IDENTIFICATION AND REHABILITATION OF WEAK URBAN COOPERATIVE BANKS

1.         INTRODUCTION

The Reserve Bank of India (RBI) as part of its responsibility to supervise, control and develop the urban banking movement along sound lines, it has to ensure the existence of a strong and viable urban banking structure which will be in a position to render effective service to the community. However, a number of weak and uneconomic units emerged over a period of time for historical reasons. The entry of such marginal institutions whose working constituted a drag on the urban banking system prompted the RBI to create a system to constantly examine the causes of such weaknesses and devise ways and means to put them on a sound footing. This is being done by evolving certain norms for identification of such units as 'weak', fixing time bound action programmes for their rehabilitation and making arrangement for a regular flow of information regarding their progress.

This system was originally introduced in the year 1972 by erstwhile Agricultural Credit Department and was slightly modified later on.

2.         DEFINITION OF WEAK BANKS

Prior to March 2002, urban cooperative banks (UCBs) were classified as ‘weak’ if they meet any one of the following criteria:

a). Owned Funds are eroded to the extent of 25 per cent or more by unprovided for bad and doubtful debts, other bad assets and accumulated losses or overdues exceed 50 per cent of the loans and advances outstanding, and

b).     Does not comply with provisions regarding minimum share capital in terms of Section 11(1) of the Banking Regulation Act, 1949 (As Applicable to Cooperative Societies), that is, the real or exchangeable value of paid-up share capital and reserves has fallen below the stipulated norm of Rs. 1 lakh.

Based on the recommendations of the High Power Committee (HPC), the norms for classification of UCBs as ‘weak’ and ‘sick’ were revised with effect from March 31, 2002 as under:

The UCBs and their Federation / Associations represented to the Reserve Bank of India that the above norms for classification of UCBs as ‘weak’ were stringent, since each of the parameters were inter-dependent. Besides, the nomenclature of ‘weak’ UCB signalled a negative connotation, rendering the bank’s turnaround difficult. The issues were examined by the Anant Geete Committee and the Committee recommended that the Reserve Bank may consider modifications of the norms for classification of UCBs as ‘weak’ and that the nomenclature of ‘weak’/’sick’ may be dispensed with. Accordingly, as approved by the Board for Financial Supervision at its meeting held on February 27, 2003, UCBs may be classified into various grades, as under:

• Grade I: Sound banks having no supervisory concerns would be classified under Grade I
• Grade II (Problem Banks): Banks meeting any one of the following parameters are classified under Grade II banks:
• CRAR one percent below the prescribed norms, or
• Net NPAs of 10 % or more but below 15%,

or

• Incurred net loss for the financial year ended,

or

• Defaulted in the maintenance of CRR / 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 (Weak Banks): Banks meeting any two of the following conditions would be classified under Grade III:
• CRAR falls below 75% of the minimum prescribed but 50% or above the level required
• Net NPA of 10% or more but less than 15%
• Incurred net losses for two years out of the last three years
• d.  Grade IV (Sick banks): Banks meeting the following conditions will be classified under Grade IV:
• CRAR is less than 50% of the prescribed limit and
• Net NPA is 15% or more as on March 31 of the year or
• Incurred net losses for the last three consecutive years

However, in cases where the banks fulfill any one of the conditions in Grade IV, these banks in view of the fact that they do not meet the two conditions required for classification as Grade IV, will be classified as Grade III.

3.         SYSTEM OF IDENTIFICATION OF WEAK BANKS

According to the present guidelines the financial health of UCBs is determined on the basis of statutory inspections carried out by RBI at periodical intervals.  At times, special investigations are conducted on the basis of complaints received or information received from other sources also form basis to judge the financial soundness of banks.  Based on the estimate made by the inspecting officers of RBI on the erosion in value of the assets, level of overdues, and other financial indicators, the banks are classified into any one of the categories referred to above.  In such cases, the banks concerned are advised of their inclusion in the list of weak banks immediately after finalisation of inspection reports. Apart from the statutory inspections/special investigations, the banks are also required to submit annual statements showing the position of overdues, unprovided for erosion in the value of assets as per the estimates made in the inspection report.  Based on the financial particulars furnished in the annual statements, the Regional offices of RBI classify the banks into weak.

