CO-OPERATIVE BANKING SYSTEM IN INDIA: A CRITICAL ANALYSIS

By

B.Mahathi (20LLB019)

Semester: VI

5 year (B.A., LL.B.)

SUBJECT

LAW OF BANKING AND NEGOTIABLE INSTRUMENTS

DAMODARAM SANJIVAYYA NATIONAL LAW UNIVERSITY NYAYAPRASTHA,

SABBAVARAM, VISAKHAPATNAM, 531035, ANDHRA PRADESH
 ACKNOWLEDGEMENT

I Would like to express sincere gratitude towards Prof. Bayola Kiran for extending his
knowledge, expertise, and encouragement during the project.
ABSTRACT

The cooperative banking system in India has witnessed significant growth since its
inception, with many rural areas having been able to access banking services due to the
establishment of cooperative banks. In recent years, the Reserve Bank of India has taken
several steps to regulate and supervise cooperative banks to ensure that they follow sound
banking practices and protect the interests of depositors.

This project aims to study cooperative banking in India and its impact on financial inclusion.
The project will examine the history of cooperative banks in India, their functioning, and the
regulatory framework governing them. Further, the project will also analyze the challenges
faced by the cooperative banking sector in India and propose recommendations to improve
their performance.
INTRODUCTION

Cooperative banking is an important sector of the Indian banking system, which comprises
over 1,540 cooperative banks. These banks are unique in that they are owned and operated
by their members who are both depositors and borrowers. Cooperative banks in India
provide banking services to rural and urban areas, and they play a significant role in the
financial inclusion of marginalized communities.

The cooperative banking system in India has witnessed significant growth since its
inception, with many rural areas having been able to access banking services due to the
establishment of cooperative banks. In recent years, the Reserve Bank of India has taken
several steps to regulate and supervise cooperative banks to ensure that they follow sound
banking practices and protect the interests of depositors.

This project aims to study cooperative banking in India and its impact on financial inclusion.
The project will examine the history of cooperative banks in India, their functioning, and the
regulatory framework governing them. Further, the project will also analyze the challenges
faced by the cooperative banking sector in India and propose recommendations to improve
their performance.

Overall, the project intends to provide a comprehensive analysis of the cooperative banking
sector in India, highlighting its importance in the Indian banking system, and its role in
achieving greater financial inclusion.
RESEARCH QUESTIONS

1. How have cooperative banks in India evolved over time, and what impact have their
unique structure and governance model had on their financial performance, customer
base, and community development outcomes?

2. To what extent have cooperative banks been able to fulfill their social and economic
mandate in the face of competition from commercial banks and changing regulatory
frameworks, and what are the key drivers of success or failure in this context? A critical
analysis of the challenges and opportunities facing cooperative banks in India.

LITERATURE REVIEW

"Evolution of Agriculture Finance in India: A Historical Perspective" 1provides an

insightful review of the development of agricultural finance in India. The article aims to
highlight the evolution of agricultural credit in India and the policies and strategies adopted
by the government to support farmers. The article also examines the challenges faced by
farmers in accessing credit and provides recommendations for improving the agricultural
credit system. The article starts by outlining the history of agricultural credit in India, which
dates back to the colonial era. The author highlights that the colonial government's focus
was primarily on promoting commercial agriculture, and farmers were largely excluded from
accessing credit. This led to the exploitation of farmers by moneylenders and resulted in
indebtedness and poverty. The article then moves on to discuss the post-independence era,
where the government recognized the importance of agriculture and started implementing
policies to support farmers. The author explains that the government established various
institutions such as the Agricultural Refinance and Development Corporation (ARDC) and
the Agricultural Credit Department (ACD) to provide credit to farmers.

The author also notes that the government introduced the Lead Bank Scheme, which aimed
to provide credit to farmers through commercial banks.

1
Bharti, Nisha, "Evolution of Agriculture Finance in India: A Historical Perspective," 5 Journal of Agricultural
Economics 10 (2018).
The article then analyzes the impact of liberalization on the agricultural credit system in
India. The author argues that liberalization led to the withdrawal of government support for
agriculture, resulting in a decline in credit availability for farmers. The article highlights that
the government responded by introducing new policies, such as the Kisan Credit Card
scheme and the Rural Infrastructure Development Fund, to support farmers.

The research paper titled "Growth and regulatory framework governing cooperative Banks
in India"2 provides an in-depth analysis of the regulatory and legal frameworks that govern
cooperative banks in India.

