Banking Article, Banking Finance 2022, Banking Finance June 2022

Local Area Banks – Is Small Not Beautiful?

On 24th December 2020,RBI cancelled the licence of Subhadra Local Area Bank Ltd, Kolhapur as the affairs of the bank was conducted in a manner detrimental to the interests of its present and future depositors and the bank had breached the minimum net worth requirements. RBI has also initiated winding up proceedings before the High Court of Maharashtra. With the exit of one more Local Area Bank(LAB) , currently only two LABs are operating  in the banking firmament in India.

The Local Area Bank Scheme was introduced in August 1996.The then finance minister Shri P. Chidambaram in his budget speech in 1996 said that “it has been agreed with RBI to promote the setting up of new private local area banks with jurisdiction over two or three contiguous districts. This would enable the mobilisation of rural savings by local institutions and at the same time, make them available in the rural areas”.

Initially tenbanks were licensed under Section 22 of the Banking Regulation Act ,1949 and currently only two banks are functioning. The minimum start-up capital was fixed at Rs.5 crores which was later raised to Rs.25 crores. The promoters of a LAB could be individuals, corporate entities and societies and share of NRI promoters was not to exceed 20% of the total number of promoters.

Scope of activities

The area of operation of a LAB was initially restricted to 3 geographically contiguous districts which was later raised to 5 districts with focus predominantly on rural and semi –urban areas to bridge the credit gap in agriculture and allied activities,SMEs, agro-industrial activities,trading activities and non-farm sector.

The LABs would be governed by the provisions of RBI Act,1934 and Banking Regulation Act ,1949 but in regard to liquidity requirements and interest rates, they are governed by the provisions applicable to RRBs under Regional Rural Bank Act,1976.

The 10 LABs that were given in principle sanction by RBI in 1996 were as follows, but a couple of them surrendered

their licenses and did not take off. :

Name of the bank Head Quarters State
The Capital Local Area Bank Ltd Phagwara Punjab
Central Gujarat-Dabhoi Vadodara Gujarat
The Coastal Area Bank Ltd Vijaywada Andhra Pradesh
The South Gujarat Local Area bank Ltd Navsari Gujarat
Krishna Bhima Samrudhi Local Area Bank Ltd Mahabubnagar Andhrapradesh
Vinayak Local Area Bank Ltd Sikar Rajasthan
Priyadharashni LAB Jalgaon,Jalna,Aurangabad Maharashtra
Manipal LAB Dk,UK,Shimoga Karnataka
Kongunadu Salem Salem Tamilnadu
Subhadra LAB Sangli,Kolhapur and Belgaum Maharashtra

Source: RBI data on banking outlets 2002

Performance review:

Out of the 10 LABS, only two LABs have survived as of 2020. It is obvious that LABs have not made any impact on the local communities, amongst whom they are functioning ,in terms of, depositmobilisation, credit deployment, customer acquisition etc.

RBI constituted a Review Group in July 2002 to study and recommend measures to strengthen LABs under the chairmanship of Shri. G.Ramachandran ( Former Finance Secretary ,Govt of India) and the expert group  recommended ,inter alia, that there should be no new licensing of LABs and the existing ones should reach a share capital of Rs.25 cr from Rs.5 cr over a period of five to seven years and the capital adequacy ratio should be raised to 15% and LABs need to be treated like any other commercial banks.

Despite the fact that LABs are  in existence for  more than 24 years, LABS have not grown in size and scale over the years and currently enjoy a market share of less than one percent in deposits.

Market Share of Banks  as on 31/3/2019

Category of Banks Deposits (in Rs. Cr) % Share
Public sector Banks 84,86,215 63.29
Private sector Banks 37,70,013 28.29
Foreign Banks 5,81,857 4.36
Regional Rural Banks 4,34,445 3.26
Small Finance Banks 49,178 0.36
Payment Banks 883 0 .0066
Local Area Banks 747 0.0056

Source: Trends and Progress Report of RBI

It was felt that the LABs would have a restricted area of operation and a bad harvest in the area of operation would adversely impact loan recovery of the branches and savings of the locals and their growth was dependent on deepening of financial services and  meet the credit gaps in the districts they operated. Most of the LABs were set up in districts which was adequately banked and they had to compete with the stronger players with limited resources at their disposal.LABs were conceived as low-cost structures with a 15% capital adequacy ratio and their business model was found to be inherently weak with small ticket loans where returns from assets and the spread was not generating   good returns to the shareholders. Their size and scale of operation hampered their ability to borrow at cheaper rates in the market and through repos. Their cost to income ratio was generally high. Their deposit growth was zig-zag and uneven and loan growth was constricted by limited resources and many had to be closed down because licenses were cancelled by RBI for breach of norms.

The two well-functioning LABS are located in Andhra Pradesh and Telenganastates  but they have not experienced steady and sustained growth over their 20 years of existence. They are not able to match their counterparts in terms of product offerings , technology infusion due to investment involved and have not capitalised on the local sentiments .

Another important aspect is the role of promoters and the ‘fit and proper criterion’ and the professionalism needed to perform in the highlycompetitive banking landscape. They have not been able to capitalise on the competitive edge by virtue of their being a local bank for meeting the needs of the local people. The performance of the remaining  two LABs that are operating in AP and Telangana is given below:

Key Business Statistics as on 31/3/2020 Coastal Bank (LAB) Krishna Bhima Samruddhi Bank (LAB)
Deposits in Rs. Cr 551.23 282.93
Advances in Rs. Cr 456.84 199.71
Profit in Rs. Cr 19.43 2.66
No. Of Branches 50 29
No. Of Employees 333 358

Source: respective websites of banks

In these days of merger and consolidation, the future of LABs solely rests on their ability tocompete with the other players in terms of innovative product offerings, digital supremacy and mobilisation of low cost resources. It would be an uphill task to maintain their individuality and identity. It is only a matter of time before the LABs are cannibalised by the more established players in the market.

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