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Transformation of Urban Co-operative Banks Is there a need for it ?

By Ms.Neeraja, Mr. Vishal Bandekar, Mr.Brajesh Nandan, Mr.Talankar & Mr.Rajpurkar The term Urban Co-operative Banks (UCBs), refers to primary cooperative banks located in urban and semi-urban areas. These banks, till 1996, were allowed to lend money only for non-agricultural purposes. This distinction does not hold today. These banks were traditionally centred around communities, localities and work place groups. They essentially lent to small borrowers and businesses. Today, their scope of operations has widened considerably. The origins of the urban cooperative banking movement in India can be traced to the close of nineteenth century when, inspired by the success of the experiments related to the cooperative movement in Britain and the cooperative credit movement in Germany such societies were set up in India. Cooperative societies are based on the principles of cooperation, - mutual help, democratic decision making and open membership. Cooperatives represented a new and alternative approach to organization as against proprietary firms, partnership firms and joint stock companies which represent the dominant form of commercial organisation. The urban cooperative banks have contributed significantly to the well being of low income groups of the urban and semi urban populace. Though urban cooperative banks were initially conceived to be small entities confining their area of operation to small towns and municipal limits of cities, over a period of time some of them have started expanding to the entire state and in some cases beyond their respective states of registration. Further details such as the beginnings of the Cooperative Credit Societies, Cooperative Societies Act and its further amendment, other related Acts stipulated by the Government of India, Control over the Urban Cooperative Banks, features of the urban banking movement and the recent developments may be referred to in Annexure I.

Structure of Co-operative Credit Institutions In India

(As at end March 2012)


Scheduled (52)

Multi State (25)

UCBs (1,618)

Single State (27)

Multi State (18)


Credit Cooperatives Non Scheduled (1,566)

(96,149)

Single State (1,548)

Rural Cooperatives

Long Term (717)

SCARDBs (20)

PCARDBs (697)

(94,531) Short Term (93,814) StCBs (31) DCCBs (370) PACs (93,413)

Regulations : The urban cooperative banks have contributed significantly to the well being of low income groups of the urban and semi urban populace. Perhaps, the urban cooperative movement in India, was the first ever attempt at micro credit dispensation in semi urban and urban areas. The UCBs and other cooperative banks were essentially governed by the State Governments under the provisions of their respective Cooperative Societies Acts. But with the increasing demand for introduction of deposit insurance to cooperative banks, it was felt necessary to bring them under the purview of the Banking Regulation Act,1949 (B.R.Act). The urban cooperative banks were, therefore, brought under the purview of B.R. Act, effective from 1 March 1966. With this, UCBs were subjected to dual command by RBI exercising control over their banking related functions and State Governments exercising supervision over their managerial, administrative and other matters. Notwithstanding the phenomenal progress registered by UCBs, today they are facing five major problems (i) dual control, (ii) inadequate legal framework to regulate UCBs compared to the powers RBI has been vested with to regulate commercial banks, (iii) increasing

incidence of weakness, (iv) low level of professionalism and (v) apprehensions about the credentials of promoters of some new UCBs. Good corporate governance is critical to efficient functioning of an entity and more so for a banking entity. It is felt that irrespective of the size of the operations, banks need to run on professional lines and UCBs are no exception to this rule. In view of the same, it is felt that at least 2 directors with suitable banking experience or relevant professional background should be present on the Boards of UCBs and the promoters should not be defaulters to any financial institution or banks and should not have any association with chitfund/ NBFCs/cooperative bank or commercial bank in the capacity of Director on the Board of Directors. Though urban cooperative banks were initially conceived to be small entities confining their area of operation to small towns and municipal limits of cities, over a period of time some of them have started expanding to the entire state and in some cases beyond their respective states of registration. The opponents of expansion of area of operation of UCBs argue that UCBs would lose their cooperative character and structure which give them their identity viz. local feel, compact area of operation and mutual help, if they indiscriminately expand their area of operation. Proponents of expansion of area of operation, on the other hand, argue that expansion of area of operation does not necessarily dilute the cooperative character because the clientele of UCBs having common interest belonging to common ethnic group, may spread over different parts of the state or more than one state. When some Cooperative Banks of Europe have nation-wide and worldwide presence, restricting UCBs operations to districts of their registration would place artificial barriers on their growth. In light of the above it was felt necessary to study the case of an Indian Cooperative Bank and understand its background and whether there is a necessity for developing such a bank to enable it to compete not just within the country, but globally. For our study we have chosen Development Credit Bank (erstwhile Development Co-operative Bank) which transformed itself into a Private Sector Bank and Saraswat Cooperative Bank which is planning or rather initiating steps towards privatization. After a brief comparison between these two banks we will be able to draw a line on whether there is really a need for Saraswat Cooperative Bank to shed its image of a Urban Co-operative Bank and transform itself into a Private Sector Bank, or whether still remaining as a Urban Co-operative Bank, it will be able to achieve their Corporate Goals or rather their Vision. Saraswat Co-operative Bank their beginning and their transition over passage of time The Bank has a very humble but a very inspiring beginning. On 14th September 1918, "The Saraswat Co-operative Banking Society" was founded. Mr. J. K. Parulkar became its first Chairman, Mr. N.B. Thakur, the first Vice-Chairman, Mr. P. N. Warde, the first Secretary and Mr. Shivram Gopal Rajadhyaksha, the first Treasurer. These were the people with deep and abiding ideals, faith, vision, optimism and entrepreneurial skills. These dedicated men in charge of the Society had a commendable sense of service and duty imbibed in them. Even today, the Banks honorable founders inspire a sense of awe and respect in the Bank and amongst the shareholders.

