Kerala’s Co-operative banking system in crisis post demonitization

Kerala finance minister Dr TM Thomas Issac describes co-operative banks as the lifeline of Kerala economy and he is right. But with the recent turn of events, these banks stare at bleak future and will indeed bear the biggest brunt of demonitization.

The quantum of deposits in the cooperative banks has always been baffling because the 2012 credit survey showed a high level of indebtedness by people in rural areas. If the people in rural areas are in such debt, how can the banks, which serve the same areas, have so much in cash? Obviously, the inference is that the deposits are not by poor people, but by those with a lot of cash. Nobody, other than the banks, know the details of these deposits. No source of income is asked, no TDS filed, no PAN required and hence no reporting to the Income Tax Department. The interest that accrues from these accounts are also tax-free. Some, therefore call this the Swiss Banks of Kerala. There is certainly some merit in the argument that it’s a great mechanism for the rural moneybags to evade tax unless they come under the lens of the RBI.

Co-operative banks in Kerala enjoy a rich legacy; they provided credit for farmers since the 1950s and 1960s, years before commercial banks found a foothold in the state. With a customer base of more than 10 million, the four-tier banking system is one of the largest in the country. It has 20 state co-operative banks, 60 urban co-opeartive banks, 784 district co-operative banks and 1,611 primary co-operative banks under its umbrella. The primary banks have more than 2,500 branches. The state, urban and district banks follow the Reserve Bank of India (RBI)’s guidelines, while the primary banks come under the district banks and follow the directives of the Registrar of cooperative societies. Primary banks account for 80% of the estimated 1.27 lakh crore deposits. Primary cooperative banks deposit money with the RBI-monitored district banks.

The crisis in co-operative banking system began almost a week after Prime Minister Narendra Modi’s surprise announcement that made 1000 and 500 rupee banknotes illegal tender. On November 14, the RBI stopped primary co-operative banks and district co-operative banks from accepting and exchanging the demonetised banknotes.In the interim period that had passed, between November 9 and 14, Rs 280 crore worth of old notes had been collected as deposits from account holders, though banks did not give out new notes. These deposits are believed to have been registered as pre-dated fixed deposits.

It is believed that money-laundering suspicions forced the RBI to impose curbs on these financial transactions. The apex bank has not given any specific reasons for the decision so far, but its order paralysed the primary co-operatives. While the district banks are issuing new currency, primary banks can now neither accept scrapped notes nor issue new ones. They just have to do a balancing act with a meagre amount of Rs 24,000, provided by the district banks every week.

At the core of the current crisis lies the issue of transparency. It is alleged that primary co-operatives do not follow the KYC (Know Your Customer) process, thus making it easy to stash black money in benami accounts, i.e., accounts whose beneficiary is not the account holder on record. Successive state governments have objected to the RBI’s attempt to bring primary co-operatives under its ambit and make the system more transparent.

Both LDF and UDF state goverments have hugely contributed to the current predicament of these banks. They have always resisted move to make the system transparent obviously due to political reasons. And it is amusing to notice that both LDF and UDF hand in hand are now running from pillar to post for relief.

A task force set up for the revival of rural co-operatives in 2004, chaired by A Vaidyanathan, Emeritus Professor at Madras Institute of Development Studies, had suggested that “State governments need to make legislative amendments to enable the RBI to exercise its regulatory powers under the Banking Regulation Act directly, and not through the Registrar of Cooperative Societies (RCS), if the cooperative banks are to be regulated effectively”. It further noted: “The state governments should enter into an appropriate memorandum of understanding (MoU), agreeing to desist from interfering directly or indirectly in the management of the finances of these banks”.
Successive state governments have brushed these recommendations under the carpet and never acted on them.

The issue has taken a political turn with BJP state general secretary, K Surendran, alleging that the ruling Communist Party of India (Marxist) and the principal opposition Congress party stashed illegal money in cooperative banks, and this is why they are afraid of RBI intervention.

In a letter to Jaitley, he said that close to Rs 30,000 crore of black money had been deposited in cooperative banks in the state without paying income tax. “The depositors include politicians, real estate mafias, hawala dealers and terrorists. It will be for the benefit of the country if these deposits are verified and necessary action is taken,” he wrote. 

With the Centre adopting a tough stand on unaccounted black money, observers believe that the primary co-operative banks have to fall in line and commit themselves to follow RBI guidelines, if they wish to resume banking services.

However even if the regulations are eased these banks may face further issues. Firstly a potential exodus of investors to private and nationalised banks could wreak havoc. With a meagre Rs 40,000 crores currently in hand and an estimated Rs 80,000 crores currently in the market as loans, these banks will not be able to return the Rs 1.27 lakh crores deposits they have accumulated.

As for BJP, it is a political win. Not only did they choke the money flow of Congress led UDF and LDF in Kerala, they have also effectively managed to destroy the co-operative sectors controlled by these two alliances.