The authors highlight the dual control system in place, which involves the Reserve Bank of
India (RBI) and the Registrar of Cooperative Societies (RCS). The RBI regulates and
supervises the banking functions of cooperative banks, while the RCS governs their
management and administration. The authors examine the roles and responsibilities of both
regulatory bodies and how they work together to regulate and supervise the cooperative
banking sector.

The article also discusses the various regulatory guidelines and policies implemented by the
RBI, such as the Prudential Norms and Income Recognition Asset Classification (IRAC)
guidelines, which help ensure compliance with legal and regulatory requirements. The
authors highlight the importance of regulatory compliance for the stability and sustainability
of cooperative banks, and the need for strong legal and regulatory frameworks to ensure the
proper functioning of these banks.

The authors also explore the legal framework that governs cooperative banks in India. They
examine the provisions of the Cooperative Societies Act, 1912, and the Multi-State
Cooperative Societies Act, 2002, which provide the legal basis for the functioning of

2
Vinayek, Ravinder and Rushi, "Growth and Regulatory Framework Governing Cooperative Banks in India",
1 International Research Journal of Management and Social Sciences 11 (2014).
cooperative banks. They discuss the role of the Registrar of Cooperative Societies in
regulating the legal aspects of cooperative banks, including their registration, management,
and dissolution.

The article also highlights the challenges faced by the cooperative banking sector in
complying with regulatory and legal requirements. The authors discuss issues of
governance, management, and financial sustainability, which are often attributed to weak
legal and regulatory frameworks. They emphasize the need for capacity building, technology
adoption, and infrastructure development to improve the efficiency and effectiveness of
cooperative banks while complying with legal and regulatory requirements.

In conclusion, the authors provide recommendations for improving the regulatory and legal
framework governing cooperative banks in India. They stress the need for stronger
governance mechanisms, better management practices, and improved financial
sustainability, as well as the importance of regulatory compliance and legal frameworks.
The authors also stress the need for capacity building, technology adoption, and
infrastructure development to improve the efficiency and effectiveness of the sector while
complying with legal and regulatory requirements.

The paper titled "Effect of Non-Performing Assets on Operational Efficiency of Central Co-
operative Banks"3 examines the impact of non-performing assets (NPAs) on the operational
efficiency of central co-operative banks in India. The authors analyze the causes and
consequences of NPAs and how they affect the performance of banks.

The authors provide a comprehensive literature review of the concept of NPAs and its impact
on the banking sector in India. They discuss the historical background and evolution of
NPAs, including the regulatory framework that governs the management of NPAs. The

3
JN Michael, G. Vasanthi, and R. Selvaraju, "Effect of Non-Performing Assets on Operational Efficiency of
Central Co-operative Banks," International Journal of Research in Management & Social Science, vol. 6, no.
4, 2018, pp. 15-26.
authors provide insights into the various reasons for the rise in NPAs in the banking sector,
such as economic slowdown, wilful defaults, and weak credit appraisal systems.

The authors also provide a detailed discussion on the operational efficiency of central co-
operative banks. They describe the factors that influence operational efficiency, such as
technology adoption, human resource management, and financial management. The authors
highlight the importance of operational efficiency in the banking sector and how it can lead
to sustainable growth.

The article also discusses the relationship between NPAs and operational efficiency in
central co-operative banks. The authors examine the impact of NPAs on various parameters
of operational efficiency, such as asset quality, profitability, and solvency. They provide
empirical evidence to support their findings and discuss the implications of their study on
the performance of central co-operative banks.

The authors also examine the measures taken by central co-operative banks to address the
issue of NPAs and improve their operational efficiency. They describe the various strategies
adopted by banks, such as debt restructuring, recovery management, and improved credit
appraisal systems. The authors provide insights into the challenges faced by banks in
implementing these measures and the need for a coordinated approach from various
stakeholders, including the government, regulators, and the banking industry.

In conclusion, the authors provide recommendations for improving the operational

efficiency of central co-operative banks while managing the issue of NPAs. They stress the
need for proactive measures to address the root causes of NPAs, such as improving credit
appraisal systems and adopting technology to enhance operational efficiency. The authors
also highlight the importance of effective management of NPAs and the need for a
coordinated approach from various stakeholders to address this issue.
Overall, the article provides a comprehensive literature review of the impact of NPAs on the
operational efficiency of central co-operative banks in India. The authors' analysis highlights
the importance of managing NPAs to improve the performance of banks and the need for a
coordinated approach from various stakeholders to address this issue. The article will be of
significant interest to policymakers, researchers, and practitioners working in the banking
sector in India.