The Society was initially set up to help families in distress. Its objective was to provide temporary accommodation to its members in eventualities such as weddings of dependent members of the family, repayment of debt and expenses of medical treatment etc. The Society was converted into a full-fledged Urban Co-operative Bank in the year 1933. The Bank has the unique distinction of being a witness to History. The Bank, which was originally founded in 1918, i.e. close on the heels of the Russian Revolution, also witnessed as a Society and as Bank-the First World War, the Second World War, India's freedom Movement and the glorious chapter of post-independence India. During this cataclysmic cavalcade of history, the Bank as a financial institution and its members could not of course remain unaffected by the economic consequences of the major events. The two wars in particular brought in their wake, paucities of all kinds and realities and stood by its members in distress as a solid bulwark of strength. The Founder Members and the later-day managements of the Bank continued to demonstrate their unwavering faith in the destiny of the common man and the co-operative movement and they encouraged the shareholders to save despite all odds. BANKs MISSION STATEMENT "To emerge as one of the premier and most preferred banks in the country by adopting highest standards of professionalism and excellence in all the areas of working !!!" MILESTONES Thanks to these sustained and assiduous efforts over 25 years after its inception, the Bank had gained Strong foundation in terms of its membership, resources, assets and profits. By 1942, the Bank was fulfilling all the banking needs of its customers. During the late fifties, the Bank grew from strength to strength. The Bank had established five branches within the city of Mumbai and one each at Pune and Belgaum. In its 50th year, the Bank chose a bee motif to symbolise the Bank's emblem - a fitting and appropriate characteristics of a Bank that believed in hard work, a search for all that is good, a team spirit to achieve its objectives and a selfless service to its members and customers. The Bank has grown in stature, progressed in its social and economic objectives and produced an image of what an ideal bank should be. Resultantly, in the year 1977-78, the Bank's gross income crossed the Rs.3.00 crore mark for the first time. In 1988 the bank was conferred with "Scheduled" status by Reserve Bank of India. The Bank is the first co-operative bank to provide Merchant Banking services. The Bank got a permanent license to deal in foreign exchange in 1978. Presently the Bank is having correspondent relationship in 45 countries covering 9 currencies with over 125 banks.In 1992 Bank completed 75 years. Bank also crossed the business level of Rs 700 Crores.

The Beginning of the 21st Century has been a giant leap forward for the Bank. Bank chose a path of organic/inorganic growth and their pace of growth accelerated.Bank's total business which was around Rs.4000 Crores in 2000 almost tripled to Rs.15295 Crores in 2007. Bank in the year 2008 launched the Branding Initiative .The purpose of such an exercise was to reconfirm the thrust of Bank on its core values,which can be summed up as "Sense of Belonging ".The name of the Bank should always inspire the Sense of Belonging in all its stakeholders and that Bank continues to fulfill the changing needs and expectations of the customer with unflinching gusto and aplomb. Last two decades the Bank has witnessed a steady growth in the business and also taken several Strategic Business Initiatives like undertaking Business Process Reengineering initiative. Merging seven coop Banks and then consciously nurturing them. Bank tied up with VISA international for issuance of Debit Card. The Bank has a network of 226 fully computerized branches as on 31st-Mar-2012 covering six states viz. Maharashtra, Gujarat, Madhya Pradesh, Karnataka, Goa and Delhi. The Bank is providing 24- hour service through ATM at 147 locations. As on 31st March,2012 Bank business had surpassed Rs.33000 Crores. Bank has retained its coveted position as ZERO NET NPA Bankfor the eighth successive year. In 2011 Bank was granted permission for All India Area of Operation by Reserve Bank Of India. Bank has an ambitious business expansion plan in place to have a presence in all major cities of the country, reach a business level of Rs.50000 Crores by 2016 and Rs.100000 by 2018. The Bank gently reminds everyone of the numero-uno position which the Bank holds in the Cooperative Sector. The usage of state of art technology coupled with personal ambience's to make everybody comfortable once again reiterates Bank's adherence to "Think Global, Act Local". With increase of business in mind and the zeal to cater to the different sections of the society thus reaching a large canvass of customers, there is no doubt that for the Bank to achieve their vision and mission, they need to transform themselves and would be required to shed their tag of an urban cooperative bank to a Private Sector Bank which will have larger acceptability not only in India but also globally. This will also ensure openings for smaller urban cooperative banks to cater to the local demands within the State or a particular region. The need for UCBs to be converted to private banks has been analysed by taking Saraswat Bank and comparing it with Development Credit Bank.

