Two weeks ago I wrote a piece arguing that the FRDI (Financial Resolution and Deposit Insurance) Bill has two major flaws. One
, the India banking system, dominated by public sector banks
(PSBs), cannot suffer a systemic collapse as long as PSBs
are owned by the government. Hence the FRDI Bill is irrelevant
, it enshrines in law that creditors, who have nothing to do with either bank mismanagement or regulatory failure, will have to convert their money into the shares of failing banks
. This is grossly unfair, especially because those who are the most culpable in financial failures — the regulators and government officials — are totally unaccountable.
The word limit did not permit me to go into another major flaw of the Bill, perhaps the most outrageous one: While planning to handle bank failures, the Bill skirts the issue of one part of the financial system that collapses regularly: Cooperative banks. In defending the Bill, various government spokespersons and ministers have argued that the government will ensure that depositors’ interests are protected through deposit guarantee. What they have avoided mentioning are the following facts:
1. Under the Deposit Insurance and Credit Guarantee Corporation rules, each depositor is supposed to get Rs 1 lakh in the case of bank failure. Now, here is a fact that every person discussing the FRDI should know: Every paisa of the deposit insurance payout has so far gone to cooperative banks for several decades. Yes, there is not a single instance of deposit insurance money having been paid to a scheduled commercial bank that has closed down. While 100 per cent of payments are made to cooperative banks, less than 8 per cent of the premium is raised from the 2,000-odd cooperative banks. Facts about deposit insurance are different from the government propaganda that is being forwarded in Whatsapp.
2. Every year, cooperative banks fail all over the country. According to one estimate, as many as 165 cooperative banks have been shut down only in Maharashtra in the past 30 years, at a rate of five-six a year. We estimate that at least one cooperative bank goes belly up every month in India. Depositors often get just 10-15 per cent of their money.
3. Even this money does not come immediately
. The Reserve Bank of India cannot distribute the money unless the bank is liquidated. This takes a decade in some cases.
In fact, the main action of the RBI
is to supersede the bank’s board and appoint an administrator with no powers to conduct banking operations. He can only pay salaries, recover loans, and pay depositors in pre-decided driblets.
4. Cooperative banks are under the dual regulation of the RBI and the Registrar of Cooperatives (RoC). The RoC has neither the expertise nor the interest in regulating them. The RBI has some expertise but no interest as long the regulation remains dual.
In most cases, the RBI’s role as a regulator of cooperative bank is lackadaisical and dubious.
5. While India’s so-called nationalist government is following the diktat of the G-20 and importing regulations that are irrelevant to India, it is doing nothing to fix its own quirky and archaic regulation of the cooperative banks.
Cooperative banks are owned, controlled, and looted by politicians and political parties. They inflict huge losses on innocent depositors, especially senior citizens, who get attracted by the higher interest they pay on term deposits. Instead of an FRDI Bill to steal the money of creditors, we needed a Bill to clean up the crooked and politicised cooperative banks.
Indeed, it is worth examining what role this government has played regarding cooperative banks since it came in with the promise of eradicating corruption and reforming the financial sector. On November 5, 2014, just a few months after the Narendra Modi government took charge, it announced a massive Rs 2,375-crore injection into 23 district central cooperative banks across the country. These include 16 in Uttar Pradesh, three each in Jammu and Kashmir and Maharashtra, and one in West Bengal. The government claimed that the move was designed to protect small depositors of these cooperative banks. Critics said the bailout was a quid pro quo for getting a political leg-up, mainly in UP.
Now here is a startling fact. These 23 did not even have the licence to operate! They were the worst among 313 banks whose finances were so grim that they ought to have been shut down under the RBI’s own licensing rules. But they were saved by amending the rules. So much for maximum governance!
In the previous NDA regime, it broke the rules and compensated depositors of the Madhavpura Mercantile Cooperative Bank, which went bankrupt lending to Ketan Parekh, without liquidating the bank for political gains.
It is bad enough that cooperative banks are tools for politicians to dole out money to cronies. It is worse that the RBI
is not asked to supervise and regulate them before they fail. At Moneylife we have been exposing one such scandalous case, which is the Bombay Mercantile Bank, of which I hope to write next time.