Urban Cooperative Banks - Future Concerns

 

Urban Cooperative Banks – Future Concerns

Urban Cooperative Banks (UCBs) occupy nearly 8 percent of the financial sector space. The topic for discussion at the College of Supervisors on the 24^th  July 2023 was on “Business Development Plans, Risk Management and Governance.”

UCBs are neighbourhood banks coming under the regulations of both the State Cooperative Acts and the Banking Regulation Act 1949 and its amendments. Financial Stability Report June 2023 acknowledges their contribution to the financial sector. Credit growth of UCBs both scheduled and non-scheduled UCBs reaching 6.7 percent and 4.9 percent respectively.

The discussion is timely for more than one reason: After the Third Five Year Plan, there was no mention of Cooperatives as economic sector in the subsequent plans until the NDA government formed a separate Ministry of Cooperation and formulated a National Cooperative Policy. Second, Multi-State Cooperative Act 2023 was on the anvil. (It was passed in the Parliament on the 25^th July 2023. Third, these UCBs were in the media and the press for several reasons: 1. failure of PMC Bank, RBI raising the threshold of guarantee limit of deposits from Rs. One lakh to Rs.5 lakhs; 2. depositors’ interests occupied the prime interest of the regulator after a series of failures and irregularities;3. consolidation of banks through merging of weak banks with strong banks, 4. introduction of 4-tier structure in UCBs based on their business levels considering their heterogeneity, 5. implementing some of the Viswanathan Committee recommendations – particularly to help raising capital beyond the membership through setting up National Urban Cooperative Finance and Development, an Umbrella Organisation, 6. Board of Management with functional experts as a support mechanism for the elected Boards has been put in place; 7.inter-cooperative agency cooperation in strengthening the sector, increasing number of penalties on good number of banks for several regulatory breaches; 8.new threshold of lending to priority sector by 2026 depending on the tier to which they belong, 9. poor governance and 10. risk management standards.

It has been noticed that majority of the Tier-3&4 UCBs have been conforming to the regulatory directives, introduced core banking solutions (CBS), opened ATMs, integrated with the larger payment systems like the UPI through appropriate technologies, and mostly compliant with the prudential norms prescribed by the RBI.

All the UCBs follow the regulation of submitting their Annual Business Plans to the RBI. This is more ritualistic. Business Development Plans are not prepared with bottom-up approach. There is no Board approved strategy for preparation of such plans annually. Even after the constitution of the Boards of Management as adjuncts to the Board (These BoMs do not have any discretion and they perform only advisory role). The credit to risk weighted assets ratio (CRAR) of scheduled UCBs (around 52 banks) remained stable at 15 percent and the non-scheduled UCBs at 17.8 percent. FSR acknowledges that ‘tier-wise CRAR of UCBs is well above the minimum regulatory requirement.’ Net worth of all the
UCBs is stated to be comfortable. Yet there are continuing concerns on their contribution. Some of the financially sound and well managed banks (FSWM) have been attempting total transformation akin to commercial banks relating to technology, like internet banking, mobile banking, one-stop solutions etc. Capacity building at various levels in this regard and cyber security are the challenges they are facing.

Three important aspects that seized my attention while reviewing their performance are: 1. The role of Board of Management, 2. Priority Sector lending imperative, and 3. Umbrella Organization.

Board of Management is supposed to guide and assist the Board of Governance with no delegation or commitment to them. They are outside the actual Board of Directors and yet in it. Instead of such ambiguity, there can be negotiation with the State Governments to adopt certain rules to facilitate the elected Boards to have nominated Directors from professional cadres satisfying the fit and proper criteria for such nominations too. This would settle the issue of enhancing the capability of the Boards. Further, training of the Board of Directors, measuring the performance of the Board of Directors on the basis of a written statement of what value addition they would like to bring to the Board and how they would like to participate in the stability and sustainable growth of the institution, annual Board retreats etc., should receive the attention of the regulators.

Agenda of the Task Force on Cooperative banks (TAFCUB) in several states is being prepared by the RBI while the concerned Registrar of Cooperatives of the State and the Associations as the other constituents are not being consulted mostly, save exceptions. Its functioning has become too routinised during the last ten years. Since the purpose of the TAFCUB is to resolve local regulatory issues without escalating them to higher levels, and improving the functional efficiency of UCBs, it is desirable and necessary that the agenda becomes more consultative.

