TA for Rural Financial Sector Restructuring Case of Credit Co-operatives in India Background The Rural Financial Market (RFM)

is one of the key drivers of the rural economy in general and poverty alleviation in particular in developing countries. The extensive rural financial market in India has been playing a major role in promoting investments in the rural economy and has a consequent impact on employment generation and poverty. Most of these financial institutions are state promoted institutions, where the policies and its roll out has been done on parameters which often defies management logic and financial discipline. The same is true for India also. Among the various rural financial institutions in India, the co-operative credit structure is the oldest and is still playing a significant role (See Annexure 1). However, the state of financial and non-financial affairs in the co-operative institutions is far from satisfactory (as on March 2003). To rejuvenate the credit cooperative structure (CCS), the Ministry of Finance has constituted a Committee to look into various aspects of the CCS in the country, namely, structure, regulation and supervision, performance and operational issues. The mandate of the Committee was to suggest a suitable restructuring plan with a focus on re-capitalization of co-operatives, based on sound policy, regulatory, governance and management parameters and principles. ADB was partnering with GOI in form of Technical Assistance (TA) with a view to support the restructuring process with extension of both funding facility in the re-capitalization process in future and also providing required inputs to both Committee and Ministry, on role and functioning of the various players in the RFM, including those of CCS. The proposed TA required an assessment of the current RFM and identify the lacunae in functioning of the various organizations operating in this market, which also included the CCS. In order to support the restructuring exercise, ADB through its bid process, had selected the consortium of major accounting firm (Lead Firm) and emerging micro-finance institution (Associate Firm), to carry out the necessary study to detail out the current operating and performance scenario in the CCS, the constraints and problem faced by CCS and thereafter propose a suitable re-structuring plan (See Annexure 2). One of the important clients of this exercise was the aforementioned Committee appointed by Ministry of Finance. Time frame The assigned study has to be completed in a period of 9 months. This was divided into two phases. In the first phase, diagnostic institutional and operational review of the CCS in chosen 5 states were to be completed to get an understanding of the issues to be addressed in the restructuring process. Based on the findings and iterative stakeholders consultation, suggest a

restructuring plan in Phase 2 for CCS in respective states as well as the overall structure in the country. Present Stage of the project The Team Leader of the consortium had due discussions with ADB support team in Manila and agreed on coverage of 5 states, namely, Andhra Pradesh, MP, Rajasthan, West Bengal and Kerala. An initial first cut assessment of the CCS structure was done prior to meeting to arrive at the sample states. The consortium also had taken up initiatives to build a 10 member state team, comprising of Auditors, Rural Financial Specialist, Management specialists, Banking specialist, etc. The problem was finding out experts who were proficient in local language for collection of required information at the district and village level. But after due search, team was finalized for three states, namely, AP, West Bengal and Rajasthan. It was later decided that team from Rajasthan and AP will cover MP and Kerala respectively. To roll out the study, a core team was constituted. The core team consisting of Team Leader, MD of the Associate Firm and Full Time International Consultant (specializing in financial Cooperatives) was responsible for monitoring of progress, checking of quality of the diagnostic study in the respective states. It has been also planned to cover the state in a period of one month wherein visits to 3 DCCBs and 2 PACS in each DCCBs will have to be completed. In addition, there has to be discussions with apex agencies in each state. The core team had also firmed the period of visits in respective states. The teams were busy in preparation of the in-depth study in each state.
Class discussion

1. What are the various aspects the state team should focus on during their study perioddetail it out? 2. Towards this, what preparations are required? 3. Contemplate the possible issues/problems the team could face during implementation? 4. What could be closure process in the study?

Annexure 1: Cooperative Credit Structure and Performance The present structure of the Rural Financial Market has emerged after a series of interventions by the Government and Reserve Bank of India after independence. It mainly consists of formal institutional sources and the informal non-institutional private individuals. In the formal sector, a multi-agency approach has been followed to provide the necessary financial services in the rural areas. The various institutions are the Scheduled Commercial Banks, Regional Rural Banks and the Cooperative Credit Institutions. The cooperatives cater to both the short term and long term credit need of the rural consumers. The short-term credit need of the rural consumers is fulfilled by three institutions, namely, the State Cooperative Banks (SCBs), District Central Cooperative Banks (DCCBs) and the large network of the Primary Agricultural Credit Societies (PACS) in the villages. On the other hand, the State Cooperative Agriculture and Rural Development Banks (SCARDBs) provide long-term credit in the rural economy. In Andhra Pradesh and Jharkhand the long-term structure has been merged with the short-term structure. Dual supervision is in vogue in CCS wherein both Registrar of Co-operative societies (RCS) and National Bank for Agriculture and Rural Development (NABARD) have different supervisory and regulatory roles. Except for SCBs and SCARDBs, which play an apex role at the state level, all these institutions operate at the grass root level, which is supported by the National Bank of Agricultural and Rural Development (NABARD) through its refinance policy. NABARD is also a supervisory, monitoring and coordinating agency for these institutions, implementing the various policies of the government and channelising credit to the rural sector. Fig1: Structure of the Short term Credit Co-operative in India

