Large banks – too big to fail;Co-op banks-too big to be a cooperative!

By Balu Aiyer

I recently had the opportunity to share the stage with luminaries from the banking sector and stalwarts from cooperative banking field in India. Mr. R. Gandhi, Deputy Governor of the Reserve Bank of India (RBI); Mr. R. Amalorpavanathan, Deputy Managing Director of, National Bank for Agriculture and Rural Development (NABARD); Dr. M.L. Abhyankar, National Federation of Urban Cooperative Banks and Credit Societies Ltd. (NAFCUB); and Dr.R. Vishwanathan, National Institute of Rural Banking (NIRB). The occasion was the 25th anniversary celebrations of the NIRB. NIRB has performed yeoman service to the rural banking sector by offering a variety of training programs; especially benefiting  cooperative credit institutions and the Regional Rural Banks.

Mr. R. Gandhi in his inaugural address acknowledged the role played by cooperatives banks in financial inclusion and taking care of banking and credit needs of the lower and middle strata of society. He lamented on the decline in co-operative character of banks and quoted a study conducted by the College of Agricultural Banking, Pune that pointed to low attendance in AGMs, restrictive practices in admitting new members, low voting turnout for election of new management, re-election of the same management or their family members, unanimous elections, lack of meaningful discussions in AGMs, etc. He observed that the co-operatives especially Urban Co-operative Banks (UCBs) are losing their cooperative character and that some of them have become ‘too big to be a cooperative’. Really?! This got be wondering – if large banks are too big to fail! Are cooperative banks – too big to be a cooperative?

The notion of “Too big too fail,” came to being following the bankruptcy of Lehman Brothers in September 2008 that triggered the financial crisis. The herd rush out by banks for safe havens increased pressure on governments to act and led to taxpayer bailouts to prevent the “whole” financial system from collapsing. The banks were found to be engaged in speculating against local interests, involved in deals to drive up commodity prices; leveraged buyouts with borrowed money resulting in layoffs and factory closures; and free-for-all fanciful mortgages that bilked billions of dollars from unsuspecting companies, international investors and individuals. The financial crisis showed the connected nature of many of the largest financial institutions through a web of short-term loans, credit guarantees and other financial contracts. The five banks, JPMorgan Chase, Citigroup, Barclays, UBS and Royal Bank of Scotland, all pled guilty to criminal charges that they acted in concert to manipulate international interest rates and foreign currency exchange. And what did the banks get in return. This is captured well in the letter written by Camden R. Fine, CEO Independent Community Bankers of America to Federal Reserve Chair Janet Yellen. “If a large bank commits a crime and even if the bank has been subject to multiple violations of the law, all the bank receives is a fine and a slap on the wrist. There are no changes in the management or the board, and the bank continues functioning as if nothing has happened. No bank should be too big to fail nor too big to jail. There should not be one set of enforcement procedures for large, megabanks and another for the rest of the financial industry.”

In light of the above, what does Too Big To Fail mean in the World of Cooperative Banking? This is answered in the research report by The European Association of Cooperative Banks, “European and Cooperative Banks in the Financial and Economic Turmoil: First Assessments.” It delineates five characteristics of the European cooperative banking model that have contributed to its resiliency. These are strong capitalization, a business model that puts members and customers first, built-in anti-cyclical behavior, tight bottom-up control mechanisms, and a democratic governance scheme. Among the anti-cyclical behavior built-ins is a distinctive mechanism that has not only given cooperative banks’ the wherewithal to withstand systemic market shocks but has added resilience to the financial industry as a whole during times of financial crisis: the internal cross guarantee or institutional protection agreement. These agreements, integral to almost all European cooperative networks, require each independent cooperative bank to guarantee the deposits of all members of its network, thus providing an extra layer of protection to depositors in the event of a single bank’s failure. These guarantees are in addition to any extended by national authorities. Indeed, the web of interdependence between cooperative members and cooperative customers, and between independent cooperative banks, gives new meaning to the phenomenon of “too big to fail.”

