RBI Proposes Reopening Licensing Window for Urban Co-operative Banks

Syllabus: GS3/Indian Economy

Context

• Recently,  the Reserve Bank of India (RBI) has proposed reopening the licensing window for Urban Co-operative Banks (UCBs) after two decades of halt.
  • RBI suspended UCB licensing nearly 20 years ago after a wave of financial failures among newly licensed small UCBs.

About the Urban Co-operative Banks (UCBs)

• They are co-operative societies that engage in banking activities, including accepting deposits and lending money, mainly to members of the co-operative and the general public within urban and semi-urban areas.
• UCBs are member-owned, operating on the principle of ‘one member, one vote’, regardless of the amount of share capital held, unlike commercial banks, which operate as joint-stock companies.

Legal and Regulatory Framework

• Banking Regulation Act, 1949 (Part V): It regulates their banking functions such as lending, deposits, liquidity, and prudential norms.
  • It is administered by the Reserve Bank of India (RBI).
• Co-operative Societies Acts (of respective states or the Central Co-operative Societies Act, 2002): It governs the registration, management, elections, and audit of UCBs.
  • It is administered by the Registrar of Co-operative Societies.

Objectives and Role

• Promoting financial inclusion among small traders, artisans, and salaried groups in urban and semi-urban areas.
• Providing credit facilities to members at reasonable interest rates.
• Mobilizing local savings for productive and social purposes.
• Strengthening co-operative principles such as mutual help and democratic management.

Structural Profile of UCBs

• As of March 31, 2025, India had 1,457 UCBs comprising 838 (Tier 1; 57.5%), 535 (Tier 2), 78 (Tier 3), and 6 (Tier 4) banks.
• In deposit terms, large UCBs dominate the sector:
  • Only 7% of UCBs hold deposits exceeding ₹1,000 crore, but they account for 62.5% of total deposits.
  • Conversely, 52% of UCBs hold deposits below ₹100 crore, constituting a mere 5.6% of total deposits.
• The aggregate assets of UCBs stood at ₹7.38 lakh crore, and total deposits at ₹5.84 lakh crore as of FY25, up from ₹4.35 lakh crore and ₹3.55 lakh crore respectively in 2015.

Eligibility Criteria For New Licensing

• The High-Powered Committee on Urban Co-operative Banks, led by RBI Deputy Governor, had recommended that new licenses be issued only to financially sound and well-managed co-operative credit societies.
• The RBI proposes restricting eligibility to large co-operative credit societies that:
  • Have been operational for at least 10 years;
  • Maintain a good financial track record for at least five years;
  • Possess a Capital to Risk-Weighted Assets Ratio (CRAR) of not less than 12%, and;
  • Maintain Net Non-Performing Assets (NNPA) at not more than 3%.
• According to the RBI, such criteria aims to ensure that only financially stable and well-governed entities transition into UCBs.

Related Concerns & Issues

• Overlapping Authority & Compliance Challenges: The dual control structure of RBI and Co-operative Societies Acts often leads to overlapping authority and compliance challenges, especially in governance and supervision.
• Challenges Related To Governance: The ‘one member, one vote’ principle, while democratic, discourages capital investment and growth.
  • The entry and exit of shareholders at face value provides no incentive for investors, making co-operative bank shares unattractive.
• Challenges Related To Capital: Capital raising difficulties persist due to the non-perpetual nature of co-operative share capital, which can be refunded and is often linked to borrowing activities.
• Other Concerns: The RBI’s analysis of UCB license cancellations between 2020–2025 revealed recurring issues of management fraud, governance lapses, and director-related lending violations, particularly among smaller UCBs.

Strengthening UCBs in India

• RBI’s Policy Initiatives and Structural Reforms: The RBI introduced a graded regulatory framework that classifies UCBs into four tiers based on deposit size and risk profile.
  • Tier 1: Small local UCBs
  • Tier 2: Medium-sized regional UCBs
  • Tier 3 and Tier 4: Large UCBs with multi-state operations;
    • It enables proportionate regulation, ensuring smaller banks are not overburdened while large ones follow stricter governance norms.
• Enhanced Regulatory Powers under the Banking Regulation (Amendment) Act, 2020:
  • Approve CEO appointments and board members in UCBs.
  • Supersede management boards in case of governance failures.
  • Initiate reconstruction or merger schemes to safeguard depositor interests.
• Strengthening Governance and Management:
  • Professionalization of Boards: The RBI emphasizes the inclusion of domain experts in UCB boards like professionals in banking, accounting, and law to improve oversight.
  • Eliminating Director-Related Lending: UCBs are strictly prohibited from granting loans to directors or their relatives, a practice that has led to several past failures, to avoid conflicts of interest.
• Improving Capital Adequacy and Financial Resilience:
  • Introduction of Innovative Capital Instruments: The RBI has encouraged exploration of Tier-II capital instruments and debt-like products to enhance capital buffers, since traditional shares in UCBs are non-tradable and refundable.
  • Consolidation and Mergers: The RBI encourages voluntary mergers of weak UCBs with stronger ones to create financially sustainable entities capable of adopting modern technology and practices.
  • Stronger Risk Management Frameworks: UCBs are now required to implement:
    • Comprehensive risk-based supervision,
    • Early Warning Systems (EWS) for credit risk, and
    • Stress testing for capital adequacy and liquidity.
• Technological Modernization: Digital transformation is key to strengthening UCB operations. The RBI promotes:
  • Adoption of Core Banking Solutions (CBS) for seamless transactions;
  • Integration with digital payment platforms such as UPI and NEFT;
  • Implementation of cybersecurity frameworks and data protection norms.
• Depositor Protection and Transparency: Deposits in UCBs are covered under the Deposit Insurance and Credit Guarantee Corporation (DICGC) up to ₹5 lakh per depositor.

Road Ahead

• The strengthening of UCBs is a long-term process requiring a balanced mix of regulation, modernization, and co-operative ethics. For future resilience, UCBs need to:
  • Diversify revenue sources while maintaining prudent lending.
  • Build robust internal controls and auditing mechanisms.
  • Embrace digital banking and green finance opportunities.
  • Move toward self-sustainability rather than dependency on state or sectoral support.
• These measures can restore trust, improve efficiency, and position UCBs as strong, inclusive pillars of India’s financial architecture, if implemented effectively.

Source: IE