Saraswat Bank
Performance The bank's operations are out of a core banking platform and it is therefore in a position to offer anywhere anytime banking offered by private banks. It also offers Visa cards and internet banking services and has for a long time been offering forex services to its customers. As against the Rs 500 crore capital prescribed by RBI for private banks, Saraswat has net owned funds of Rs 1,714 crore which gives it a capital adequacy ratio of 12.37%. It has also managed to bring down its non-performing assets to 3.25% of advances. The bank has reported a net profit of Rs 235 crore for the year ended March 2012-an increase of 11% from Rs 212 crore in FY10. Target The bank has embarked upon an ambitious target of achieving a business level of Rs 1 lakh crore by 2021. By 2016, they are looking at a total business of Rs 50,000 crore and 250 branches, and by 2020, they are targeting a business of Rs 1 trillion and 1,000 branches. Problems for UCBs in raising Capital Currently, growth prospects for the 1,600-odd UCBs are hamstrung due to limited options for raising capital. These banks primarily depend on plough back of profits and borrowers' subscription to share capital at the time of loan disbursement, to shore up their capital. Capital raising is a major constraint for UCBs and hence Saraswat Bank was banking on the proposed amendment to the Multi-State Co-operative Societies Act so that it can issue shares to members at book value, say Rs. 250 instead of face value (Rs.10). Cooperative banks can raise capital only by selling shares to customers. Also because of the cap on dividend their shares are not very attractive to investors as they do not provide the same upside as that of companies that are registered under the Companies Act. After the Madhavpura scam, RBI did not issue licences for new branches till 2009, so inorganic growth had been their only option.

Past Strategy for Growth Most large UCBs have expanded through acquisitions in recent years. According to its 2011/12 annual report, the central bank has received 168 merger proposals since 2005/06, and cleared 125 of them. In the last five years, India's largest multi-state co-operative bank, Saraswat resorted to acquisitions to grow business. Between 2006 and 2009, it acquired seven UCBs which had a total of 87 branches. "It invested Rs 270 crore from its reserves to make the net worth of

these UCBs positive. These banks had cumulative business of Rs 1,700 crore. Its business has quadrupled since the acquisition.

Restrictions on UCBs
Restrictions on Operations Currently, commercial banks have to invest a minimum 24 per cent of their deposits in Government Securities. These investments are required to fulfil the statutory liquidity ratio (SLR) norm. However, in the case of UCBs, this limit is set higher at 25 per cent. Every branch that a co-operative bank opens has to be backed up by a net worth of Rs 2 crore each. The total amount of deposits placed by an UCB with other banks (inter-bank) for all purposes including call money / notice money, and deposits, if any, placed for availing clearing facility, CSGL facility, currency chest facility, remittance facility and non-fund based facilities like Bank Guarantee (BG), Letter of Credit (LC), etc shall not exceed 20% of its total deposit liabilities as on March 31 of the previous year.

Capital Raising Constraints Though UCBs, which as of March-end 2011 collectively had deposits and advances aggregating Rs 2,12,031 crore and Rs 1,36,341 crore, respectively, have been allowed to issue preference shares and long-term deposits to augment their capital, both these options are not preferred. The constraint for UCBs in issuing preference shares is that they can be issued only at face value. Investment in these shares is unattractive as no exit mechanism is available for investors wanting to liquidate them. In the case of long-term deposits, the RBI's approval is required to pay back depositors even if a bank is financially sound. This is proving to be a deterrent for prospective investors.

Restrictions on Investments Investments in perpetual debt instruments are not permitted. Investments in non-SLR securities should be limited to 10% of a bank's total deposits as on March 31 of the previous year. Investments in unlisted securities should not exceed 10% of the total non-SLR investments at any time.

Lending Restriction The cooperative structure also places restrictions on the size of the loans that the bank can extend to each client even if it has the resources to provide very large loans. Commercial banks, however, face no such restriction and their growth is only restricted by the amount of capital they can raise. The exposure to an individual borrower does not exceed 15 per cent of capital funds The exposure to a group of borrowers does not exceed 40 per cent of capital funds. UCBs cannot lend more than Rs 10 lakh against the pledge of shares.