As on March 2005, the distribution of UCBs in various Grades is as per the table:

4.         CAUSES FOR WEAKNESS OF BANKS

• A.    Internal Factors
• Management
• Directors with questionable characters
• Favoritism in sanctioning of loans and advances and recruitment
• Sanctioning of loans to directors, relatives violating directive on maximum limit of advances
• Lack of interest in turnaround of the bank
• Interference in the day-to-day functioning of the bank
• Staff
• Low productivity
• Staff with low morale
• Lack of qualified and trained staff
• Lack of interest in the turnaround of the bank
• Involvement of staff in frauds, misappropriation, etc.
• Loan policy and procedure
• Lack of proper system for assessment of loans proposals
• Predominance of loans for unproductive purposes which do not generate income to repay loans
• Lack of system of verification of end use resulting in misuse
• Concentration of loans to a few directors/preferred borrowers
• Financing of defaulters
• Lax in initiating action against defaulters
• Delay in realizing the security offered
• Financial
• Low capital base
• Low level of business resulting in inadequate margin
• Injudicious management of funds
• Over extended position of loans and advances
• Heavy overdues and non-performing advances resulting in low margin
• Heavy losses due to frauds, misappropriation etc.
• Reliance on high cost deposits
• Low yield on assets
• House Keeping
• Location Poor upkeep of premises
• Lack of publicity
• Poor customer service

B.        External

• Changes in policies such as interest rate structure etc.
• Political interference
• Escalation of establishment cost due to wage revision
• Competition from banks and other non-banking financial intermediaries
• Lack of potential
• Natural calamities in the area of operation of the bank

5.         MONITORING OF WEAK BANKS

5.1       Bank Level Review Committee

Banks which are classified as 'weak' are simultaneously placed under the scheme of rehabilitation.  The bank is advised to constitute Bank level review committee consisting of Chairman and chief executive officer of the bank and a representative each of the Cooperation Department, Federation and DCCB.  The task of the bank level review committee is essentially to draw an action plan for rehabilitation of weak banks within a specified time frame as per guidelines of RBI.  The details guidelines in this regard are given in Annexure III.  The committee is expected to meet at quarterly intervals to review the progress made by the bank vis-à-vis the targets fixed for improvement of business and recovery of overdues in the action plan.

5.2       State level review committee

For attending to the entire work relating to rehabilitation of weak banks including the monitoring of the working of the district level review committees for rehabilitation of weak banks, drawing up of action programmes for non-viable institutions monitoring the position of banks which do not satisfy Section 11 of the Act ibid etc., state level review committees are set up at the instance of RBI with the following members.

• 1)      Registrar of Cooperative Societies as Chairman
• 2)      Representative of the Managing Director of the State Cooperative Banks as Convener
• 3)      Chairman/Chief Executive of the State Federation/Association of Urban Banks
• 4)      A representative of the Regional Office of the Urban Banks Department of the RBI.

The Committee is expected to:

• 1)                  Review the programme of rehabilitation of weak banks.
• 2)                  Monitor the implementation of the action programmes drawn up for banks not satisfying Section 11 of the BR Act and decide on the future course of action in the case of such banks by merger or liquidation as the case may be.

5.3       Role of State Cooperative Banks (SCBs)

Being the leader of cooperative movement, the SCBs were advised to assume responsibility for rehabilitating weak banks in June 1973, so as to ensure effective and expeditious implementation of the rehabilitation should be drawn up in respect of weak banks in their jurisdiction and their performance carefully monitored by a separate rehabilitation cell constituted for the purpose.  Besides, they were advised to review the progress of the rehabilitation of weak banks at their own board meeting with a view to suggesting steps for speeding up the implementation of the programme.  It was also stipulated to keep RBI posted with the steps taken in this regard.

6. Vision Document and TAFCUB

The Reserve Bank of India regulates the UCBs through its Urban Banks Department (UBD). In the process of regulating and supervising the UCBs it was felt that there is a need to adopt a State specific approach. The UBD came out with a Vision Document which aimed at creating a State Level Task Force on Coop Urban Banks (TAFCUB) comprising of RD, RCS, Central Office and in-charges of UBD ROs and a representative each from NAFCUB and state federations. An MOU was signed with nine states so far in this regard which included the States of Gujarat, Andhra Pradesh, Karnataka, Madhya Pradesh, Maharashtra, Chattisgarh, Uttarakhand, Rajasthan and _____. It was agreed upon by the stakeholders of the TAFCUB that it would identify the potentially viable urban cooperative banks and draw up a time bound action plan for revival of UCBs by setting specific monitorable milestones. Under the proposed operating framework of the Vision Document it has been envisaged that UCBs would be categorized into:

