The doctrine of separation of powers implies that each pillar of democracy – the executive, legislature and the judiciary – perform separate functions and act as separate entities.  The executive is vested with the power to make policy decisions and implement laws.  The legislature is empowered to issue enactments.  The judiciary is responsible for adjudicating disputes.  The doctrine is a part of the basic structure of the Indian Constitution[1] even though it is not specifically mentioned in its text.  Thus, no law may be passed and no amendment may be made to the Constitution deviating from the doctrine.  Different agencies impose checks and balances upon each other but may not transgress upon each other’s functions.  Thus, the judiciary exercises judicial review over executive and legislative action, and the legislature reviews the functioning of the executive. There have been some cases where the courts have issued laws and policy related orders through their judgements.  These include the Vishakha case where guidelines on sexual harassment were issued by the Supreme Court, the order of the Court directing the Centre to distribute food grains (2010) and the appointment of the Special Investigation Team to replace the High Level Committee established by the Centre for investigating black money deposits in Swiss Banks. In 1983 when Justice Bhagwati introduced public interest litigation in India, Justice Pathak in the same judgement warned against the “temptation of crossing into territory which properly pertains to the Legislature or to the Executive Government”[2].  Justice Katju in 2007 noted that, “Courts cannot create rights where none exist nor can they go on making orders which are incapable of enforcement or violative of other laws or settled legal principles. With a view to see that judicial activism does not become judicial adventurism the courts must act with caution and proper restraint. It needs to be remembered that courts cannot run the government. The judiciary should act only as an alarm bell; it should ensure that the executive has become alive to perform its duties.” [3] While there has been some discussion on the issue of activism by the judiciary, it must be noted that there are also instances of the legislature using its law making powers to reverse the outcome of some  judgements.  (M.J. Antony has referred to a few in his article in the Business Standard here.)  We discuss below some recent instances of the legislature overturning judicial pronouncements by passing laws with retrospective effect. On September 7, 2011 the Parliament passed the Customs Amendment and Validation Bill, 2011 which retrospectively validates all duties imposed and actions taken by certain customs officials who were not authorized under the Customs Act to do the stated acts.  Some of the duties imposed were in fact challenged before the Supreme Court in Commissioner of Customs vs. Sayed Ali in 2011[4].  The Supreme Court struck down the levy of duties since these were imposed by unauthorised officials.  By passing the Customs Bill, 2011 the Parliament circumvented the judgement and amended the Act to authorize certain officials to levy duties retrospectively, even those that had been held to be illegal by the SC. Another instance of the legislature overriding the decision of the Supreme Court was seen in the Essential Commodities (Amendment) Ordinance, 2009 which was passed into an Act.  The Supreme Court had ruled that the price at which the Centre shall buy sugar from the mill shall include the statutory minimum price (SMP) and an additional amount of profits that the mills share with farmers.[5] The Amendment allowed the Centre to pay a fair and remunerative price (FRP) instead of the SMP.  It also did away with the requirement to pay the additional amount.  The amendment applied to all transactions for purchase of sugar by the Centre since 1974.  In effect, the amendment overruled the Court decision. The executive tried to sidestep the Apex Court decision through the Enemy Property (Amendment and Validation) Ordinance, 2010.  The Court had issued a writ to the Custodian of Enemy Property to return possession of certain properties to the legal heir of the owner.   Subsequently the Executive issued an Ordinance under which all properties that were divested from the Custodian in favour of legal heirs by a Court order were reverted to him.  The Ordinance lapsed and a Bill was introduced in the Parliament.  The Bill is currently being examined by the Parliamentary Standing Committee on Home Affairs. These examples highlight some instances where the legislature has acted to reverse judicial pronouncements.  The judiciary has also acted in several instances in the grey areas separating its role from that of the executive and the legislature.  The doctrine of separation of powers is not codified in the Indian constitution.  Indeed, it may be difficult to draw a strict line demarcating the separation.  However, it may be necessary for each pillar of the State to evolve a healthy convention that respects the domain of the others.  