Limits for Individual Borrower and Group Borrower UCBs with DTL UCBs with DTL above Rs. 10 up to Rs. 10 Crore crore & up to Rs. 50 Crore Rs. 2.00 lakh UCBs with DTL above Rs. 50 Crore & up to Rs.100 Crore Rs. 3.00 lakh UCBs with DTL above Rs. 100 Crore Rs. 5.00 lakh

Criteria

Rs.1.00 lakh UCBs having CRAR equal to or more than 9% Rs. 0.25 lakh UCBs having CRAR less than 9%

Rs. 0.50 lakh

Rs. 1.00 lakh

Rs. 2.00 lakh

Decision to get privatized


Saraswat Cooperative Bank-the largest lender in the segment-plans to convert itself into a private bank. This is not the first instance of a cooperative bank converting into a scheduled commercial bank. In 1995 the shareholders of Development Cooperative Bank (DCB) resolved to register the bank as a limited company under Section 566 of the Companies Act. The bank was granted licence to carry on banking business under Section 22 of the Banking Regulation Act, 1949 on May 1995. At the time of granting licence, RBI had laid down some conditions which included listing of the bank on the stock exchanges. DCB was also required to adhere to priority sector lending and rural business obligations of new private banks. Saraswat, a bank which has a total business of 33,205 Crores which is 3 times larger than that of Development Credit Bank has a branch presence of 226 while DCB has around 82. But the Paid-Up Capital of Saraswat is only 116.92 Crores, while a much smaller DCB has 240.67 Crores. Hence, Privatization will help Saraswat bank in raising capital and increasing its balance sheet growth.

Product Comparison of the two banks

Attributes
Business Loans

Development Credit Bank

Saraswat Bank

Business Loans, Loan Against Deposit, Business Loans, Term Finance, Trade Professional Loan, Project Finance, Term Finance Finance, Trade Finance Credit Card, Debit Card Debit Card

Cards

Account Types Bank Type

Current Account ,Demat Account, Fixed Current Account, Demat Account, Fixed Deposit Account, Recurring Deposit Deposit Account, Recurring Deposit Account, Saving Account Account, Saving Account Private Co-Operative Commercial Vehicle Loan, Consumer Goods Loan, Educational Loan, Four Wheeler Loan, Home Improvement Loan, Housing Loan, Loan Against Deposit, Loan Against Gold, Loan Against Property, Loan Against Share, Two Wheeler Loan

Personal Loans

Commercial Vehicle Loan, Consumer Goods Loan, Four Wheeler Loan, Home Improvement Loan, Housing Loan, Loan Against Deposit, Loan Against Gold, Personal Loan, Two Wheeler Loan

Business Hours Investment Products

Monday To Friday 9:30 Am To 4:30 Pm, Monday To Friday 8:45 Am To 1:45 Pm, Saturday 9:30 Am To 2:00 Pm Saturday 8:45 Am To 12:00 Pm Equity, Fixed Deposit, Flexible Deposit, Fixed Deposit, Flexible Deposit, Insurance, Insurance, Mutual Fund, Stock Invest Mutual Fund, Stock Invest Demat Services, Direct Tax Payment, Electronic Clearing Service, Mobile Phone Banking ,Multi City Cheque Facility, Net Banking, Over Draft Facility, Personal Tax Assistance And Investment, Portfolio Management ,Wealth Management Service Currency Exchange, Demat Services, Direct Tax Payment, Electronic Clearing Service, Locker Facility, Mobile Phone Banking, Multi City Cheque Facility, Net Banking, NRI Services, Over Draft Facility, Wealth Management Service

Services

Development Credit Bank: Growth Trajectory


The following graphs show the phenomenal growth of Development Credit Bank in the past few years

A Sneak Peek: An alternative view How Cooperative Banks fared well in Europe and across the globe during financial crisis? Financial cooperatives have fared better than the investor-owned banks in times of crisis. Savings and credit cooperatives, cooperative banks and credit unions have grown, kept credit flowing especially to small and medium sized enterprises, and remained stable across regions of the world while indirectly creating employment. It is their unique combination of member ownership, control and benefit that is at the heart of their resilience and that provides a series of advantages over its competitors. With financial cooperatives presenting an astonishingly large slice of the global banking market, it is important to better understand the model. Financial cooperative is an umbrella term for cooperative banks, credit unions and building societies, as well as banks that are owned by agricultural or consumer cooperatives. What they all have in common is that they are customer-owned banks.

Credit unions were set up originally to serve people with the lowest incomes, many in developing countries and in North America. The majority of cooperative banks are based in Europe and serve a range of customers. In Europe and North America, there was a slight dip in 2008 (in the cooperative banks) and then there was a comeback in 2009, 2010, 2011 everything was improved. Researchers have shown that the financial cooperatives kept credit flowing during the crisis, especially to small-and-medium-sized enterprises (SMEs), and remained stable across regions of the world. They have examined financial cooperatives from their origins in Germany in the 1850s to the global movement they represent today. A recent report from ILO explains why Cooperative banks have proven to be more resilient pointing to the specificities of the cooperative model of enterprise, and concludes with a review of practical policy options and recommendations for the way governments and development agencies should approach financial cooperatives not as conduits but as partners in the wider aims of business development, insurance against episodic poverty, and decent work.

