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UCBs: 136 mergers in 15 years

RBI recently released the ‘Report on Trend and Progress of Banking in India 2019-20’. Here are the edited excerpts from the section on ‘Developments In Co-Operative Banking’:

At end-March 2020, the sector consisted of 1539 UCBs and 97,006 rural cooperative banks. Rural co-operatives make up 65% of the total asset size of all co-operatives taken together. Despite the crucial role played by the sector, its asset size was only around 10% compared to that of scheduled commercial banks (SCBs) at end March-2020. Share of rural co-operative lending in total agricultural lending has considerably diminished over the years, from as high as 64% in 1992-93 to 11.3% in 2019-20.

52 UCBs Under Directions

The financial soundness of this sector has been of concern over the last few years. Since April 1, 2015, 52 UCBs have been placed under All Inclusive Directions by the Reserve Bank. Out of the total claims settled by the Deposit Insurance and Credit Guarantee Corporation (DICGC) since inception, around 94.3% of claims pertained to co-operative banks that were liquidated, amalgamated, or restructured.

Mergers: Viability Strategy

Since 2003, 385 UCBs have had their licences cancelled or withdrawn, or have been merged with stronger ones. Beginning in 2004-05, UCBs have undergone 136 mergers till March 2020, with Maharashtra accounting for more than half of them. Despite the fall in the number of UCBs, their combined asset size continuously increased, underscoring the improvement in their financial position and effectiveness of the consolidation drive. Due to the active consolidation drive, there has been a continuous increase in the share of tier 2 UCBs in terms of both numbers and asset size.

B/S Growth Moderation

The combined balance sheet (B/S) of UCBs expanded consistently in the decade following the consolidation drive. This was propelled by robust players with strong and profitable financial performance. In recent years, however, as UCBs faced competition from other niche players like small finance banks and NBFCs, and also had to reaffirm their credibility to depositors, their balance sheet growth has moderated.

Higher Asset Brackets Fall

The asset concentration has increased after 2016-17, and distribution has become unimodal. In 2019-20, the peak plateaued compared to the previous year. The distribution has, however, continued to move rightwards as an increasing number of UCBs fall in higher asset brackets, and the share of UCBs with assets less than Rs500 mn has consistently decreased from 41.9% in 2014-15 to 31.4% in 2019-20.

Deposit Deceleration On

Growth in deposits, that constitute 90% of the total resource base of UCBs, decelerated in 2019-20 after a revival in the previous year. The average growth rate of deposits declined from 13.1% in the first decade of the consolidation drive to 8% during 2014- 15 to 2019-20, in line with the growth in balance sheet size. Since 2017-18, the deposit deceleration in UCBs was starker than in SCBs, pointing to the difficulties faced by UCBs in raising resources. The deposit deceleration was led by Scheduled UCBs (SUCBs). Supervisory data available with the Reserve Bank suggest continuation of deceleration well into 2020-21.

The share of number of UCBs with deposits below Rs250 mn decreased from 56.7% in 2007-08 to 20.5% in 2019-20, while the share of number of UCBs with deposits between Rs250 mn and Rs2.5 bn increased from 37.8% to 57.6% in the same period.

Anaemic Credit Demand

After growing at an average rate of 7.8% from 2015-16 till the previous year, loans and advances of UCBs almost stagnated in 2019-20, reflecting anaemic credit demand. The marginal credit expansion was mainly driven by non-scheduled UCBs (NSUCBs), while credit from SUCBs contracted. Although deposit growth slumped, low credit demand contained borrowings from market and SCBs.

In line with the trend of the past several years, UCBs with advances in the range of Rs100 mn to Rs250 mn formed the modal class during 2019-20 as well, contrary to the trend in deposits. Concomitantly, however, a gradual shift towards higher advances is also discernible through the years. In 2016-17, there were 38 UCBs with loan books of more than Rs10 bn; in 2019-20, their number increased to 50.

Investments In G-Sec

During 2019-20 UCBs’ investments in Central Government securities (G-Sec) contracted as they booked trading profits on softening yields. The progressive reduction in statutory liquidity ratio (SLR) requirements for UCBs – even though liquidity coverage ratio (LCR) requirements are not applicable to them – further facilitated this reduction. The investment-to-deposit ratio of UCBs continues to fall below that of SCBs, despite a comparable incremental investment-to-deposit ratio.

