Along with the monetary policy announcement on June 8, the Reserve Bank of India increased the limits on individual housing loans provided by cooperative banks.

For Tier 1/Tier 2 urban cooperative banks (UCBs) the limit was revised upwards from ₹30 lakh to ₹60 lakh and from ₹70 lakh to ₹1.40 crore respectively. Limits for rural cooperative banks (RCBs) were increased from ₹20 lakh to ₹50 lakh for those with ₹100 crore or lower net worth, and from ₹30 lakh to ₹75 lakh for others. Not just that, cooperative banks can now lend to commercial real estate developers catering to residential projects.

The intent behind the move is clear. RCBs and UCBs remain key pillars of financial support for the unbanked population and despite several attempts to push lending towards affordable housing through the mainstream channels, the needle hasn’t moved much.

These borrowers are committed customers of their local banks closest to their homes. They share a comfortable working relationship with co-operative banks. The other channels of credit — NBFCs and small finance banks — are constrained by risk-based capital allocation towards the affordable housing business. This seems to have prompted the RBI to turn to cooperative banks.

Chinks in the armour

But is the timing of this move ideal? Three years after the PMC Bank failure, cooperative banks continue being placed under curbs by the regulator for lapses in operations that are leaving them short of capital and putting depositors at risk.

Rewinding to 2019, the fall of PMC Bank was then linked to its nexus with the real estate group HDIL, promoted by the Wadhawan family (who were also the promoters of Dewan Housing Finance Corporation).

With HDIL doubling up as one of the largest shareholders of and also a key borrower from PMC Bank, the firm’s financial failure played a major part in the bank’s collapse. Given its size and relevance in the UCB space (₹10,000 crore of advances) after much struggle, the RBI managed to chart a way forward for PMC Bank and a way out for its depositors.

After the PMC Bank debacle, the RBI imposed directions and monetary penalties on a string of co-operative banks, to ward off similar crises.

Under such circumstances, allowing cooperative banks to increase their exposure to housing loans and to developer loans could expose the system to further risks. Cooperative banks and the real estate business have an unmissable common feature — political nexus.

While they now fall under the RBI’s oversight and monitoring, it is doubtful if co-operative banks and their managements have severed their political connections. Therefore, the soundness of their due diligence and risk underwriting practices remain inferior to well-run scheduled commercial banks.

Among home loan products, affordable housing loans with over two per cent gross non-performing assets (even in case of a well-managed NBFC) have the highest delinquency rates and are most vulnerable to the income vagaries of the borrower who tends to be in the lower income strata.

While the hike in loan limits may not seem large from a systemic perspective, they need to be seen in the context of the size of co-operative banks.

According to the RBI’s latest Trend and Progress of Banking Report, out of the 1,534 operational UCBs, only three per cent have a loan book of ₹1,000 crore or more and they account for 51 per cent of total UCB credit. With the business being highly fragmented, even an asset quality loss as miniscule as ₹5 crore can be disruptive for co-operative bank balance sheets.

Partnering with SFBs

Instead of expanding the room for UCBs to lend directly to the affordable housing segment, the RBI can perhaps explore co-lending models that leverage the strengths of both UCBs and SFBs.

In 2018, the RBI introduced voluntary transition of UCBs to small finance banks (SFB).

The objective was to increase the institutional shareholding and make UCBs widely held entities. This was expected to help in course correction of the deficiencies in underwriting and risk management practices. The conversion was also expected to help untangle the political connections.

However so far only Shivalik Mercantile Cooperative Bank has made the cut to convert itself to an SFB. Most UCBs hesitate to convert given the regulatory changes they would have to undergo.

As a precursor to the process, allowing SFBs to partner or co-lend with UCBs may have been a more workable route to expand credit growth in the affordable housing market.

That way, SFBs would also acquire wider market reach and can look beyond the loan against property segment that remains their current comfort zone in the housing space.

Despite the stated objective to of having to cater the unbanked and under-banked segments, the mainstay for SFBs remains credit products targeted at the urban and semi-urban areas. Their penetration in Tier 3/4/5 cities has been patchy as customers resist migrating from their local banks.

Exactly for this reason, the co-lending model between SFBs and UCBs makes commercial sense. Now that UCBs are the RBI’s babies, it shouldn’t vacillate on its long-term vision for these banks.

If institutionalising and professionalising them is the objective, raising the credit limits to affordable housing is at best an interim alternative which won’t help their cause in the long run.