The paper "Performance evaluation of Co-operative banks in India" by Dr . Sunil Bhaskar

Chandanshive4 analyzes the performance of cooperative banks in India. The author notes
that the cooperative banking sector plays an important role in the Indian economy,
particularly in rural areas. However, there is a lack of studies that have evaluated the
performance of these banks.

In the literature review section of the paper, Dr. Chandanshive describes various studies that
have been conducted on cooperative banks in India. He notes that there have been studies
on the financial performance of these banks, as well as their governance and management
practices. However, he states that there is still a need for further research in this area,
particularly in light of recent regulatory changes that have impacted the sector.

The author's study involved analyzing the financial performance of cooperative banks in
India using various indicators, such as return on assets, return on equity, and non-performing
assets. He analyzed data from 2009-2010 to 2013-2014 and found that the performance of
cooperative banks varied across different regions and types of banks. He also conducted a
comparative analysis with commercial banks and found that cooperative banks generally
underperformed compared to their commercial counterparts.

4
Sunil Bhaskar Chandanshive, Performance Evaluation of Co-Operative Banks in India, 6 Indian
Academicians And Researchers Association, 390-95 (2019).
Overall, the paper highlights the need for further research and analysis on the performance
of cooperative banks in India. It provides a comprehensive literature review of the existing
research on this topic, as well as insights into the author's own research findings.

LEGAL FRAMEWORK OF COOPERATIVE BANKS IN INDIA

The legal framework for cooperative banks in India has undergone several changes over the
years to promote their growth and development while ensuring their safety and soundness.
However, there are some challenges and limitations that need to be addressed to improve
the functioning of cooperative banks in India.

Firstly, the Cooperative Societies Act is a state subject, which means that the legal
framework varies across different states, resulting in inconsistencies in the regulation of
cooperative banks. This can lead to difficulties in complying with regulatory requirements
and can hinder the growth of cooperative banks across the country.

Secondly, while the RBI regulates cooperative banks5, its regulatory powers6 are limited
compared to those of commercial banks. This has led to cases of fraud and mismanagement
in cooperative banks, which have affected the depositors and eroded public confidence in
the sector. Therefore, there is a need for stronger regulatory powers for the RBI to ensure
the safety and soundness of cooperative banks.

5
Reserve Bank of India Act, 1934, §§ 22 (empowering RBI to issue directions to banks for credit control), 23
(requiring banks to maintain cash reserves with RBI), 45 (imposing penalties for violation of RBI regulations),
56 (empowering RBI to inspect, supersede board of directors, and cancel license of banks), 56A (empowering
RBI to authorize the bank to obtain financial assistance from other sources), 56B (allowing RBI to provide
financial assistance to banks), 58 (empowering RBI to regulate the management of banks), 36AB (mandating
deposit insurance for banks).
6
Banking Regulation Act, 1949 §§ 5(cc), 10B, 11, 22, 24, 26, 35A, 35AA, 45, 56 (providing definition of
cooperative bank, empowering RBI to supersede board of directors, requiring license for banking operations,
mandating cash reserves, submission of periodical returns, giving directions on governance, management and
financial reporting, empowering RBI for reconstruction or amalgamation, imposing restrictions on functioning,
and canceling license for non-compliance).
Thirdly, the cooperative banking sector in India faces several challenges such as inadequate
capital, poor management, and governance issues. The legal framework needs to address
these challenges and provide support for the growth and development of cooperative banks.

Fourthly, there is a need for greater financial inclusion in the cooperative banking sector to
promote economic development and reduce poverty in rural areas. The legal framework
needs to provide incentives for cooperative banks to expand their outreach and offer
financial services to under-served areas and communities.

The legal framework of cooperative banks in India has evolved over time to address the
needs of the sector and ensure its safety and soundness. However, there are several
challenges and limitations that need to be addressed to improve the functioning of
cooperative banks in India.

One of the key challenges faced by cooperative banks is the lack of uniformity in the legal
framework. The Cooperative Societies Act is a state subject, and the regulatory framework
varies across different states, resulting in inconsistencies in the regulation of cooperative
banks. This can lead to difficulties in complying with regulatory requirements and can hinder
the growth of cooperative banks across the country. Therefore, there is a need for greater
coordination between the central government and state governments to ensure a uniform
legal framework for cooperative banks.

