Inherent risks in banking and fiduciary responsibility of banks towards their depositors necessitate a system of protection of depositors and accordingly, most of the jurisdictions, globally, have deposit guarantee schemes for bank depositors. However, a deposit guarantee scheme provides a restricted coverage, does not ameliorate risks at an institutional level, and does little to protect a bank from delinquency and bankruptcy. Moreover, notwithstanding the quality and effectiveness of a deposit guarantee scheme, bank customers do face inconvenience, difficulty, and losses in case a bank’s financial position deteriorates. This is far more important for cooperative banks whichplay an important role in providing banking services and meeting the credit needs of the retail, small and medium scale borrowers, as these face greater challenges due to their comparatively smaller size, governance issues, regional functioning, and limited access to the funding market.
2. STRUCTURE OF CO-OPERATIVE BANKING IN INDIA
The primary co-operative banks, popularly known as Urban Co-operative Banks (UCBs) in India are registered as co-operative societies under the provisions of, either the respective State Co-operative Societies Act(s) of the state concerned or theMulti-State Co-operative Societies Act (2002) of the union of India. These are essentially cooperative societies, licensed by the Reserve Bank of India, for conducting banking business. UCBs have a heterogeneous geographic and size-wise distribution in India.
As on March 31, 2018, out of the total number of UCBs in India, three states had the most number of UCBs, namely, Maharashtra (32%), Karnataka (17%), and Gujarat (14%).In terms of business, as on March 31, 2018, there were 1551 UCBs (Figure 1) with an aggregate deposit and advances of ₹ 4565 billion, and ₹ 2805 billion, which were about 3.9%, and 3.2% of the aggregate deposits and advances of the scheduled commercial banks respectively as per the report on Trend and Progress of Banking in India. Despite not boasting of very significant size, the UCBs have a reasonable socio-economic significance due to their interface with a good number of clients coming from lower-medium socio-economic strata in India. However, there have been concerns with regard to financial soundness and quality of corporate governance in UCBs.
As per the information available in the annual report (2017-18) of Deposit Insurance & Credit Guarantee Corporation (DICGC), a subsidiary of Reserve Bank of India, 345[i] UCBs have gone into liquidation starting from the year 1977 up to March 31, 2018.
These bank liquidations involved the settlement of depositors’ claims amounting to about ₹ 48 million. Considering the limited coverage of ₹ 0.1 million per depositor by DICGC, it is certain that a number of depositors would have lost their money in these UCBs. In case of India, though a deposit insurance coverage for deposits up to ₹ 0.10 million is available for all bank depositors, there is neither any effective umbrella organization, or central institution, nor any institutional set up for resolution, restoration, or protection scheme for cooperative banks, especially the Urban Cooperative Banks (UCBs). The German Cooperative banking model with its unique institutional protection scheme through an umbrella organization could be worth examination and replication in India.
3. BANKING STRUCTURE IN GERMANY
Germany’s banking system comprises of three key segments, called pillars — private commercial banks, public-sector banks, and cooperative banks .
The private commercial banks account for about 40% of total assets in the German banking system. The public banking sector, comprising savings banks represents about 26% of total banks’ assets. These banks have local governments, such as municipal corporations, and local bodies as their owners and operators in the area under their respective local governments. The cooperative banking sector in Germany consists of local cooperative banks and one central bank, namely, DZ Bank AG. The cooperative banks are owned by their members, and they have the mandate to support their members while also providing banking services to the general public. Like the savings banks, cooperative banks operate within a mutually agreed regional jurisdiction. There has been consolidation in the German banking system, in general, to achieve economies of scale, regulatory requirements and financial stress.