Viswanathan Committee ‘s view is that “there is ample space for financial institutions that operate on the principles of co-operation and the inclusivity that they get. As such, the Vision for the UCB sector should be to emerge as the neighbourhood bank of choice powered by passion for inclusive finance as the core of the business model. This can happen only if their operations are founded on financial strength, strong branding, cutting edge technology driven processes, and skilled human resources coupled with an enabling regulatory environment. These internal drivers can be available to a bank either on a stand-alone basis or acquired through network arrangements. There are now several enabling factors, both for the UCBs themselves and the RBI as the regulator, to actualise this vision.”

Action still awaits the validated recommendations of the above Committee. Many of these aspects have been discussed while delivering my talk, the PPt of which is attached. 

*Text of the address at the College of Supervisors, RBI on the 24^th July 2023 at Mumbai.

 

Degenerating Value: A Scar on Democratic Fabric

 

Degenerating ‘Values’, a Scar on Democratic Fabric

B. Yerram Raju*

When R. Durgadoss and I wrote ‘A Saint in the Board Room’ we never thought of being prophetic. When we see the recent controversies on ‘Mahatma’ getting off the mark on twitter, and the controversy over the Prime Minister Modi inaugurating the Parliament on the 28^{th of} March 2023, setting aside the chorus in the country for the Lady President of India from the Dalit Community to substitute him, the degenerating values and the decline in governance made me recall the values emphasised in the 2011 Book referred above. Reinforced, as it looked, there was  a relentless fight of the women wrestlers of repute waging a war in the streets of Delhi calling for punishing the offender who intruded into their privacy.

“Leaders like Gandhi acquired discipline to put to operation the knowledge gained into actual learning. He came across a book titled, ‘Unto the Last’ by John Ruskin, while he was in South Africa. In this book Ruskin states that the liberation of the individual lay in the liberation of the community. This ideology transformed Gandhi. He said, “I arose with the dawn ready to reduce these principles into practice”. These principles are based on simple living and pursuit of honesty. Today, we have many who speak of principles and few, who think of practising them.

Gandhiji felt that one who cannot wage war over the internal conflicts that require no arms, it is incredible that non-violence cannot stop war among nations. This recall bears significance in the conflict between Russia and Ukraine. Except these two nations at war, every other nation in the world wants them to be at peace and this is refusing to happen.

Words of Wisdom from Gandhiji

“Cleaning oneself is the first step to realize God. When one cleanses his soul, the spreading effect will have a telling effect on others. He said it was better to conquer desire and hatred than winning wars with weapons. Further he believed that one should have humility as one of the main virtues with the outer boundary of the humility being “ahimsa” or “non-violence.”

Gandhiji said unto himself: ‘I myself do not feel like a saint in any shape or form’ (Young India Jun 20, 1924).[i] It is important to watch the biological clock in life:

Age	Designated as	Our role in this period
0 – 20	Butterfly	We have colourful dreams; we do not bother for anything
20 – 40	Migratory bird	We go in search of career to better environmental destinations
40 – 60	Donkey	We bear the burden of the family
60 – 80	Snail	We slowly withdraw into a shell, looking more inwards
80 – 100	Crane	We wait for our final journey towards the eternal world

 

Business ethics, however, is not driven by such biological clock.

Philosophical outlook these days is inversely proportional to the age. One can find examples of politicians aged 70 and above are actively pursuing the wrong road to wealth these days. The child in him has no role model to earn wealth by any other means.

We have people loving movies of hatred, street fights, wars, and unnatural weaponry to show their winning streak. As they age, they learn only to lie and earn money at any cost by dubious means. We see children getting used to opium in one form or other. Not a day passes without hearing the news of police catching hold of such persons.

Cultivating the right values should start from childhood and their practice depends on the world they witness. Young parents today do not have time to spend with their children to teach any of those values, for, they are busy in their pursuit of wealth. They suddenly realise that all this pursuit vanishes on a single day when they are handed over exit chit. Lakhs of jobs are lost in the guise of running their organization better.

The purpose of the educational system is to prepare its students for a lifetime learning experience that will go better and faster than it would have otherwise done without formal education. The test of every religious, political, or educational system is the philosophies that it produces and the spirit that it preserves. “If the system violates intelligence, it is bad. If it injures character, it is vicious and if it injures the conscience, it is criminal”.[ii]

Character and governance are shadowed. Child of the day is in wilderness seeing those street fights among politicians, and frightful support to ill-gotten wealth. It is time for all of us to think – reminisce into the glorious past that produced Gandhiji, Vijaya Lakshmi Pundit, Gopala Krishna Gokhale, Jawaharlal Nehru, Vajpayee, Rabindranath Tagore, Swami Vivekananda and not think of the colour of the cloth one wears – white or saffron.