Another challenge is the limited regulatory powers of the Reserve Bank of India (RBI) over
cooperative banks compared to commercial banks. The RBI regulates cooperative banks
under the Banking Regulation Act, 1949, but its regulatory powers are limited. This has led
to cases of fraud and mismanagement in cooperative banks, which have affected the
depositors and eroded public confidence in the sector. Therefore, there is a need for stronger
regulatory powers for the RBI to ensure the safety and soundness of cooperative banks.

Moreover, the cooperative banking sector in India faces several challenges, such as
inadequate capital, poor management, and governance issues. The legal framework needs to
address these challenges and provide support for the growth and development of cooperative
banks. One such example is the issue of capital adequacy, where cooperative banks have
been struggling to meet the capital adequacy norms set by the RBI. The legal framework
needs to provide incentives for cooperative banks to raise capital and strengthen their
financial position.

Another challenge is the lack of financial inclusion in the cooperative banking sector. There
is a need for greater financial inclusion to promote economic development and reduce
poverty in rural areas. The legal framework needs to provide incentives for cooperative
banks to expand their outreach and offer financial services to under-served areas and
communities.

In conclusion, while the legal framework for cooperative banks in India has been developed
to promote their growth and development, there is a need for further reforms to address the
challenges and limitations faced by the sector. This would help strengthen the sector and
enable it to play a greater role in promoting financial inclusion and economic development
in the country.

CASE ANALYSIS OF COOPERATIVE BANKING SYSTEM IN INDIA

PANDURANG GANPATI CHAUGULE VS. VISHWASRAO PATIL MURGUD

SAHAKARI BANK LTD. & ORS.

Facts :

Pandurang Ganpati Chaugule (the appellant) had mortgaged his land to Vishwasrao Patil
Murgud Sahakari Bank (the respondent) to secure a loan . When Chaugule failed to repay
the loan, the bank initiated proceedings under the Securitisation and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) to take
possession of the mortgaged property. Chaugule challenged the bank's action, arguing that
cooperative banks like the respondent were not covered under the SARFAESI Act.
Issues:

Whether cooperative banks are covered under the SARFAESI Act and hence can take
possession of a defaulter's mortgaged property to recover the loan amount.

Legal Provisions:

he Securitisation and Reconstruction of Financial Assets and Enforcement of Security

Interest Act, 2002 (SARFAESI Act).

Arguments of both parties:

The appellant argued that the SARFAESI Act does not apply to cooperative banks, as they
are governed by the Cooperative Societies Act. The respondent, on the other hand, argued
that the SARFAESI Act applies to all financial institutions, including cooperative banks.

Judgement:

The Supreme Court held that cooperative banks are covered under the SARFAESI Act and
have the power to take possession of a defaulter's mortgaged property to recover the loan
amount. The Court noted that the objective of the SARFAESI Act is to empower banks and
financial institutions to recover their dues quickly, and cooperative banks should not be
excluded from its purview.

Critical analysis:

The judgement is significant as it settles the long-standing issue of whether cooperative

banks are covered under the SARFAESI Act. It also highlights the importance of cooperative
banking in India and recognizes their role as financial institutions. However, the judgement
has also been criticized by some experts who argue that it may weaken the cooperative
banking system, as it exposes them to the same risks and challenges faced by commercial
banks.
THANE BHARAT SAHAKARI BANK V. RESERVE BANK OF INDIA

Facts:

Thane Bharat Sahakari Bank had challenged the regulatory powers of the Reserve Bank of
India (RBI) over cooperative banks in India. The RBI had issued a notice to the bank,
prohibiting it from issuing fresh loans or accepting deposits without prior approval from the
RBI. The bank argued that it is a cooperative society registered under the Maharashtra
Cooperative Societies Act, and hence not subject to the RBI's regulatory powers under the
Banking Regulation Act.

Issues:

The main issue in the case was whether cooperative societies registered under the
Maharashtra Cooperative Societies Act are exempted from the regulatory powers of the RBI
under the Banking Regulation Act.

Legal Provisions:

The primary legislation governing banks in India is the Banking Regulation Act, 1949. The
Act defines a bank as a company that carries on the business of banking. The Act empowers
the RBI to regulate and supervise banks in India.

Arguments of Both Parties:

Thane Bharat Sahakari Bank argued that it is a cooperative society registered under the
Maharashtra Cooperative Societies Act, and hence not subject to the RBI's regulatory
powers under the Banking Regulation Act. The bank contended that the Banking Regulation
Act applies only to companies carrying on the business of banking and not to cooperative
societies.