[1] Keshavananda Bharti vs. State of Kerala  AIR 1973 SC 1461

[2] Bandhua Mukti Morcha  AIR 1984 SC 802

[3] Aravali Golf Club vs. Chander Hass  (2008) 1 SCC (L&S) 289

[4] Supreme Court in Commissioner of Customs vs. Sayed Ali (2011) 3 SCC 537

[5] Mahalakshmi Mills vs. Union of India (2009) 16 SCC 569

Last month, Reserve Bank of India (RBI) released the report of the Expert Committee on Urban Co-operative Banks (Chair: Mr. N. S. Vishwanathan).  In this blog, we discuss some broader issues with the functioning and regulation of urban co-operative banks (UCBs), and some of the suggestions to address these as highlighted by the committee in its report.

Need for Urban Co-operative Banks

The history of UCBs in India can be traced to the 19th century when such societies were set up drawing inspiration from the success of the co-operative movement in Britain and the co-operative credit movement in Germany.  Urban co-operative credit societies, were organised on a community basis to meet the consumption-oriented credit needs of their members.  UCBs are primary cooperative banks in urban and semi-urban areas.  They are co-operative societies that undertake banking business.  Co-operative banks accept deposits from the public and lend to their members.  Co-operative banks are different from other co-operatives as they mobilise resources for lending and investment from the wider public rather than only their members.

Concerns regarding the professionalism of urban cooperative banks gave rise to the view that they should be better regulated.  Large cooperative banks with paid-up share capital and reserves of one lakh rupees were brought under the scope of the Banking Regulation Act, 1949 with effect from March 1, 1966.  Prior to this, such banks were regulated under the scope of state-specific cooperative laws.  The revised framework brought them under the ambit of supervision of the RBI.  Till 1996, these banks could lend money only for non-agricultural purposes.  However, this distinction does not apply today.  

The Expert Committee noted that UCBs play a key role in financial inclusion.  It further observed that the focus area for UCBs has traditionally been communities and localities including workplace groups.  They play an important role in the delivery of last-mile credit, even more so for those sections of the population who are not integrated into the mainstream banking framework.  UCBs primarily lend to wage earners, small entrepreneurs, and businesses in urban and semi-urban areas.  UCBs can be more responsive than formal banking channels to the needs of the local people.

Over the years, concerns have been raised about non-professional management in UCBs and that this can lead to weaker governance and risk management in these entities.  RBI has also taken regulatory action on several UCBs.  For instance, in September 2019, RBI placed Punjab and Maharashtra Co-operative Bank under restrictions on allegations of serious underreporting of non-performing assets.  The bank could not grant loans, make investments or accept deposits without prior approval from RBI.  While these restrictions were originally put in place for six months, the time frame was extended several times and has now been extended till December 31, 2021.  In addition, low capital base, poor credit management and diversion of funds have also been issues in the sector.

Shrinking share in the banking sector

There were 1,539 UCBs in the country as of March 31, 2020, with deposits worth Rs 5,01,180 crore and advances worth Rs 3,05,370 crore.   Even though 94% of the entities in the banking sector were UCBs their market share in the banking sector has been low and declining and stands at around 3%.  UCBs accounted for 3.24% of the deposits and 2.69% of the advances in the banking sector.  The Committee noted that state-of-the-art technology adopted by new players, such as small finance banks and fintech entities, along with commercial banks can disrupt the niche customer segment of the UCBs.

Figure 1:  Growth in deposits of UCBs (in Rs crore)

Source: Report of the Expert Committee on Urban Co-operative Banks; PRS.

Figure 2:     Growth in advances of UCBs (in Rs crore)

Source:  Report of the Expert Committee on Urban Co-operative Banks; PRS.

Burden of non-performing assets

UCBs had the highest net non-performing asset (NNPA) ratio (5.26%) and gross non-performing asset (GNPA) ratio (10.96%) across the banking sector as of March 2020.  These levels correspond to around twice that of private sector banks, and around five times that of small finance banks.  The Committee noted that, as of March 2020, UCBs have the lowest level of net interest margin (difference between interest earned and interest spent relative to total interest generating assets held by the bank) and negative return on assets and return on equity. 

Figure 3: Asset quality across banks (in percentage)

Sources:   Report of the Expert Committee on Urban Co-operative Banks; PRS.