75 year-old independent India, growing economically as the fastest among nations in the world, ranking fifth now, should not show cracks in its aspirational century in 2047. Next few years should be the years of correction in thinking, federal cooperation, respecting the views of the opposition, allowing debate over dissent, and a determined pursuit of shaping the next generation based on values and ethics. The saga of Mallyas, Nirav Modi, Chokshi, and the still brewing Adani story should be consigned to forgotten history. The nation has the right to freedom of expression and autonomy of institutions within the well-defined boundaries, and transparency. The largest democracy of the world, as it would emerge, should be the beacon light as it was during its epic history.

New structures always make the legacy, a forgotten past. But the new Triangular Parliament Structure built on cultural ethos of the nation could herald a new dialogue, symbolise cooperative federalism and usher in an era of value-driven democracy.

 

*The writer is co-author of ‘A Saint in the Board Room (2011)’, an economist and risk management specialist.   

 

 

 

 

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^[i] Mahatma Gandhi’s Significance for Today: John Hick, Pg 2 of 11 (http://www.johnhick.org.uk/article15.html)

^[ii] Henry Frederic Amiel, Journal, 17 June 1852

Risk Profiling of Manufacturing Micro and Small Enterprises

 

India’s Micro, Small and Medium Enterprises (MSME) viewed as the lifeblood of the Indian economy, contribute 30 percent to GDP and of them micro enterprises alone are estimated to employ 23 percent of India’s total workforce, according to the data of the Union Ministry of MSME. Access to credit has been the most contentious issue discussed on public platforms and IMF estimated that only 23 percent of the total number of enterprises in this segment got formal access to credit.

 

Post-pandemic, government of India has been laying lot of emphasis on the growth of micro, small and medium enterprises and extending incentives and products for easing the conduct of their business. The Union Finance Minister, in her usual meetings with the bankers, draws her untiring attention to the need for increase in credit to these enterprises. Banks, on their part, do not lose the opportunity to exhibit their fancy to lend to such enterprises.

 

Trust deficit was the major contributory factor from the lenders’ perspective. It is therefore considered expedient to look at the risk profile of such enterprises and see the possible mitigating factors.

 

Latest Profile of the Sector

Interestingly, TransUnion CIBIL-SIDBI MSME Pulse Report for July-September presents a very hopeful perspective presenting a growth of 24 percent year-on-year (Y-o-Y). Credit to ‘micro’, viewed as unmoving window of Banks for five continuous years since 2017 and even on the negative window, reported a 13 percent growth in credit outstanding y-o-y as of September 2022 versus 10.6 percent y-o-y for all the MSMEs y-o-y. Growth in disbursements for micro, small, and medium enterprises had been at 54 percent, 23 percent, and 9 percent respectively during the period.

 

According to RBI’s Financial Access Survey, 72.83 percent of MSME Credit is concentrated in ten states: Maharashtra, Gujarat, Tamil Nadu & Pondicherry, Uttar Pradesh, Delhi, Karnataka, Rajasthan, West Bengal, Telangana, and Haryana. Maharashtra takes the major slice of 26.19 percent. This obviously means that government assistance to the sector also reached these states in a significant measure, at least proportionately viewed.

 

Very small (with aggregate credit exposure not exceeding ₹ 10 lakh), micro1 (with aggregate credit exposure between ₹ 10-50 lakh) and micro2 (with aggregate credit exposure between ₹ 50 lakh-1 crore) experienced growth of 20 per cent, 15 per cent and 11 per cent y-o-y respectively showing sudden spurt in micro lending, which is not just a post-pandemic bounce back, it added.

 

Delinquency rates dropped y-o-y across all the three lender categories (public sector banks/PSBs, private sector banks(PVBs) and NBFCs); the highest drop was in PVBs segment (from 2.8 per cent in FY22-Q2 to 1.5 per cent in FY23-Q2).[i] Street Vendors’ financing programme, MUDRA loans (Rs.3.4cr sanctioned during FY21-22), 59-Minute loan programme for the MSMEs contributed to the steady uptick that was presented apart from the Union Finance Minister dinning into the ears of bankers that credit to MSMEs has been sluggish. There was a pressure on the banks to perform.

 

This positive vibration whittles down suddenly when we hear the Union Minister of State for MSME submits to the Parliament, duly reported in the Financial Express dated 23.02.23: “The number of Udyam-registered MSMEs closed in the current financial year has nearly doubled from the last financial year’s count, showed official data. From 6,222 MSMEs shut during FY22, the count has jumped to 12,307 as of March 9 in FY23 while only 175 units were closed between July 1 (when the Udyam portal was launched) and March 31 in FY21, taking the total number of MSMEs closed to an all-time high of 18,704. Maharashtra had the highest number of casualties with 4,871 Udyam-registered MSMEs shut since July 2020 followed by Tamil Nadu (2,326), Uttar Pradesh (1,568), Gujarat (1,558), Rajasthan (1,297), Bihar (1,075), and more.”