The RBI argued that the Banking Regulation Act defined a bank as a company that carries
on the business of banking and that cooperative societies, whether registered under the
Maharashtra Cooperative Societies Act or otherwise, falls within the definition of a bank.
The RBI also stated that it has the statutory duty to promote the soundness and stability of
the banking system.

Judgment:

The Bombay High Court rejected the bank's contentions and held that the RBI has the
statutory power to regulate and supervise cooperative banks under the Banking Regulation
Act. The Court observed that the primary objective of the Banking Regulation Act is to
prevent harm to the depositors' interests and to secure the financial health of banks.

The Court relied on the provisions of the Banking Regulation Act and the decision in KM
Chinnappa v. Union of India to uphold the RBI's regulatory powers over cooperative banks.
The Court rejected the bank's argument that as a cooperative society, it is not a bank and,
hence, not subject to the RBI's regulation.

The Court held that "cooperative society or otherwise, insofar as a banking business is
concerned, RBI has the entire authority to regulate or supervise the same." The Court also
noted that

RECOMMENDATIONS

The cooperative banking sector in India has been facing several challenges, including poor
management, governance issues, inadequate capital, and limited regulatory powers.
However, there are several solutions that can be implemented to address these challenges
and improve the functioning of cooperative banks in India.

Strengthening the Regulatory Framework: The regulatory framework for cooperative

banks needs to be strengthened to ensure the safety and soundness of the sector. The Reserve
Bank of India (RBI) should be given greater regulatory powers to monitor and supervise
cooperative banks, and there should be a uniform legal framework for cooperative banks
across all states. This would help to enhance the efficiency of the sector and improve the
confidence of depositors.

Improving Governance and Management: The governance and management of cooperative

banks need to be improved to ensure their long-term sustainability. The board of directors
of cooperative banks should be composed of professionals with relevant expertise and
experience. The board should also be independent and accountable to the stakeholders.
Regular training and development programs should be provided to the management and staff
of cooperative banks to enhance their skills and knowledge.

Enhancing Capital Adequacy: Cooperative banks need to maintain adequate capital to meet
the regulatory requirements and support their growth and development. The government and
RBI should provide incentives and support to cooperative banks to raise capital through
equity and debt instruments. This would help to improve the financial position of
cooperative banks and enable them to expand their operations.

Promoting Financial Inclusion: Cooperative banks have a significant role to play in

promoting financial inclusion in India, especially in rural areas. The government and RBI
should provide support to cooperative banks to expand their outreach and offer financial
services to under-served areas and communities. This would help to promote economic
development and reduce poverty in the country.

Embracing Digitalization: The adoption of digital technology can help to enhance the
efficiency and effectiveness of cooperative banks in India. Cooperative banks should invest
in digital infrastructure to improve their operational efficiency and provide digital financial
services to their customers. This would help to enhance the customer experience and enable
cooperative banks to compete with other players in the financial sector.
In conclusion, cooperative banks in India face several challenges, but there are several
solutions that can be implemented to address these challenges and improve their functioning.
These solutions include strengthening the regulatory framework, improving governance and
management, enhancing capital adequacy, promoting financial inclusion, and embracing
digitalization. By implementing these solutions, cooperative banks can play a significant
role in promoting economic development and financial inclusion in India.

CONCLUSION

The cooperative banking system has been an integral part of India's financial landscape,
providing crucial support to the agricultural and rural sectors. Despite facing numerous
challenges and setbacks over the years, cooperative banks have continued to play a
significant role in promoting financial inclusion and empowering local communities. With
the recent regulatory reforms and technological advancements, the cooperative banking
sector in India is poised for growth and transformation. However, there is still a long way to
go in terms of improving governance, strengthening risk management systems, and
enhancing transparency and accountability. It is essential for policymakers, regulators, and
stakeholders to work together to address these issues and create a more robust and
sustainable cooperative banking system that can effectively meet the evolving needs of the
economy and society.
REFERENCES

• Cooperative Banking: Role and Prospects" by S. K. Misra and V. K. Puri (2013)

• Bharyi, Nisha, "Evolution of Agriculture Finance in India: A Historical Perspective,"
5 Journal of Agricultural Economics 10 (2018).
• Vinayek, Ravinder and Rushi, "Growth and Regulatory Framework Governing
Cooperative Banks in India", 1 International Research Journal of Management and
Social Sciences 11 (2014).
• JN Michael, G. Vasanthi, and R. Selvaraju, "Effect of Non-Performing Assets on
Operational Efficiency of Central Co-operative Banks," International Journal of
Research in Management & Social Science, vol. 6, no. 4, 2018, pp. 15-26.