What does it mean to be a member of a financial cooperative? There are three aspects: ownership, control and benefit. Ownership rights mean that one has power to decide if a business continues to exist, is sold off or wound up. This is why, even when members do not have any control over a business it cannot be sold without their permission. Ownership usually gives control rights,even if these are attenuated by rules and practices that allow boards to operate with very little input from members. At the minimum, members have the right to vote on new appointments to the board and to approve annual accounts.Ownership also confers a right to share in the benefits accruing from the business and also to have a say in how these benefits are allocated. Because cooperative banks and credit unions tend to federate and to create jointly owned central banks and subsidiaries, we have to add in the advantages of scale and scope that come from being part of a larger system. Finally, there are significant benefits to the wider society from having a customerowned financial sector.

It is not enough to say that there are advantages from being a cooperative; they need to be compared to other types of financial institution that may have similar advantages. The comparison with investor-owned businesses is implicit in the argument set out below. However, there are two other types of financial institution that should be considered: savings banks and micro-finance institutions. A detailed study of the advantages of cooperative banks would have to take into account the relative advantages of these competitors.Some recent reports have distinguished between shareholder-owned and stakeholder-owned banks, aligning European cooperative banks with savings banks.The savings bank sector is very large, especially in Western Europe where it has 19 per cent of banking assets. It is particularly strong in Spain (39 per cent of assets) and Germany (35.5 per cent), where it competes head to head with the cooperative banking sector.63 In less economically developed countries, the main competitors to financial cooperatives are other types of microfinance institution. They consist of a range of ownership types, the differences between which are often ignored in the literature.64 A systematic comparison is beyond the scope of this report, but is worth noting that the Grameen Banks system has several features in common with financial cooperatives, especially in its revised version,Grameen II. OWNERSHIP The advantages derived directly from ownership should apply even if there is minimal member involvement in decision-making. Advantage 1: It corrects market failure Ownership of the means by which a good or service is produced prevents ownership by a different interest group that might exploit the economic weakness of individual members. Another way of putting this is that without the financial cooperative existing there would be market failure. At the founding stage this is important. There is the danger of monopolistic supply by moneylenders. Even when there is more competition among suppliers of capital, there is the danger of lock in; here suppliers can exercise control over producers through supplying credit. This is particularly serious for small farmers who rely on short-term credit to tide them over the season. In the nineteenth century, cooperative banks in Europe, followed in the twentieth century by credit unions worldwide, provided small businesses with the credit they need when commercial banks were unwilling to lend. In the less economically developed countries, these ownership advantages are as relevant now as they were then. Financial deepening depends heavily on credit unions becoming established, since the costs to conventional banks of serving the poor make this sector unprofitable and the only alternative is monopolistic supply by moneylenders. Of course, this built-in advantage of financial cooperatives only applies if they are well managed and are not subverted by their managers, or by interest groups such as politicians or local elites. The danger of this is worse in other types of financial institution. Savings banks are non-owned, in that neither the customers nor a separate group of shareholders are owners, and a variety of interests are represented on their boards. During the banking crisis, savings banks in Spain and regional public banks in Germany (that are part-owned by savings banks) were found to be unsound because politicians had influenced lending decisions.

