Sixty years ago, in August 1960, two large banks—the Lakshmi Commercial Bank and the Palai Central Bank of Kerala—failed in quick succession. The banking sector had no regulator then. The then finance minister Morarji Desai was having a gruelling time convincing the RBI to regulate the thousand-odd banks. The central bank refused to do so because it had limited staff and resources and did not have the legal mandate to regulate banks.
The finance ministry had already advised these banks to voluntarily consolidate two years ago, but there were hardly any mergers or acquisitions. Meanwhile, banks were falling like ninepins. Desai, who had been advocating self-regulation, was forced to make consolidation and amalgamation compulsory so that only strong banks that met the liquidity norms would be allowed to function.
D N Ghosh, who was then the deputy secretary of the banking division prior to becoming Chairman of SBI in 1984 and of L&T and Phillips in the nineties, writes in his memoirs: “For the next three years, endless applications for consolidation was processed by the banking division—almost two dozen daily.” In 1964, the number of commercial banks was pared down to 92. Of these, the central bank found that 20 were still financially unsound to be included in the RBI’s second schedule.
So there started a debate in Parliament over how to make them accountable. Finally, the Banking Companies Act was changed to the Banking Regulation Act in August 1966 for the RBI to effectively regulate them. Sixty years later, can the RBI regulate 1 lakh NBFCs and co-operative banks? In 2015, after the RBI started its Asset Quality Review of banks, many laws were put in place to both resolve stressed assets and stop money laundering and bank frauds.
But banking frauds have risen and so have the non-performing-assets. As the banks tightened the lending norms, the problem aggravated for NBFCs and co-operative banks, which like sick industries, were getting easy credit from the commercial banks. After 2018, a series of NBFCs collapsed, starting with the IL&FS, DHFL and HDIL adding another Rs 2 trillion to the bad loan account. Several co-operative banks such as the CKP Bank, Kapol Co-operative Bank, Rupee Co-operative Bank, City Co-operative Bank and the PMC Bank that were placed under the RBI’s watch since 2010 have collapsed.
The depositors lost money while the fraudsters closely associated with the bank management made hay. Not one co-operative bank placed under the RBI’s watchlist in the last decade has been revived. The regulator has neither the manpower nor the powers or a blueprint to revive the co-operative banks. Still, 44 more co-operative banks were placed under the watch of the regulator in 2020.
The problem is twofold. The RBI has a staff of 16,000, nearly half of what it had in the nineties. It is barely enough to regulate the three dozen commercial banks. On the other hand, there are 11,000 NBFCs, 1,500 urban co-operatives banks and 96,000 rural co-operative banks, which would require an army of supervisors, inspectors and analysts to monitor and regulate. For effective regulation, the number of NBFCs must be brought down to below 100 and the co-operative banks to below 1,500.
This means that forced consolidation of both NBFCs and co-operative banks must take place at the earliest, just like the forced consolidation of commercial banks in the sixties. Bank frauds have been doubling each year and touched Rs 1.82 lakh crore in the year 2019-20. That was nearly 1.2% of the GDP. The Sahara co-operatives and others have added another Rs 1 lakh crore to scams in the past year. A large number of frauds and NPAs are occurring in the co-operative banking sector that accounts for just 10% of the business but caters to 25% of the population at the bottom of the pyramid.
These RCBs and UCBs, which are largely funded by commercial banks, are sparsely regulated simply because of their large numbers and wide geographic spread. Most of these banks have poor asset bases when compared to liabilities and have political families in their boards who resist change. Instead of taking action on these banks selectively after they have nearly gone bust, a forced consolidation is needed to reach a scale so that they can be divested and rejuvenated.
Sandip Sen (sen.sandip@gmail.com)
Journalist and author, has written three books on economic governance