licence cancelled, thereby, increasing the sufferings of those innocent depositors, until the bank is finally liquidated.

With the promulgation of the ordinance by the President, the banks will now be audited according to the norms of the RBI instead of that of the state registrars. The central bank will also have the power to supersede the board of such banks by taking charge of certain banking actions for an interim period, but such can be done only when the bank in question is found to be in an exceptional circumstance; and with the consultation of the respective state government. The resultant effect of the ordinance is that the state registrars will continue to undertake the administrative functions, that they used to perform earlier, but simultaneously, the cooperative banks of the country have been made more answerable to the RBI.

The Principal Act provides that RBI may apply to the central government to place a banking company under a moratorium, during which, no legal action can be initiated or continued against the bank for a period of up to six months. Further, the bank cannot make any payment or discharge liabilities during this period. The ordinance, however, adds that during the period of moratorium, the bank cannot grant any loans or make investments in any credit instruments.

The Principal Act also stipulates that during the period of moratorium, RBI may prepare a scheme for reconstruction or amalgamation of the bank, if it is satisfied that such an order is needed to secure proper management of the bank, or in the interest of depositors, general public, or the banking system. However, the ordinance allows RBI to initiate such a scheme as mentioned above, without imposing a moratorium.

It is also pertinent to herein that the ordinance provides that a cooperative bank, with the prior approval of the RBI and such other conditions as mentioned therein, may issue equity shares, preference shares, or special shares on face value or at a premium to its members or to any other person residing within its area of operation, by way of public issue or private placements. Further, it may issue unsecured debentures or bonds or other like securities with maturity of not less than ten years to such persons.

In view of the aforesaid changes, the ordinance is, indeed, a positive move taken by the central government, with a view to help and end the misery of depositors by protecting their money deposited in such cooperative banks so that they do not have to face any inconveniences in the form of restrictions on daily withdrawals, as was seen in the Punjab and Maharashtra Cooperative Bank fiasco. Such a move would not only give the RBI more power to regulate cooperative banks but also safeguard the money of the depositors.

(Disclaimer: The opinions expressed above are the personal views of the author and do not reflect the views of ZMCL.)