Access to finance in remote rural areas

1
Access to finance in remote rural areas
- The case of cooperative banks

• September 09, 2009
• Nachiket Mor
• Chair, Advisory Council
• IFMR Trust

2
High Quality Financial Services Delivery

• Delivery of a complete range of financial
  services in a continuous, flexible, reliable and
  convenient manner1
• Localised and community-based (especially in
  rural areas)
• Deeper understanding of needs and risks
• Better able to respond with customised solutions
• Long-term stakes in the community
• 1. Rutherford and Morduch (2003)

3
Existing originators in rural areas

• Scheduled Commercial Bank branches
• Cooperative Banks
• Regional Rural Banks
• Micro finance institutions (NBFCs, Section 25
  companies, societies and trusts)

4
Cooperative Banks Importance

• They are everywhere
• Three Tier structure State Cooperative Banks
  (SCBs), District Central Cooperative Banks
  (DCCBs), Primary Agricultural Credit Societies
  (PACS)
• About 100,000 PACS, 368 DCCBs, 31 SCBs
• Total of 122,590 service outlets
• Average population/branch in rural areas
• 4393 (including cooperative banks)
• 14893 (excluding cooperative banks)
• Presence in remote rural locations
• Source Report of Committee on Financial
  Inclusion, 2008

5
Cooperative Banks Importance

• They already have vast outreach
• Membership gt120 million
• 42 of members are small and marginal farmers.
  37 are marginalised social groups
• PACS and DCCBs have a local character governed
  by local community and managed by the staff from
  rural areas
• Outreach to marginal farmers is high though total
  contribution in agricultural lending has fallen
  from 42 in 2002-03 to 13 in 2008-09
• Source NAFSCOB, ADB Report on cooperatives

6
Cooperative Banks Performance

• Profitability/sustainability is low
• Majority of PACS and a quarter of DCCBs in loss
  (March 31, 2006)1
• About a quarter of DCCBs and SCBs eroded their
  net worth (2002-03)2
• The accumulated losses of the system aggregate
  over Rs. 9,100 crore (March 31, 2006)1
• Non-performing assets (NPA), as a percentage of
  loans outstanding at the level of SCBs and DCCBs,
  at the end of March 2006 were around 16 and 20
  respectively1
• 1. Committee on Financial Inclusion, 2008
• 2. Task force on Revival of Cooperative Credit
  Institutions, 2004

7
Cooperative Banks Some generally recognised
issues

• Borrower-driven system Focus on pushing credit,
  rather than building community-based thrift and
  credit institutions
• Poor internal governance and management
• Regulation and Supervision Dual control
• Many cooperative banks (SCBs, DCCBs) are governed
  by the Cooperative Societies Act of the States as
  well as the Banking Regulation Act
• Ambiguity in demarcation of roles
• High level of interference by the state
  governments
• Spiral of poor performance Would you want to put
  your money in an institution with 20 NPA?

8
Cooperative Banks The Reform Programme

• Fundamental elements of reform program
• Eliminate state government control of the system
• Enhance supervision and regulation so that coops
  classified as banks (SCBs, DCCBs) can be
  effectively supervised by RBI
• Implement a pre-capitalisation audit, provide
  accounting, technological and human resource
  development support
• Re-capitalize coops to reduce accumulated losses
  and restore the value of members capital
  (Increase CRAR to a minimum 7)
• PACs that meet the recovery threshold of 30 will
  be eligible for recapitalization
• Recapitalization linked to policy, legal, and
  institutional reforms.

9
Cooperative Banks

• The conventional wisdom on cooperative
  performance fails to explain some issues
• There is a wide distribution in performance some
  coops have done well
• Source Vaidyanathan Committee Report,
  2004
• Almost every DCCB in Rajasthan is in profit.
• Arent the better cooperative banks also facing
  the same issues?
• Then what is driving their performance? Perhaps a
  deeper reflection is needed

10
A vision for a well-functioning financial system
11
Additional design issues for consideration

• Management of credit risk in cooperatives
• How are cooperatives managing exposure to
  systemic risk due to
• High geographical concentration
• Concentration on agricultural credit (gt60 as on
  March 31, 2006-07) exposure to rainfall/weather
  risk
• How are cooperatives managing adverse selection
  and moral hazard?
• No joint liability
• High Loss Given Default (LGD) for collateral

12
Additional design issues for consideration

• Management of credit risk in cooperatives (contd)
• Some options for managing systemic risk
• Transferring the systemic risk and proportionate
  returns (securitisation) with NABARD as market
  maker
• Pricing the risk in the interest rate
• Purchasing rainfall/weather insurance
• Cooperative banks, especially DCCBs, should have
  risk management systems (ASPs) that help them
  manage their risks actively by using basic
  derivative instruments
• Management of moral hazard Better loan
  underwriting practices, credit bureaus

13
Additional design issues for consideration

• Deposit taking Should thinly capitalised PACs
  and DCCBs accept deposits?
• Why do rural and semi-urban branches of
  commercial banks have nearly six times more
  deposits than cooperatives1?
• Rural depositors need a high level of protection
• There is high exposure to systemic risk,
  especially in PACs
• CRAR of 7 assumes a high asset quality. Is this
  adequate, given the cooperative banks past
  performance?
• How can we use the cooperatives for offering
  savings facility?
• Offering savings using the business correspondent
  model
• Perhaps coops should not be able to take deposits
  for first few years until track record of
  adequate capital has been proven.
• 1. Report of Committee on Financial Inclusion,
  2008

14
Conclusion

• Cooperatives by virtue of their outreach are
  well positioned to help solve the problem of
  financial exclusion
• They need to be transformed into more effective
  financial institutions
• For long-term effectiveness and sustainability,
  any originator should adhere to certain design
  principles
• Recapitalisation without fundamental changes in
  design may postpone failure, and enhance moral
  hazard

15

• Thank you