• Unit Banks (Deposits Less than Rs. 50 crore): These banks would have a simplified regulatory regime and CRAR maintenance could be replaced by NOF to NDTL ratio. Other stipulation prescribed under the Vision Document are:
• Exposure to sensitive sector restricted
• Lower prescribed limit for investment in G-Sec
• Restrictions to insulate them from systemic shocks
• Restricted geographical operations
• Such banks to roll back operations in far off locations
• All other Banks: These UCBs would have regulatory prescriptions as applicable to commercial banks and the extant relaxations applicable to these UCBs may continue up to the period specified. However, the following stipulations have been recommended by the Vision Document:
• There should be no concept of unscheduled multi state bank
• CRCS may ensure that a bank is scheduled before it is granted license under MCS Act
• Existing scheduled banks both under MCS Act and State Cooperative Societies who do not comply with prudential and regulatory regime akin to that of commercial banks could be excluded from second schedule of RBI Act
  

8.         Norms for deletion of banks from the list of weak banks

A weak bank's name is deleted from the list on fulfilling the undernoted criteria.

• The unprovided for bad assets (i.e. bad debts and other intangible assets) constitute less than 25% of the owned funds (excluding the provisions for bad and doubtful debts and other assets).
• The paid up share capital and reserves created out of profits exceed bad and doubtful debts, accumulated losses and other overdues over three years by at least Rs.1 lakh.
• The percentage of overdues to the loan outstanding do not exceed 25% at the end of last two consecutive cooperative years.
• The bank should have shown qualitative improvement in managerial competence, mobilization and deployment of resources, loan policy and procedures etc.

While financial parameter (1 to 3) could be assessed from the statements received from the banks, it may not be possible to assess the fourth parameter independently without an inspection.  As it may not always be possible to have an inspection of the bank during the period immediately preceding the date of review of its financial position for the purpose of annual preparation of the list of weak banks.  RBI may not be in a position to delete a bank from the list of weak banks inspite of its fulfilling the financial norms for deletion.  It may not, however, be proper to treat a bank as weak inspite of an overall improvement in its financial position.  Hence, banks which have fulfilling the financial norms for deletion as per the review are placed under a separate list styled as "weak banks under observation".  The rehabilitation committee constituted for these banks should, howver, be continued till such time the banks are actually deleted from this list after an inspection duly ensuring that there had been qualitative improvement in the bank's operational efficiency.

ANNEX – I

Present viability norms (1993)

To be achieved by the end of 3 years

(Rs. in lakhs)

ANNEX – I A

Viability norms (1986)

(Rs. in lakhs)

ANNEX – II

Rehabilitation of weak primary co-operative banks - Guidelines

The programme of rehabilitation of a weak primary cooperative bank may cover the following aspects :

Detailed investigation of overdues

2.         A detailed investigation will have to be made with a view to locating the factors that may be responsible for the high level of overdues.  The overdues may be high on account of defective loan policies and procedures of the bank such as predominance of loans for unproductive purposes which do not generate the necessary repaying capacity; sanctioning of loans in excess of the repaying capacity of the borrowers; lack of proper verification of the genuineness of purposes for which loans are advanced; misutilisation of loans, financing defaulters; inadequate security etc.  The overdues may also be high on account of lack of timely action and adequate efforts for recovery.  Case by case analysis of overdue loan accounts particularly in respect of accounts in overdue for more than 1 year will have to be made and take suitable action for early recovery.

Estimate of erosion in the value of assets

3.         The detailed investigation of overdues suggested above will enable the bank to know the prospects of realisability of its overdue debts and, on that basis, make an estimate of its likely bad and doubtful debts.  The bank may also examine the realisability of its other assets and thereafter prepare an estimate of total erosion in the value of its assets.  A comparison of the estimated erosion in the value of assets with the corresponding reserves will enable the bank to find out the shortfall in reserves.   The shortfall in reserve is indicative of the weakness of the bank and the more the shortfall the greater is the weakness.  This shortfall should, therefore, be made up by strengthening the bad and doubtful debt reserve of the bank by making allocations out of distributable profits in future years.  If the erosion is on account of accumulated losses, the bank has to change the business mix and go in for quantum jump of business.  The bank should not declare any dividend to it shareholders till it comes out of 'weak' list.