 

Gross Non-performing Assets ratio  (the ratio of total gross NPAs to the total advances made during a particular period by the lender) in MSME loans in FY22 stood at 7.6 per cent, 7.3 per cent in FY21 and 8.9 per cent in FY20. 

 

Resilience and sustainability of industrial growth is inextricably linked to the healthy growth of the manufacturing micro and small enterprises (MMSEs), that happen to front-end the supply chains of the industry at large. The data and analysis of the Transunion report does not provide information on how much is the share of growth of manufacturing MSEs. September 2022 PMI data shows that industrial growth has not kept pace with the overall growth of the economy. The growth obviously occurred in the services sector, due to the digitization of the highest scale, entry of FINTECHs, formalization of the MSMEs, widely dispersed 200-odd incentive schemes from the Union Ministry of MSME, and the unique success of unified payment interface system (UPI). Despite the U.K. Sinha Committee Report calling for cash-flow based lending of working capital to the MSMEs, RBI creating public credit registry, and pushing the banks to move to data-based lending instead of security-based lending, MMSEs did not catch the eye of the banks. Hence, risk profiling of the MMSEs would be necessary to understand the reasons for the trust deficit in the manufacturing sector.

 

Definitional Risk:

Manufacturing and Services have been combined in the way the MSMEs are defined. The changes to the definition adopting the twin criteria of investment and turnover to redefine them have given an escape window for the banks to keep at bay the MMSEs with investment below Rs.1crore (Rs. Ten million). The turnover threshold for such enterprises is five times the investment level – Rs.5cr per annum. While this definition coupled with the insistence of any new enterprise shall register on Udyog-Aadhar portal of Government of India, has enabled only the organized to have access  credit and incentives, it is yet to bring many unorganized MMSEs into the organized fold. Lenders still have their own definition – micro enterprises are those that have outstanding credit of less than Rs.1cr. The law of proportionality demands that the micro enterprises be brought under a separate statute so that the benefits meant for them reach without infringement.

 

By nature, micro manufacturing enterprises are owner-led proprietary or family partnerships. They do not distinguish their firm expenditure from family expenditure. Their books of accounts are also not well organised. Their maintenance of record of stocks of raw materials and finished products is less systematic than their counterparts in the small and medium enterprises even. They are mostly sub-contractors as their scale of production does not permit them to participate in private or public tenders directly. But their working capital cycle accommodates this unorganised way of running their enterprises. They lack counselling and guidance from their lenders as the later have little time for these large numbers in their books of accounts that tend to slip to non-performance at the turn of the hat. Thus, these enterprises have origination risk. Information asymmetry and adverse selection, the two factors that adversely affect the credit risk need mitigation.

 

Covenant Risks: These MMSEs in their eagerness to borrow money sign on the dotted line before their lender. They do not understand the implications of the covenants they are agreeing for. Earlier they were not knowing even the rates of interest. At least now, thanks to the widely publicised monetary policy interventions periodically, they know the interest rates. But they are ignorant of the insurance clauses and their implications. They do not, in many a case, know that their machinery and stocks are jointly insured with the lender and the premium is directly deducted annually from their working capital account. The extent of insurability is least known to them. Such insurance is invariably made with the insurance arm of the Bank that lends the enterprise. But the covenants of the policy are little known to them as the Banks do not share any copy of the insurance policy. This is a grey area.

 

Compliance Risk: MMSEs fail to comply with the regulations relating to products, processes, and finance more out of ignorance than out of own volition. Neither the regulatory institutions nor the financial institutions spare time to explain the implications of non-compliance of the rules and regulations. Environmental regulations and financial regulations are the most breached. Labour Code that has four components are least explained to the MMSEs. It is not uncommon to find that these enterprises fail to maintain even a muster roll and even where maintained does not agree with the reality. The number of persons actually engaged and the number in the roll rarely tally. There is a cost involved in compliance and such cost is felt onerous by the micro manufacturers. When the cost of compliance is more than the cost of avoidance, they prefer the latter. Transparency in the cost of compliance is also found wanting. These are areas of immediate correction to take these enterprises to the globally competitive levels.