It is not that the cooperative banks are above board. In 1966 when the Banking Regulation Act was made applicable to urban co-operative banks, there were about 1,100 of them with deposits and advances of Rs.167 crore and Rs.153 crore, respectively. The next four decades saw phenomenal growth with their deposits rising to Rs.1.12 trillion and advances to over Rs.70,000 crores. With the business growth, the politicization of the sector also rose even though the urban co-operative banks are regulated and supervised by both the state governments, through the Registrars of Co-operative Societies, and the Reserve Bank of India. In 2005, the banking regulator stopped issuing fresh licences to the urban cooperative banks and since than it has cancelled the licenses of many. The points highlighted in the survey referenced by the Deputy Governor ring a deafening bell, which falls on deaf ears. What was interesting in the finding was the wide difference in response to the survey and that stated in personal discussions and feedback. Each day brings news of one more cooperative bank collapsing or a license being cancelled.

Mr. Gandhi was very vocal in what ails cooperative banks – reluctance in adapting new technology, decline in cooperative character, lack of professionalism and lack of corporate governance in cooperative institutions. He spoke on one P, policy (CRR, SLR, prudential norms, Basal III norms,…); but omitted two Ps – people and politics. In cooperatives, people are at the core and politics at the periphery; in reality though, the situation is reversed. While politics is fine, the political influence and interference in cooperative banks is a reality. What do cooperative banks do when they are asked to waive loans? Give loans selectively? When politicians interfere with the working? The remedies proposed by the RBI do not look at empowering people through transparency in information, education about their rights, communication about risks and working, making the banks managers and directors accountable to members, and developing rating systems for cooperative banks to make the member better informed. The fix proposed seem standard that could fit any bank.  A Central Banker could be considered as a MD. To be a good doctor requires two capacities; first, to make a good diagnosis of the patient’s ills and second, to prescribe the right medicines to cure the patient. The diagnosis of what ails the cooperative banks has been well made; however the treatments proposed fall short and could well kill the cooperatives, good and bad. The question is, is this the hallmark of a good doctor? Will killing the cooperatives (good and bad), address the needs of the lower and middle strata of the India?

Jean-Louis Bancel, president of Crédit Coopératif and chair of the International Co-operative Banking Association (ICBA) in an interview said, “The objective of International Cooperative Alliance is to prevent a “one size fits all” government policies. But whatever the size, it is important to understand that all cooperatives have in common their involvement in the real economy, from financing people’s housing to granting loans to SMEs. This investment in real economy explains broadly why co-operative banks were so resilient during the financial crisis. This is why we are worried to see that the regulators are not taking into account the special nature of co-operative banks when setting rules for the sector. It is sometimes a long process to convince the regulators to take into consideration the special characteristics of co-operative banks. Some regulators pretend it is not possible because it would breach the “level playing field”. This is obviously not true. Their denial to take into account the people’s choice and the legislator’s decision is either a denial of democracy or a hidden ideological policy to impose a “no choice” strategy.”

The divergence in understanding of cooperative banks and their unique structure and the remedies proposed thereof, calls for the urgent need to have a dialogue between national regulators and cooperative bankers from India and elsewhere. The ICBA, a sectoral organization of the ICA, which facilitates the promotion at the international and regional levels the distinctive co-operative values of co-operative banks and of the advantages of using them over other banks took part in a Round Table Discussion in Mumbai in April. ICBA and the National Federation of State Cooperative Banks Limited (NAFSCOB) will look into issues that have been holding back cooperative banks from achieving their full potential and bring these to the attention of RBI, NANARD and policy makers in an event planned for 2016.

This would be a good place to quote from the last paragraph of the Resilience in a downturn: The power of financial cooperativesreport, “finally, we should remember that financial cooperatives are not just about financial deepening. Like other types of cooperative, they are ‘people-centered’ businesses, owned by the people they serve. This makes them more challenging than other types of micro-finance institution to promote, but also much more sustainable.”

I would like end by quoting the line Mr. Gandhi said immediately after the too big to be a cooperative, “to keep the spirit of democracy alive, urgent steps need to be taken by the institutions themselves to keep co-operatives relevant to their members.” I would add RBI and NABARD to consider themselves as key institutions to sustain the cooperative banks.

-The writer is the Regional Director of ICA (A-P)