Analysed on the new scale of revised CAMELS rating model, UCBs in the top-ranking categories with ratings of A, B+, and B formed the majority of the sector. The number of UCBs with the lowest rating (viz. D rating) increased marginally over the previous year.

Capital Adequacy

At end-March 2020, more than 95% of UCBs remained above the statutory requirement, as per the Basel I norms, of maintaining a capital to risk-weighted assets ratio (CRAR) of 9%. NSUCBs, that are characterised by a smaller business size, have stronger capital positions than SUCBs. On the upside, however, around 84% of UCBs in each category maintained CRARs greater than 12% during the year.

Asset Quality Down

Historically, UCBs have had higher level of NPAs than SCBs. Since 2015-16, however, this position reversed, with the asset quality review (AQR) resulting in greater NPA recognition in SCBs, while the asset impairment of UCBs inched up gradually over time. In 2019-20, the GNPA ratio of UCBs again surpassed that of SCBs. The change was driven by improvement in the asset quality of SCBs for two consecutive years while the slippages of UCBs increased. In 2019-20, the asset quality of both SUCBs and NSUCBs deteriorated, with the latter recording a larger increase in the GNPA ratio. The rise in NPAs may partly be attributable to stagnant growth in loans and advances and weak balance sheets. While both gross NPAs and provisioning increased during 2019-20, the growth in the latter was not fully commensurate with the growth in the former, resulting in an increase in net NPA ratio.

NIM Lowest Since 2001

The overall operating profit of UCBs took a major hit in 2019-20 as their interest income, that constitutes around 89% of total income, declined for the second consecutive year due to deceleration in investments and high growth of NPAs. This was accompanied by an increase in interest and non-interest expenditure. The decline was mainly driven by the SUCBs, although marginal profits of NSUCBs provided a silver lining. The strained profitability of SUCBs was evident in return on assets (RoA) and return on equity (RoE), where the former turned negative after a gap of more than 15 years.

The net interest margin (NIM) in 2019-20 was lowest ever recorded as per the data available from 2000-01. The shrinking income drove up the cost to-income ratio. While the profitability indicators of NSUCBs also deteriorated, they fared better than SUCBs in terms of RoA and RoE, reversing the position of the previous year.

PSL On Rise

PSL for UCBs has historically been higher than the prescribed targets. During 2019-20, PSL jumped by 14.8% as compared to the level in the previous year, while its share in total lending increased by 6 percentage points. Thus, the UCBs exceeded the PSL target by Rs317 bn or by 10.38% in 2019-20. Incidentally, UCBs’ participation in PSL certificates is low due to technical challenges.

Targets For UCBs: By 2024

Going forward, their share of PSL is expected to rise further as per the revised target of 75% of ANBC or CEOBSE, whichever is higher. UCBs shall comply with the above target by March 31, 2024, with 45%, 50%, and 60% of ANBC or CEOBSE, whichever is higher by end-March 2021, 2022 and 2023, respectively.

Umbrella Entity, BR Act

RBI is initiating measures to improve standards of corporate governance in UCB sector, even while strengthening cybersecurity and improving reporting standards for UCBs.

During 2019-20, the co-operative sector faced certain financial challenges. Episodes of frauds during the year affected the asset quality and profitability of UCBs. Although the spill-over was largely contained, this episode brought to the fore the systemic risks. Several structural issues confront the sector such as dual regulation by the Reserve Bank and the central/ state governments, inability to combine the principles of co-operation with professionalism, lack of avenues to raise additional capital, the need of technological upgradation and more recently, incidences of frauds. The enactment of the Banking Regulation (Amendment) Act, 2020 is expected to address some of these problems. The government and the Reserve Bank have undertaken several measures to improve governance and oversight of co-operative banking system, including by an amendment to the BR Act that empowered the Reserve Bank with greater regulatory control over UCBs, StCBs and DCCBs. The formation of an umbrella organisation should help ease funding constraints appreciably.

During 2020-21 so far, uncertainties related to covid-19 have affected the operations of this sector, as they did for the other financial institutions.

Need To Strengthen

Meanwhile, commercial banks’ expansion of reach and presence in rural and remote areas by leveraging on technology and the banking correspondents’ network has also intensified competitive pressures on the co-operative sector. Given their overwhelming contribution to financial inclusion and massive reach, however, the need to strengthen the sector and render it self-sustaining cannot be overemphasised in the interests of the communities they serve.

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