 

Human Resource Risks: MMSEs employ on average 8-10 workers including the owners. They invariably depend on migratory labour instead of labour because of the low wages they demand and reliability. Many studies have indicated that they spend little resources on skilling, re-skilling, and up-skilling as the cost of such human resources development is beyond their capacity to absorb. In fact, these MMSEs act as providers of skilled persons to the Small and Medium Enterprises as the labour learn their art of working on the machine duly trained by the proprietors. Some States have insisted on engaging locally available skills and their experience with such persons on the production front has become counter productive and costly. They cannot afford to train their labour in reputed institutions. They require peripatetic trainers who are rarely available.

 

Product Risk: According to a number of studies, 60-70 percent of the MMSEs may conform to the quality of the product requirements but fail in packing and forwarding requirements. This puts the buyers at risk and therefore, the related payments.

 

Pricing Risks: Several manufacturing MSEs adopt neighbourhood pricing of their products as they would not like to lose out in competition with the peers. They lack abilities to cost their products. They also do not much understand the leakages that occur in their supply chains. The product is not priced cost plus. Since debt is their major source of capital they always look to loan swaps and interest subsidy as a major source to beat the pricing competition.

 

Technology Risks: While several enterprises are aware that new technologies have the potential to increase their efficiency, their ability to finance those new technologies is very limited. Quite many are scared to approach their lenders as they would have been in arrears already either of the interest or principal payment. They must have already availed one or two name-sake restructuring of their loans. Their ability to calculate return on investment in technology is also extremely limited. Banks hardly find time to spend time with the entrepreneur and guide him.

 

Payment Risk

Global Alliance for Mass Entrepreneurship (GAME) estimated that the problem of delayed payments to MSMEs is in the magnitude of Rs. 10.7 lakh crore, with 80 percent of this being attributable to delays to micro and small enterprises (MSEs). The problem of delayed payments is exacerbated by the lack of credit, specifically working capital facilities, that are available to these businesses. Reports such as the IFC’s 2018 Financing India’s MSMEs estimate that the total addressable debt requirement of micro and small enterprises was Rs. 24 lakh crores in 2018, with an estimated 70 percent attributable to the elevated working capital needs of these businesses.

 

Sovereign Risk: Industrial policies, Budgetary announcements, Export-Import policies, Trade Policies and not-so-enriching interface between various government departments that deal with the MSMEs and the Union Ministry of Finance, inter-state coordination issues are the various factors that impinge on sovereign risk. Enterprises have to adjust themselves and accommodate for the changes in the way they function rather than seeking instantaneous remedies to their business dealings.

 

Policy formulation for the MSMEs is at risk because of lack of reliable data. There has been no census of the units since 2004, the year of last Census. The data on the Union Ministry of MSME portal is that of 2012. While the data on Udyam registration is captured in isolation, its integration with the existing data did not take place. There is no data of mortality in the figure of 6crore-odd enterprises mentioned on the website.

 

While several state governments and union governments announce a host of incentives, the reach is suspect due to a variety of constraints: 1. Expediency decides the allocated budget for release to the sector and the first hit is the MMSEs, the most vulnerable. 2. There is invariably lack of information relating to the cost of securing these incentives – in terms of number of visits the entrepreneur has to make to the concerned department; the cumbersome approach to the person who actually decides on the sanction and release of the incentives. 3. Weak negotiating ability of the Industrial Associations over the incentive releases, etc.

 

Digitalization of enterprises, Account Aggregators (yet to mature in its access and use), Open Credit Enablement Network (OCEN), Co-lending with NBFCs, Factoring, Trade Related Exchange System (TReDs), have lately entered the Risk Mitigation instrumentality. Yet, the ability of the MMSEs to take advantage of these mitigants is way behind both in terms of awareness and the skills.

 

Therefore, there is a need for developing a separate framework for the MMSEs and a broad-based ecosystem involving policy makers, institutions that act as policy instruments, RBI, Indian Banks Association, NBFCs, Ministry of Agriculture and Cooperation, Ministry of Electronics and Information Technology, Ministry of Environment, Ministry of Energy of the Union Government and the ten state governments that have the major share in MMSEs. This framework should be discussed with the stakeholders in the leading ten states before firming up. Separate line of budget should be provided to meet the announced incentives and institutions like the NIMSME, NIRD, Central Universities and those that are licensed to run technology hubs should monitor the working of the framework.

*The author is an economist, risk management and SME Turnaround Specialist.

 

https://www.moneylife.in/article/risk-profiling-of-manufacturing-micro-and-small-enterprises/70258.html

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[i] https://www.thehindubusinessline.com/money-and-banking/loan-disbursements-to-msme-sector-grew-24-in-q2fy23-transunion-cibil-sidbi-report/article66652635.ece