4. COOPERATIVE FINANCIAL NETWORK IN GERMANY
Germany’s local cooperative banks are quite formidable and have an extensive banking service network in Europe, with 875 cooperative banking institutions,comprising Volks Banks and Raiffeisen Banks. It boasts of more than 30 million customers, including about 18.6 million cooperative members. The local cooperative banks own the capital of the central institution, DZ Bank AG, which is structured as a company and provides liquidity support and specialized services, such as securitization, collateral management, merchant banking, etc. to cooperative banks. As on December 31, 2018, the cooperative financial network had an asset size of Euro 1293.17 million, which was approximately 17% of the total bank assets in Germany.The networkalso boasts of a healthy common equity tier I capital ratio of 13.6%[ii]. Besides owning a central bank, the cooperative financial network in Germany also has an umbrella organization, called the National Association of German Cooperative Banks (BVR)[iii], which acts as an umbrella organization for the German co-operative financial network. As an umbrella organization, BVR represents the interests of the co-operative banking group at both national and international fora and also operates a dual system of bank protection in the form of depositinsurance and institutional protection. The deposit insurance scheme of BVR operates under national deposit insurance legislation (pursuant to section 43 EinSiG[iv]) in compliance to EU Deposit Guarantee Schemes Directive, 2015 (DGSD), while the BVR institutional protection scheme (IPS) is an additional, voluntary system for protection of cooperative banks at the institutional level and ensures that the banks remain strong and interests on all the bank clients are safeguarded.
5. INSTITUTIONAL AND DEPOSIT PROTECTION SCHEME FOR GERMAN COOPERATIVE BANKS THROUGH UMBRELLA ORGANISATION
The BVR’s protection scheme is a kind of self-help organization of the Cooperative Financial Network that was formed voluntarily and operates on the basis of its statutes under the Articles of Association of the BVR. The protection scheme run by the BVR helps in ensuring the stability of and public confidence in the cooperative financial network. The scheme is in operation since 1934, but no cooperative bank so far has ever turned insolvent.The BVR protection scheme is run without any government supportand is designated as BVR-ISG for deposit insurance, and BVR-SE for the institutional protection.The BVR-ISG has been officially recognized as a deposit insurance system and fulfils the statutory requirement of ensuring that depositors affected by a bank’s insolvency are compensated in accordance with national deposit insurance legislation. The BVR protection scheme (BVR-SE), the bank protection scheme, operates alongside the BVR-ISG (Figure 3). Member institutions contribute towards both the schemes for seeking protection. In addition, the BVR is legally authorized to take measures to avert any threats posed to a bank’s continued existence as a going concern. In order to perform its responsibility under the protection scheme, the BVR implements preventive measures aimed at obviating adverse trends and developments at the affiliated institutions and, if necessary, advises measuresfor a financial or operational restructuring of the concerned cooperative banks so that they can meet their legal obligations without any difficulties.
In most of the cases, no requirement arises for extending funding support to a cooperative bank from the BVR. However, in caseof necessity, cover funds are assured by the BVR with a view to obtaining an unqualified opinion from the auditors of the respective cooperative bank. This is followed by a financial restructuring of the bank as per the advice of the BVR, which aims at protecting the bank from becoming insolvent andavoiding a situation in which depositors are to be compensated. The protection scheme run by the BVR aims to protect all individuals and non-bank clients of the affiliated institutions. TheBVR protection scheme is regulated and monitored by the BaFin[v], the German Federal Financial Supervisory Authority. BaFinhas the right to obtain information from, and audit the protection scheme. The BVR prepares its annual financial statements and an annual report on the activities and financial position of the protection scheme and puts in place a risk management framework for the cooperative financial network. These statements and reports are audited by the independent auditorsfrom outside the Cooperative Financial Network. Audit reports are shared with the BaFin, Deutsche Bundesbank, the cooperative auditors’ associations, and the administrative board of the BVR.
6. RISK MANAGEMENT UNDER INSTITUTIONAL PROTECTION SCHEME
The Cooperative Financial Network in Germany is a decentralized structure in which the individual banks operate independently with a central bank (DZ Bank AG) and an umbrella organization (BVR). In this system, the risk management primarily involves finding the risk-carrier institutions, which could be the weakest link in the network. The BVR puts in place a system whereby the individual cooperative bank’s financial position along with the risk position is ascertained with a view to ensure that the entire cooperative financial network as a unit can be considered as financially sound. BVR’s risk management process for the institutional protection scheme includes the following three steps.
