Here's A Closer Look At Safety In Co-Operative Banking

The Reserve Bank of India (RBI) on September 30, 2023 said it has cancelled the banking licence of Lucknow Urban Co-operative Bank, as the lender does not have adequate capital and earning prospects.

Following this move, the RBI requested the Commissioner and Registrar of Co-operative in Uttar Pradesh to wind up the bank and appoint a liquidator for the co-operative bank.

So, what does this mean for depositors?  

In the event of liquidation, every depositor will be entitled to a deposit insurance claim, with a monetary cap of Rs 5 lakh provided by the Deposit Insurance and Credit Guarantee Corporation (DICGC).  

Incidentally, according to the bank’s data, a staggering 99.53 per cent of depositors are expected to receive the full amount of their deposits from DICGC, offering some relief.  

Here, it’s crucial to differentiate between various types of co-operative banks, especially in light of the Karuvannur Co-operative Bank scam in Kerala and several other similar scams that have come to light involving co-operative banks in the last one month.

Do All ‘Co-operative Banks’ Get DICGC coverage?

State co-operative banks, district central co-operative banks, and urban co-operative banks that are registered with DICGC offer insurance coverage of up to Rs 5 lakh for depositors because they are regulated by RBI or National Bank for Agriculture and Rural Development (NABARD).  

But a different scenario emerges when primary co-operative societies run primary co-operative banks by engaging in banking operations and adopt the term ‘bank’ in their names. These primary societies fall under the jurisdiction of the Registrar of Co-operative Societies in specific states, rather than being regulated by RBI or NABARD. Consequently, depositors in these societies do not enjoy the protective umbrella of the DICGC insurance.

Are They Really ‘Banks’?

People not well versed in banking terms often get confused, as these co-operative societies, originally meant for small-scale deposits and loans, particularly in agricultural lending to members of these co-operative societies, started referring to themselves as ‘banks’.

To address this issue, RBI issued a circular on November 22, 2022 warning co-operative societies against using the term ‘bank’ in their names and accepting deposits from non-members. These societies have not received licenses under the Banking Regulation Act and lack authorisation from RBI for banking activities, RBI said. As a result, deposits placed with these societies do not benefit from DICGC insurance coverage, it added.

Says Sudheer M, a Securities and Exchange Board of India (Sebi)-registered investment advisor: “The regulatory hold on a co-operative bank is very thin compared to a scheduled co-operative bank. So, the deposits in some co-operative banks can be at risk. Management can also be influenced by political pressure, when giving out loans. Further, due to problems with capital adequacy ratio norms, RBI may place co-operative banks under moratorium and a depositor may not be able to withdraw their deposits timely, thus affecting his liquidity. A risk averse investor should stay away from lure of a few basis points (bps) hike in deposit interest rates, and avoid co-operative banks."  

The Enforcement Directorate (ED) investigations regarding Kerala’s Karuvannur Co-operative Bank scam, have highlighted the challenges within the co-operative banking sector.  

Meanwhile allegations have also been levelled against two other co-operative banks in the state. The absence of stringent corporate governance, coupled with light-touch regulation, local political interference, lapses, and corruption, has been a cause for concern.

According to data revealed by the Kerala government in July 2022, a total of 399 co-operative banks and societies had committed financial fraud over the preceding six years. These frauds encompassed improper calculation of deposit interest rates, loans disbursed without adequate collateral, and irregularities in bank property auctions, among others.

In conclusion, for depositors in state co-operative banks or urban co-operative banks, deposits up to Rs 5 lakh are covered by DICGC. However, for amounts exceeding this threshold, it may be advisable to consider transferring funds to other scheduled co-operative banks. Importantly, depositors in primary co-operative societies face a higher risk, as their investments lack DICGC protection.