In the less economically developed countries, non-governmental organizations (NGOs) that provide micro-finance have been criticized for being unaccountable to their clients. Advantage 2: It prevents a conflict of interest between owners and customers. Economists have long ago identified the relationship between a banks shareholders and its customers as an agency problem. Equity shareholders may prefer a higher risk profile for the institution than would depositors due to the fact that they have limited liability; their potential for profit is unlimited, while the potential for losses is limited. Depositors do not share in the profits, but they do share disproportionately in the risks. In customer-owned banks this particular agency problem is avoided, since the owners and customers are the same people. There is no separate shareholder interest and the banks can be expected to work in the interests of their customers.In fact, in a retail bank there is no need for outside shareholders. All that is needed is a mechanism for bringing together those who wish to save money with those who need to borrow it; the bank merely recycles the money. In this view, investors are merely middlepersons who take the profits while adding little value to the business. A recent report for Rabobank spells out what it means when cooperative banks successfully put customers at the core of the business. There is a longterm focus on customer value. Healthy profitability is necessary but it is not a goal in itself. The banks operate in local retail markets, so have access to stable sources of funding in customer deposits. Centred on relationship banking, they produce strong local ties and networks. They have an informational advantage that makes them better equipped to assess creditworthiness, so they tend to have higher lending levels than their competitors. However, this advantage is weakened by the availability of government-backed deposit insurance, which protects customers against risk. Ironically, investorowned banks are now being forced to take out such insurance, and so the interests of shareholders and customers may not be so much at odds. Also, in financial cooperatives there is a difference of interest between depositors and borrowers,though this is a much less severe agency problem than that between shareholders and customers; a good governance system can easily bring the interests into line. Advantage 3: It provides an efficient, low cost model of banking Financial cooperatives have a dual bottom line, focusing on customer value as well as equity. They can use their comparatively low costs, abundant capital and lack of a profit maximization constraint to pursue expansion. They only need to remunerate the part of capital that is in member shares, and then not generously. Because they do not have to pay external shareholders, they can reduce the margin between the interest rates they charge to borrowers and pay to savers. They can even decide to sell products at below market price, incorporating the anticipated profits into the products. Consequently, they are able to attract a large share of retail deposits, so experience comfortable liquidity, with high deposit to loan ratios. In good times they become net lenders in interbank markets. In bad times, the reserves can be built up to cushion them against poor performance; the cooperatives simply do not distribute as much dividend to members, or they adjust their prices upwards so as to extract more surplus.69 It is true that they cannot issue shares in order to raise capital easily and quickly, nor can they rely on the limited amount of capital raised through member shares. However, they allocate virtually all their earnings to reserves that are then used to finance further growth. Their central banks are usually able to issue various forms of hybrid capital, and some of these banks can attract capital via listed subsidiaries.

All of these advantages are shared with savings banks, which helps explain why in Europe the cooperatives and savings banks both have large market shares and have competed successfully with the investor-owned banks. Before the banking crisis, they were criticized by some analysts for unfair competition, because they put investor-owned banks at a is advantage. However, in countries where they are strong, they have combined to suppress profit margins throughout the banking sector.

Advantage 4: It provides no incentives to risk taking Why are financial cooperatives so much less risky? They are not under pressure to maximize profits, a pressure that in investor-owned banks often leads to insecure lending and the sale of complex products that pass the risk on. They are more highly capitalized than their competitors. They are under less short-term pressure and are more inclined to adopt a longer term horizon in their business decisions and lending policies. It is less easy for them to raise external capital independent of their members, and so they avoid reliance on wholesale markets. They are not subject to the pressure from investors for immediate returns, and so a longer-term focus results. Their business strategy is all about relationship building; a number of studies find that cooperative banks are more willing to establish a long-term relationship with their clients, especially with SMEs.72 They have been found to have a more stable stream of earnings than other types because they are able to use their reserves as a buffer.It is when customer-owned banks stray from their natural business model that excessive risk-taking begins. Even then, they are better able to cope with losses through the mutual support network provided by their national federations. Unlike the too big to fail investor-owned banks, the biggest cooperative banks have been found to be better able to smooth out their gains and losses during the peaks and troughs of the business cycle.74 Again, this advantage is shared with savings banks and other non-profits, provided they are well governed. Disadvantage 1: It is not easy to raise capital in a crisis One consequence of ownership by customers is that it is not easy for cooperatives to raise capital outside the virtuous circle of savings and credit. If they have to open up membership to a separate group of investors through listing on a stock exchange - then they cease to be cooperatives. If they set up subsidiaries and joint ventures that raise hybrid forms of capital, they run the risk of losing money that their members will ultimately have to pay back. They can raise money from their customer-members through issuing various types of subordinated shares that pay interest but do not carry voting rights, and this helps recapitalize the business in times of trouble. However, they may have to accept that there are limits to their growth. Experts agree that the knowledge that capital cannot easily be replaced acts as a check on risky behaviour. After the banking crisis, this lack of access to outside capital can be seen as a strength not a weakness. Disadvantage 2: It has difficulty incentivizing managers A related disadvantage is that, because of member-ownership, financial cooperatives cannot align the interests of their managers with those of the shareholders by issuing performancerelated share options. There is a potential conflict of interest between managers and members. However, empirical evidence shows that their employees are more likely to be involved in

decision-making; they have higher job security, and the chance to work in their own region or community. They are close to the customers culturally, share in the profits, and receive valuable training.75 In general, they do have flatter pay scales than the investor-owned banks, so it is more difficult to attract talent. However, after the banking crisis the lack of incentives for managers to take risks, and the lack of expertise in sophisticated markets can now be seen as advantages. CONTROL By member control we mean enough of a curb on directorial and managerial authority to ensure that the business is run mainly in the interests of members and under their ultimate direction. There are several advantages that members gain from keeping this kind of control over their cooperative. Advantage 1: It guarantees the advantages that are derived from member-ownership. The intrinsic advantages of ownership are not guaranteed for long if boards take decisions that are not in the interests of members. The first advantage of member control is, therefore, that it guarantees the advantages that are derived from member-ownership.