Action for recovery of overdues

4.         Default may be either due to borrower's inability to repay or unwillingness to repay.  It is necessary for the bank to initiate suitable action promptly to guard its interests by proceeding against the borrower as well as the security offered by him.  The investigation of overdues will enable the bank to determine the course of action to be taken for recovery of overdues.  Generally, the period of default and the nature and extent of security available will be the guiding factors for determining the course of action.  Whereas persuasive measures may yield the desired results in cases where overdues are comparatively recent and are fully secured, more positive steps, such as filing of arbitration cases, may be necessary in cases where the overdues have been continuing for more than 6 months and the loans are either unsecured or the security is inadequate.  While investigating each overdue loan account, it would be desirable for the bank to make a periodwise and security-wise classification of overdues and on that basis draw up a definite programme of action for recovery in respect of each overdue loan.  Legal action may also have to be initiated for the recovery of amounts involved in misappropriations, etc.

5.         Filing of arbitration cases and obtaining awards would not in itself bring in the recoveries from the borrowers.  Several cases have been observed where sizeable amounts in respect of suit-filed and decreed debts have proved irrecoverable either on account of delay or reluctance on the part of the bank to send the awards for execution.  The bank should, therefore, promptly send for execution all the awards obtained against the borrowers.  The progress in the filing of arbitration and execution cases and the recovery of overdues should be reviewed by the Board of Directors of the bank in each meeting and the Board on a review of the progress should suggest further measures to be taken in this behalf.

Rationalisation of loan policies and procedures

6.         Many of the evils that weaken the financial soundness of a banking institutions are due to its defective loaning policies and procedures.  A thorough review of the loan policies and procedures of the bank under rehabilitation will, therefore, be necessary with a view to streamlining them.  An analysis of overdue loan accounts suggested in para 1 above would throw light on the defective features in the loan policies and procedures of the bank.  There may be preponderance of loans for unproductive purposes such as for meeting consumption needs, repairs to houses, ceremonial expenses, etc.  While grant of loans for consumption purposes and meeting the family needs is one of the legitimate functions of a primary co-operative bank, such advances do not generate any repaying capacity and, therefore, should have to be kept within reasonable limits.  It would be desirable for the bank to encourage loans for productive purposes such as trade and commerce, small scale industries, technical training, purchase of implements and other materials required by artisans, setting up of legal/medical practice, etc. which enhance the income earning capacity of the borrowers and thereby make the loans self-liquidating.  It should be ensured that loans for unproductive purposes do not exceed 15 to 25 per cent of the total loans and advances.

7.         Loans may have been sanctioned without regard to the repaying capacity of the borrowers rendering the recovery of such loans difficult.  It is necessary that the repaying capacity of the borrowers is worked out on a realistic basis taking into account his total income, expenditure, existing indebtedness, etc. and the loans are restricted to be well within his repaying capacity.

8.         Security also constitutes an important consideration for determining the realisability of loans.  It has to be seen whether there is preponderance of unsecured loans.  It is also possible that though the security is obtained, it is relegated to a mere formality because either it does not conform to the essential attributes viz. marketability stability and transferability on the necessary formalities are not observed for creating an effective charge on them in favour of the bank. According to sound banking practice, advances should be backed by tangible security which should be adequate, readily realizable, stable in value and free from encumbrances.  It is likely that bulk of the advances may have been sanctioned by the bank against the security of the mortgage of real estates which does not satisfy the above tests of good security.  It would be desirable for the bank to diversify its lending risks by obtaining from the borrowers easily relisable securities such as government and other trustee securities, quoted shares, gold ornaments, merchandise, etc. and restrict its unsecured advances.

9.         The bank should have to ensure that its loans and advances are not concentrated among a few borrowers, but are spread over a large number of members of different categories.  For this purpose, a definite ceiling may be prescribed in the bylaws of the bank on the borrowings of a member against any/all types of security.

10.       The bank should also have to ensure that in each case the type of loan sanctioned has relevance to the nature of accommodation required.  For example, financial accommodation for meeting the working capital requirements of merchants, traders, artisans and industries should be sanctioned in the form of cash credit and not in the form of fixed loans and loans to members with fixed incomes and to salaried class should be made repayable in monthly instalments.

11.       The bylaws of a primary cooperative bank generally lay down broad lending policies such as the purposes for which loans can be advanced, maximum amounts that can be sanctioned against different types of securities, etc.  Further details in this regard may be incorporated in the subsidiary rules framed for different types of loans and advances.  The application forms prescribed for different types of loans and advances should provide for all essential details such as purpose of loan, period of loan, income and expenditure of the borrower, etc. so as to realistically assess the need and the repaying capacity of the borrower.  It should be ensured that loans are sanctioned by the competent authority only after through scrutiny and verification of details given in the application and with reference to the past performance of the borrower.  A defaulter should not be financed under any circumstances.  The bank should also evolve arrangements for supervision over and verification of the hypothecated/pledged stocks.