- Institutional Classification Process – Automated Procedure
- Prevention Management – Standard Procedure
- Support Mechanism – Individualized Standard Procedure
A brief description of these processes is presented in the following paragraphs.
Institutional Classification Process
The BVR protection scheme haswell-designedsystems for identifying, classifying,and monitoring the risks of all its member institution as also risks to the institutional protection scheme as a whole. Risks are assessed by way of assigning of rating on the basis of the BVR protection scheme’s classification system.The rating process, based on the respective member institution’s annual financial statements assigns one of the nine credit rating categories, which range from A++ to D.Rating a member bank in accordance with the classification system forms the basis of the risk-adjusted guarantee fund contributions for the protection scheme and also helps in the preventive management.For the institutions that are also members of BVR-ISG, the 2017 rate for contributions to the guarantee fund of the protection scheme was set at 0.036% of the assessment basis (2016: 0.04%), along with individual discounts or surcharges depending upon the classification. For the other member institutions, the contribution rate was fixed at 0.083% of the assessment basis[vi].The results of the rating classification are supplemented by further analysis using a data pool which provides risk indicators to identify and examine particular abnormalities in the member institutions.
The aim of preventive management is early identification and rectification of adverse financial indicatorswith a view to preventing the need for financial support from the scheme. Besides data analysis, additional discussions with the banks under stress are arranged by the BVR to decide about the suitable measures for stabilizing and improving their business performance. Based on the risk ratings, the preventive management process is triggered whenever a bank is classified as B- or lower. In addition to financial-based risk ratings, the impact of environmental factors such as interest rate is also taken into account for the BVR protection scheme. In addition, the protection system also involves monitoring of large institutions simply because of the size of their balance sheet.
- Support Mechanism
The objective of restructuring management under the BVR protection scheme is to ensure that the member institutions’ annual financial statements are able to receive an unqualified auditors’ opinion. It ensures that the respective bank regains its economic viability while accommodating the interests of all members of the Cooperative Financial Network[vii].The principles followed aim at regaining competitive position through recovery and restoring their fundamental profitability. Banks are obliged to complete the restructuring/ rehabilitation phase within a period of five years.
- INTERNATIONAL EXPERIENCEAND THEINDIAN CONTEXT
The co-operative banking in India, though quite old and spread out in the country, has not been able to come up with a cohesive network and protection scheme like the cooperative financial network in Germany. It remains divided between the rural and urban banking streams much like the Raiffeisen and Volks Bank in the German structure. However, unlike the German model, where these banks have gradually combined, in India, they continue to remain in separate streams with a certain overlap in their functions. In this context, it is worth mentioning that the idea of setting up of an umbrella organization (UO) for the UCB sector was first mooted in the year 2006 by the Working Group (Chairman: Shri N S Vishwanathan) set up by the Reserve Bank on Augmentation of Capital of UCBs. It was examined in greater detail by the Working Group on Umbrella Organization and Constitution of Revival Fund for Urban Cooperative Banks (Chairman: Shri V S Das) in 2009, and the Expert Committee on Licensing of New Urban Co-operative Banks (Chairman: Shri Y H Malegam) in the year 2011. The need for UO was also stressed by the High Powered Committee on UCBs (Chairman: Shri R Gandhi) in the year 2015. Reserve Bank of India through its statement on Development and Regulatory policies dated February 07, 2019 had announced that a decision on the specifics of an umbrella organization for UCBs in India shall be taken.
Co-operative banks play an important role in the social cohesion, financial inclusion, and economic development in the geographical and demographic areas they operate. Establishment of a network of cooperative banks with a central institution and umbrella organization could boost their financial and operational strength. An institutional protection scheme not only binds the cooperative banks in a common network but also strengthens the member institutions through its preventive and supportive measures. The success of co-operative banks, central institutions, co-operative financial network, and the institutional protection scheme in Germanyis worth deliberations for possible implementation in India.