Advantage 2: It aligns the interests of members with those of boards There is strong evidence that effective member control is linked to business success. In a study of several hundred agricultural cooperatives in India, it was found that success could be explained in relation to governance. His theory is that there are three conditions for success: the purposes of the organization are central to the members; the governance structure ensures patronage cohesiveness; and the operating system finds competitive advantage in the relationship with members. To achieve these conditions the members have to be in control of Far from being a check on the success of the customer-owned banking model, member involvement has been one of the drivers of its success worldwide. Advantage 3: Member control lowers risk-taking and so makes the business more durable The more members are involved in governance the more likely it is that the organization will avoid excessive risk-taking. The problem in the customer-owned banks that lost money during the crisis was partly one of inadequate member control; they did not understand the riskiness of the investments that were being made on their behalf . Advantage 4: It provides informational advantages to the bank,enabling it to lend to lower income groups. The fact that the customers are also members, and are involved in decision making should provide the financial cooperative with an informational advantage.The strong local presence and the proximity of the banks enable them to have a better understanding of the needs and the risk profiles of their customers, and ultimately to overcome the information problem. This enables them to provide credit to lower-income earning individuals and businesses with no or little collateral,because they are able to reduce the transaction costs associated with screening borrowers as well as monitoring and enforcing repayments. In other words, these institutions effectively prevent opportunistic behaviour on the part of borrowers.

Advantage 5: It increases opportunities to pursue ethical aims as well as shareholder value. The involvement of members creates opportunities for them to pursue other aims than just business success. They can express ethical aims in the way the business is run. For instance, the Cooperative Bank of the United Kingdom has been a market leader in ethical banking, being the first bank to offer free current accounts, pledging that it will not lend to companies that its customers regard as unethical. Contrast the cases of unethical behaviour of bankers in the investorowned sector in recent years, and their disastrous effects on the world economy.

Disadvantage 1: Members may not be motivated to participate in governance Member control is not easy to achieve, but it is not as difficult as economic theorists used to believe. Their argument went like this: in a cooperative, ownership is dispersed among many members, each of which has an incentive to free ride on the efforts of others. Also, the acquiring of the information and skills needed for effective oversight is costly. Therefore, members will not have control and managers will subvert the business for their own benefit. There are two weaknesses in this argument. First, it rests on an inadequate theory of human motivation that has become completely untenable; people will often take part in governance even if it is personally costly, because they are motivated by collectivistic incentives as well as by individualistic ones. Second, the complex governance structure of cooperative federal systems tends towards stability; the influence of members ensured through their being represented at all levels. Researchers who have studied them find that they work much better in practice than the theorists would expect.

Annexure I The Beginnings The first known mutual aid society in India was probably the Anyonya Sahakari Mandali organised in the erstwhile princely State of Baroda in 1889 under the guidance of Mr.Vithal Laxman also known as Bhausaheb Kavthekar. Urban co-operative credit societies, in their formative phase came to be organised on a community basis to meet the consumption oriented credit needs of their members. Salary earners societies inculcating habits of thrift and self help played a significant role in popularising the movement, especially amongst the middle class as well as organized labour. From its origins then to today, the thrust of UCBs, historically, has been to mobilise savings from the middle and low income urban groups and purvey credit to their members - many of which belonged to weaker sections. The enactment of Cooperative Credit Societies Act, 1904, however, gave the real impetus to the movement. The first urban cooperative credit society was registered in Canjeevaram (Kanjivaram) in the erstwhile Madras province in October, 1904. Amongst the prominent credit societies were the Pioneer Urban in Bombay (November 11, 1905), the No.1 Military Accounts Mutual Help Co-operative Credit Society in Poona (January 9, 1906). Cosmos in Poona (January 18, 1906), Gokak Urban (February 15, 1906) and Belgaum Pioneer (February 23, 1906) in the Belgaum district, the Kanakavli-Math Co-operative Credit Society and the Varavade Weavers Urban Credit Society (March 13, 1906) in the South Ratnagiri (now Sindhudurg) district. The most prominent amongst the early credit societies was the Bombay Urban Co-operative Credit Society, sponsored by Vithaldas Thackersey and Lallubhai Samaldas established on January 23, 1906. The Cooperative Credit Societies Act, 1904 was amended in 1912, with a view to broad basing it to enable organisation of non-credit societies. The Maclagan Committee of 1915 was appointed to review their performance and suggest measures for strengthening them. The committee observed that such institutions were eminently suited to cater to the needs of the lower and middle income strata of society and would inculcate the principles of banking amongst the middle classes. The committee also felt that the urban cooperative credit movement was more viable than agricultural credit societies. The recommendations of the Committee went a long way in establishing the urban cooperative credit movement in its own right. In the present day context, it is of interest to recall that during the banking crisis of 1913-14, when no fewer than 57 joint stock banks collapsed, there was a flight of deposits from joint stock banks to cooperative urban banks. Maclagan Committee chronicled this event thus: As a matter of fact, the crisis had a contrary effect, and in most provinces, there was a movement to withdraw deposits from non-cooperatives and place them in cooperative institutions, the distinction between two classes of security being well appreciated and a preference being given to the latter owing partly to the local character and publicity of cooperative institutions but mainly, we think, to the connection of Government with Cooperative movement.