Mobilisation of resources

12.       The resources of a primary cooperative bank generally comprise the paid up share capital, the reserves created out of the profits and the deposits mobilized by it.  Borrowings from higher financing agency will be practically Nil.  The share capital base of the bank can be strengthened by increasing the membership and introducing linking of shareholdings to borrowings.  The bank should make efforts for increasing its membership and collect share money from its borrowing members to the extend of 5 per cent of its unsecured advance and 2 1/2% of its secured advances.

 13.       Mobilisation of deposits assumes a special importance in the context of increasing and diversifying the loan operations of the bank and from the point of view of embarking on new activities such as financing small scale industries.  The bank should also introduce attractive schemes for mobilizing deposits such as cumulative deposits, pigmy deposits, recurring deposits, etc. which can suit the needs and meet the tasks of the different categories of clientele.  The rates of interest on deposits should be periodically reviewed to ensure that they are competitive with our banks.  The bank should also diversify its activities and widen the range of banking facilities to its customers.  The bank should constantly strive to improve the quality of services provided to its customers since the promptness, efficiency and courtesy are the important features that contribute to the success of a bank in mobilizing deposits.

Management of resources

14.       The proper management of resources comprises raising funds at the cheapest rates and their deployment so as to ensure maximum profits with due regard to liquidity and security.  The bulk of the resources of a primary cooperative bank comprise deposits.   While no ideal proportion can be suggested between the fixed deposits on the one hand and the savings and the current deposits on the other, in cases where fixed deposits for one year and above form more than 50 per cent of the total deposits, there may be need for taking rigorous steps for mobilizing current and savings deposits.

15.       The bank should have to ensure strict compliance with the statutory provisions regarding maintenance of cash reserve and liquid assets.  Deficits in cash reserve and liquid assets would be indicative of inefficient management of resources.  At the same time, the bank should have to avoid heavy surpluses in cash reserve and liquid assets.  In deciding the form in which liquid assets should be maintained, liquidity as well as profitability should be the governing factors.  The bank should not keep unnecessarily heavy cash balances or balances in current accounts with the notified banks/ central cooperative bank of the area which do not earn any income to the bank.  The liquid assets can be kept in the form of investments in Government and trustee securities, fixed deposits with the concerned central cooperative bank, etc. which would earn income to the bank.

16.       The most remunerative investment to the bank is in loans and advances which carry interest higher than any other form of investment.  At the same time care should be taken to ensure that is no overextended position of loans and advances.  Such a situation arises if the total investments of a bank in loans and advances exceed 75 per cent of its owned funds (including the statutory reserve fund), 70 per cent of its deposits and 100 per cent of its borrowings.  The proportion of loans granted for short term and medium-term purposes should also depend on the pattern of resources mobilized by the bank for the purpose.  The yield on advances should be worked out and should be compared with the industry average.  It it is very low vis a vis the industry, then it could be due to preponderance of loans with lower interest rates, high overdues and Non-performing Assets.

17.       Efficient management of a bank depends on the competence of its staff.  In a weak bank the staff morale would be at the lowest ebb.  The management and the CEO should exhort them with a view to produce better results.  Training plays an important role.  It may be necessary to take up with the Federation to arrange suitable training programme for the staff and workshop for the management.  The bank should specifically lay down the duties and the responsibilities of the various categories of the staff and ensure that the staff discharges them efficiently.  Normally, the productivity of the staff would be very low.  The staff should be motivated to improve their performance.

Constitution of a Review Committee

18.       A review committee may have to be constituted for the bank to periodically assess the progress in the implementation steps to be taken in this behalf.  The committee may consist of the Chairman and Secretary of the concerned primary cooperative bank and a representative each of the central cooperative bank of the area, Federation and the Cooperation Department.  The Review Committee should meet  at least once in a quarter.   The concerned Regional Office of the Reserve Bank of India will be providing necessary guidance in the implementation of the rehabilitation programme from time to time.

The Committee is expected to fix realistic targets in respect of deposits, share capita, advances and recovery.  An important requirement of the Committee is the committee should take the moral responsibility in turning around.

Reference ACD.RC:24/I(Gen)72.3 dated 13 November 1972

Note : A slightly modified version of the circular.

Revised by Shri J K Pandey, Member of Faculty, CAB