RCS
Co-op Supervisory and control role

NABARD
Banking Regulator Role

State Co-operative Bank (SCB-30)

District Central Co-operative Bank (DCCB-367)

Primary Agriculture Co-operative Societies (PACS-125000)

Snapshot of the Rural Financial Market as on March 2003 Parameter Rural and Semi Urban Outlets Borrowers at ground level Unit Number Number CBs/ RRBs 47,162 4.10 Crore Coops 1,25,202 6.39 Crore (at PACS level) 62,399 30,951 20,252 10,329 72,394 12% Yes 64,192

Rural credit outstanding Agri Loans (ST + MT) outstanding Crop Loans issued Crop loans issued to SF, MF Deposits Ground Level Interest Rates for crop loans Non Credit Services PDS, Fertilizers No. of PACS having godowns

RsCrore RsCrore RsCrore RsCrore RsCrore % p.a.

68,211 55,229 26,029 N.A. 418,259 9-12% No No

Performance of the Credit Co-operative Structure Parameter No. of Dormant and Defunct Institutions No. currently Loss Making Extent of Accumulated Losses (RsCrore) No. with Net Worth Less than Rs 1 Lac (Sec 11 non compliant) Gross Deposits (RsCrore) Erosion of Deposits (RsCrore) PACS 5,861 52,626 4,595 N.A. 19,120 Not Avbl. DCCBs 0 118 5,060 143 72,394 3,088 SCBs 0 5 250 7 39,111 187

Problems in the Co-operative Sector

(1) Governance Issues No elections for almost 10 years in 3 states Boards superseded 9 out of 30 SCBs 134 out of 367 DCCBs All CCS institutions in 4 states State Governments combine the role of Dominant Shareholder, Management, Regulator, Supervisor and Auditor Registrar of Co-operative societies (RCS) can and does influence and direct both financial and administrative matters Representatives of state governments on Boards of cooperatives have decisive say Decision making is highly politicized (2) Management problems State Govt officers deputed in top two positions in many SCBs and DCCBs Not trained in banking PACS secretaries in several states drawn from common cadre Do not generally feel accountable to the PACS Remuneration without reference to the business of PACS Staff generally ageing, not professionally qualified Boards perform day to day management functions Poor Housekeeping, Weak Internal Controls and Poor Quality, Delayed Audits

Nonetheless, some positive changes has happened in the sector with the enactment of new cooperative law in a few states, like Andhra Pradesh, Madhya Pradesh, Jharkhand, Jammu & Kashmir, etc. The essence of this Model Co-operative Act is to limit the powers of RCS to mostly audit and general supervision.

Annexe 2: TOR for CCS Component Financial Review of 3 tier Co-operatives: Field assessment to review the loan portfolio including manag ement, pricing, classification, assets provision, and recovery procedures; Assess liquidity and risk profile of assets and liabilities, security and collateral quality, loan rescheduling, profitability, capital and reserve adequacy, and nonperforming loans (NPLs)of each tier of the CCSs. Examine the audit processes and procedures, including implementation of audit recommendations DiagnosticReview of Institutions: Role of Ministries, RBI, NABARD, Apex institutions, Registrar of Co-operatives in supervision, regulation and funding of CCS Conduct governance and institutional diagnostic reviews of CCSs including governance/ownership structure, level of autonomy and accountability, organizational structure, human resource structure and compensation policy, etc.

Restructuring Plan. Based on diagnostic reviews, suggest the best- fit model, structure in governance and institutional system for CCS to solve identified problems, detail monitoring mechanism, recommend and apply performance indicators for CCSs in each state as well as overall structure. Determine MIS needs and assess performance aspects that can be computerized with particular emphasis on financial reporting, loan portfolio tracking and analysis, and human resource management in all its facets. Determine the extent to which computerization should and can be undertaken depending upon the cost and maintenance issues and provide a general overview of specifications for software and hardware.