Under State Purview The constitutional reforms which led to the passing of the Government of India Act in 1919 transferred the subject of Cooperation from Government of India to the Provincial Governments. The Government of Bombay passed the first State Cooperative Societies Act in 1925 which not only gave the movement its size and shape but was a pace setter of cooperative activities and stressed the basic concept of thrift, self help and mutual aid. Other States followed. This marked the beginning of the second phase in the history of Cooperative Credit Institutions. There was the general realization that urban banks have an important role to play in economic construction. This was asserted by a host of committees. The Indian Central Banking Enquiry Committee (1931) felt that urban banks have a duty to help the small business and middle class people. The Mehta-Bhansali Committee (1939), recommended that those societies which had fulfilled the criteria of banking should be allowed to work as banks and recommended an Association for these banks. The Co-operative Planning Committee (1946) went on record to say that urban banks have been the best agencies for small people in whom Joint stock banks are not generally interested. The Rural Banking Enquiry Committee (1950), impressed by the low cost of establishment and operations recommended the establishment of such banks even in places smaller than taluka towns. The first study of Urban Co-operative Banks was taken up by RBI in the year 1958-59. The Report published in 1961 acknowledged the widespread and financially sound framework of urban co-operative banks; emphasized the need to establish primary urban cooperative banks in new centres and suggested that State Governments lend active support to their development. In 1963, Varde Committee recommended that such banks should be organised at all Urban Centres with a population of 1 lakh or more and not by any single community or caste. The committee introduced the concept of minimum capital requirement and the criteria of population for defining the urban centre where UCBs were incorporated. Duality of Control However, concerns regarding the professionalism of urban cooperative banks gave rise to the view that they should be better regulated. Large cooperative banks with paid-up share capital and reserves of Rs.1 lakh were brought under the purview of the Banking Regulation Act 1949 with effect from 1st March, 1966 and within the ambit of the Reserve Banks supervision. This marked the beginning of an era of duality of control over these banks. Banking related functions (viz. licensing, area of operations, interest rates etc.) were to be governed by RBI and registration, management, audit and liquidation, etc. governed by State Governments as per the provisions of respective State Acts. In 1968, UCBS were extended the benefits of Deposit Insurance. Towards the late 1960s there was much debate regarding the promotion of the small scale industries. UCBs came to be seen as important players in this context. The Working Group on Industrial Financing through Co-operative Banks, (1968 known as Damry Group) attempted to broaden the scope of activities of urban co-operative banks by recommending that these banks should finance the small and cottage industries. This was reiterated by the Banking Commission (1969).

The Madhavdas Committee (1979) evaluated the role played by urban co-operative banks in greater details and drew a roadmap for their future role recommending support from RBI and Government in the establishment of such banks in backward areas and prescribing viability standards. The Hate Working Group (1981) desired better utilisation of banks' surplus funds and that the percentage of the Cash Reserve Ratio (CRR) & the Statutory Liquidity Ratio (SLR) of these banks should be brought at par with commercial banks, in a phased manner. While the Marathe Committee (1992) redefined the viability norms and ushered in the era of liberalization, the MadhavaRao Committee (1999) focused on consolidation, control of sickness, better professional standards in urban co-operative banks and sought to align the urban banking movement with commercial banks. A feature of the urban banking movement has been its heterogeneous character and its uneven geographical spread with most banks concentrated in the states of Gujarat, Karnataka, Maharashtra, and Tamil Nadu. While most banks are unit banks without any branch network, some of the large banks have established their presence in many states when at their behest multi-state banking was allowed in 1985. Some of these banks are also Authorised Dealers in Foreign Exchange viz. The Saraswat Cooperative Bank. Recent Developments Over the years, primary (urban) cooperative banks have registered a significant growth in number, size and volume of business handled. As on 31st March, 2003 there were 2,104 UCBs of which 56 were scheduled banks. About 79 percent of these are located in five states, - Andhra Pradesh, Gujarat, Karnataka, Maharashtra and Tamil Nadu. Recently the problems faced by a few large UCBs have highlighted some of the difficulties these banks face and policy endeavours are geared to consolidating and strengthening this sector and improving governance.
(Source: Adapted from a paper by O.P. Sharma, formerly of the History Cell.)

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