Supervisory Action Framework (SAF):  SAF envisages corrective action by UCB and/or supervisory action by RBI on breach of financial thresholds related to asset quality, profitability and level of capital as measured by Capital to Risk-weighted Asset Ratio (CRAR).  The Committee recommended that SAF should consider only asset quality (based on net non-performing asset ratio) and CRAR with an emphasis on reducing the time spent by a UCB under SAF.  The RBI should begin the mandatory resolution process including reconstruction or compulsory merger as soon as a UCB reaches the third stage under SAF (CRAR less than 4.5% and/or net non-performing asset ratio above 12%).

Constraints in raising capital

The Committee also observed that UCBs are constrained in raising capital which restricts their ability to expand the business.  According to co-operative principles, share capital is to be issued and refunded only at face value.  Thus, investment in UCBs is less attractive as it does not lead to an increase in its value.   Also, the principle of one member, one vote means that an interested investor cannot acquire a controlling stake in UCBs.  It was earlier recommended that UCBs should be allowed to issue fresh capital at a premium based on the net worth of the entity at the end of the preceding year.

Listing of securities:  The Committee recommended making suitable amendments to the Banking Regulation Act, 1949 to enable RBI to notify certain securities issued by any co-operative bank or class of co-operative banks to be covered under the Securities Contracts (Regulation) Act, 1956 and the Securities and Exchange Board of India Act, 1992.  This will enable their listing and trading on a recognised stock exchange.   Until such amendments are made, the Committee recommended that banks can be allowed to have a system on their websites to buy/sell securities at book value subject to the condition that the bank should ensure that the prospective buyer is eligible to be admitted as a member.   

Conflict between Banking Regulation Act, 1949 and co-operative laws 

The fundamental difference between banking companies and co-operative banks is in the voting rights of shareholders.  In banking companies, each share has a corresponding vote.  But in the case of co-operative banks, each shareholder has only one vote irrespective of the number of shares held.  Despite RBI being the regulator of the banking sector, the regulation of co-operative banks by RBI was restricted to functions related directly to banking.  This gave rise to dual regulation with governance, audit, and winding-up related functions regulated by state governments and central government for single-state banks and multi-state banks, respectively.  

2020 Amendments to the Banking Regulation Act: In September 2020, the Banking Regulation Act, 1949 was amended to increase RBI’s powers  over the regulation of co-operative banks including qualifications of management of these banks and supersession of board of directors.  The Committee noted that due to the amendment of the Act, certain conflicts have arisen with various co-operative laws.  For instance, the Act allows co-operative banks to issue shares at a premium, but it is silent on their redemption.  It noted that if any co-operative societies’ legislation provides for redemption of shares only at par, then, while a co-operative bank incorporated under that legislation can issue shares at a premium, it can redeem them only at par.   

Note that on September 3, 2021, the Madhya Pradesh High Court stayed a circular released by the RBI on appointment of managing director/whole-time director in UCBs.  The circular provided for eligibility and propriety criteria for the appointment of such personnel in UCBs.  The petitioner, Mahanagar Nagrik Sahakari Bank Maryadit, argued that the service conditions of the managing director and chief executive officer of co-operative banks are governed by bye-laws framed under the M.P. State Cooperative Societies Act, 1960.  The petition noted that co-operative as a subject falls under the state list and hence the power to legislate in the field of co-operative societies falls under the domain of the states and not the central government.

Umbrella Organisation

Over the years, several committees have looked at the feasibility to set up an Umbrella Organisation (UO) for UCBs.  It is an apex body of federating UCBs.  In 2011, an expert committee on licensing of new UCBs recommended that there should be two separate UOs for the sector.  In June 2019, RBI granted an in-principle approval to National Federation of Urban Co-operative Banks and Credit Societies Ltd to set up a UO in the form of a non-deposit taking non-banking finance company.  The UO is expected to provide information technology and financial support to its federating members along with value-added services linked to treasury, foreign exchange and international remittances.   It is envisaged to provide scale through network to smaller UCBs.  The report of the current Committee recommended that the minimum capital of the UO should be Rs 300 crore.  Once stabilised, the UO can explore the possibility of becoming a universal bank.  It can also take up the role of a self-regulatory organisation for its member UCBs.  The Committee also suggested that the membership of the UO can be opened-up to both financial and non-financial co-operatives who can make contributions through share capital in the UO.

Comments on the report of the Expert Committee are invited until September 30, 2021.