Recently, the RBI cautioned the public against some co-operative credit societies using the word “bank” in their names. Further, it has been clarified that these entities aren’t allowed to perform banking activities, as per the Banking Regulation Act, 1949, through acceptance of deposits from non-members, and nominal or associate members. Nor are their deposits protected under the deposit insurance cover of DICGC. The RBI has exhorted the public to be cautious with such misleading co-operative credit societies.

This is not the first time that the central bank has issued such an advisory. A similar press release was issued on November 29, 2017. The only difference is the reference to the statute that is supposed to have been violated. The latest advice differs from the earlier advisory by mentioning the violation of Section 7 of the Banking Regulation Act while bringing in the amendments introduced by the Banking Regulation (Amendment) Act, 2020 (Act 39 of 2020) which came into force on September 29, 2020, whereas the earlier notice made a reference to Section 7 of the Banking Regulation Act (As Applicable to Co-operative Societies) only.

However, this is the tip of the iceberg. The co-operative credit societies are plagued by a myriad of problems, which need to be addressed urgently.

The vast number of co-operative credit societies aim to promote economic interests of their members. They can maintain accounts and accept deposits from members only and not from non-members. They are registered and regulated by the Registrar of Co-operative Societies of the respective State governments and by the Central Registrar of Co-operative Societies if these entities function in more than one State. However, these societies do not come under the RBI scanner despite accepting deposits from and disbursing loans to their members.

While those co-operative credit societies with reserves and paid-up capital of over ₹1 lakh have to seek a licence from the RBI, most of them operate with a lower capital to avoid regulatory oversight.

Arcane laws

Co-operative credit societies are governed by anachronistic and arcane laws, and their customers stand to lose if these societies go bust. There could be systemic repercussions too. This is buttressed by the fact that some of these societies registered under the Multi-State Co-operative Societies Act, 2002 have reportedly garnered public deposits running into thousands of crores during the last ten years.

Interestingly, one such entity carries the following disclaimer on its website: “Multi-State Cooperative Societies are functioning as autonomous cooperative organisations accountable to their members and not under the administrative control of the Central Registrar, Ministry of Agriculture and Farmers’ Welfare. Therefore, the depositors/members are advised to take decision for investing deposits based on the performance of their society at their own risk. Central Registrar, Ministry of Agriculture and Farmers Welfare does not provide any guarantee for these deposits.”

Frequently we come across advertisements by some co-operative credit societies offering exorbitantly high interest rates (say 12 per cent) on their deposits, compared to what banks — commercial or co-operative — offer. In that case, the question is at what rate of interest would they be lending and to whom? Since these societies have little fee-based income, let us assume that they keep a minimum spread of 6-8 per cent so that they can pay salaries and wages to their employees and service the deposits. In that case, they should be lending at least at 18-20 per cent. If so, who could be the borrowers?

This is important because if a borrower is capable of borrowing at over 20 per cent he must be investing the money in very high yielding assets so that he can repay the loan and also keep an adequate margin for himself. In the real or even financial sector, it is very difficult to get such a high return.

The borrowers of this sort must be investing in highly risky and fragile assets, thus jeopardising the entire co-operative credit structure. There may be connected lending or on-lending to others in the unregulated market at still higher rates too.

So how can the societies lend to such risky borrowers, which is totally inimical to the health of the financial sector in general? Since these societies have very thin base of capital and reserves, they are ab initio fragile, and if many fail like this, a ‘domino effect’ could ensue.

Who are the depositors?

Another pertinent question is who are the depositors? Money launderers, since these societies are not subject to Know Your Customer rules and Anti-Money Laundering laws? The very fact that the societies are offering such high rates of interest, totally misaligned with the market, should raise a doubt in the minds of the people that all isn’t well with them. Why the societies are in such desperate need of funds? Are they trying to avoid a collapse?

Here a question may be asked as to the working of the Registrars of Co-operative Societies. Are they monitoring properly and adequately? A more fundamental question would be: Are they ‘modernised’ enough to do so? Ill-functioning societies need to be isolated and special precautionary investigations must be held by the controllers and supervisors.

Going by the repeated warnings issued by the RBI, it appears that the central bank may be having definite information on co-operative societies circumventing the provisions of Section 7 of the Banking Regulation Act. If that be the case, it is essential that appropriate legal action is initiated against the wrongdoers to protect the interests of depositors and safeguard the institutional framework governing the conduct of banking activities.

There is also another warning that such societies may be taking undue advantage of the poor in financially excluded areas and exploiting them. This is a lesson for financial inclusion. Can DICGC, an RBI subsidiary, take any step as the insurer of deposits? They cannot, unless and until the societies are legally brought into their ambit.

Member-depositors have to be careful before putting in money in these kinds of societies. They should be first concerned about the safety of their principal and then the return thereon. It is better to be safe than sorry.

Internal surveillance mechanism has to improve substantially.

A majority of the ills will be remedied if the State governments, along with RBI, regulate and supervise these societies. This will be good for both the common man and the financial sector at large. The ticking of the time bomb must be stopped fast and at any cost. To be forewarned is to be forearmed.

Das is a former senior economist, SBI, and Rath is a former Chief General Manager, RBI. Views are personal