CHAPTER 1

(Session 2)

COOPERATIVE BANKS IN CHANGING BANKING SCENARIO GOI REVIVAL PACKAGE FOR STCCS
With one of the largest acreage of cropland in the World and 11%of worlds land under agriculture, India continues to be one of the most prominent agricultural economies of the world. There is a huge untapped potential in the Indian market for food and agribusiness, both in mature sectors such as agri-inputs, edible oil and sugar, as well as the emerging sectors like dairy, poultry, fruits & vegetables and biotechnology.

India is the seventh largest and second most populous country in the world. Population of India rose from 361 million in 1951 to 846.3 million in 1991, breaching the billion marks in the year 2000. The population is expected to

increase at the rate of 1.54% per annum until 2010, or another 162 million people. The estimates made by the Planning Commission indicate that the Indian population will be of the order of 1.6 billion by the year 2050.

A new spirit of freedom is now stirring the country, bringing sweeping changes in its psyche. Today, India is one of the most exciting emerging markets in the world. Skilled managerial and technical manpower that match the best available in the world and a large middle class provide India with a distinct cutting edge in global competition.

The Indian economy recorded a growth of 5.4% during 2001-02 and has grown at the level of 9% for three years since 2005-06 and the accelerated growth performance was attributed mainly to agriculture sector which grew at a rate of 4%. Agriculture accounted for about 22% of the Indian GDP with 65% of population engaged in agriculture.

Cropland in India accounts for almost half the geographical area of 328.8 million hectares. The production of food grain in India during 2001-02 was 209.2 million tons and has crossed 230 million tons during 2007-08. India is the worlds

second largest producer of wheat and paddy and the leading producer of fruits and vegetables. However, the productivity of Indian crops remains at 40-50% of global average, largely due to lack of adoption of modern agriculture technology and inputs. To keep pace with the needs of the expanding population, India needs 383.2 million tons of food grains at current levels of per capita availability by 2020 and it may even go up since economic growth translates into higher purchasing power and hence higher consumption.

Credit is one of the crucial inputs for propelling the growth of agriculture. For the past few decades, institutional finance is coming in a big way to help the Indian farmer in increasing the productivity and production. All Rural Financial Institutions have played a crucial role and the role of Cooperatives was laudable till the end of 20th century as the largest purveyor of agricultural credit. However, with the liberalization and the reforms that had swept the banking industry in the past decade and half had diminished their leadership position and made the way for the new players to fill the gap. The share of the cooperatives in agriculture which used to be around 70% even in late 90s had slipped down to less than 30% due mainly to inertia to keep pace with the changes and efforts not matching with those of competitors especially from Commercial Banks of Public and Private sectors. A table illustrating the scenario is given below:

Flow of Institutional Credit to Agriculture from 1992-93 to 2004-05 Agency 1992-93 199798 Cooperative Banks RRBs 9378 (62%) 831 (5%) Commercial Banks Total 4960 (33%) 15169 13975 (44%) 2040 (6%) 15831 (50%) 31846 20718 (39%) 4219 (8%) 27807 (53%) 52744 2000-01 200102 23524 (38%) 4854 (8%) 33587 (54%) 61965 200203 23636 (34%) 6070 (9%) 39774 (57%) 69480 200304 26875 (31%) 7581 (9%) 52441 (60%) 86897 200405 31231 (25%) 12404 (10%) 81481 (65%) 125116

Note: Figures in brackets indicate its % over the total Source: NABARD Annual report, 2005-06

When the cooperative banks share in the agricultural sector is declining, public sector commercial banks & private sector banks are emerging as new champions in agricultural and rural banking. ICICI bank experienced a 37% growth in rural and agricultural portfolio from Rs.146.87 billion to Rs.201.79 billion during 200607. Agricultural lending accounts for around 10% of SBIs loan book in the financial year 2007 at a year-on-year growth of 33%. (Business Outlook, July 20, 2007)

The present banking scenario in India is witnessing sea changes. Adoption of policy reforms in Indian economy has resulted in the change of economic order towards the process of Liberalization, Privatization and Globalization (LPG). The Liberalization of the financial sector in India is exposing Indian banks to a new economic environment that is characterized by increased competition and new regulatory requirements. As a result, there is a transformation in every sphere of activities of the banks in India, especially in Governance, nature of business, style of functioning and delivery mechanisms. The new generation banks brought the necessary competition into the industry and are spearheading changes towards higher utilization of technology, improved customer service and innovative products. In spite of their huge and monolithic and bureaucratic organizational structure, public sector banks also proved to be surprisingly nimble and flexible to meet the emerging needs of customers. Thus, there is a paradigm shift form the sellers market to buyers market in the industry which forced the bankers to change their approach from conventional banking to convenience banking and mass banking to class banking. The shift has also increased the degree of accessibility of bank to common man for his varied of needs and requirements.

The business of banking revolves around effective mobilization and efficient application of funds of the bank. Changes taking place in the banking business in recent years as a result of the financial sector reforms are too fast and challenging to the bankers. This has created a complex business climate on the one side and opened up wide opportunities in the area of investments, advances, services and so on. The approach to the credit policy of the banks has also changed. Besides, the services so far offered by the bankers have taken a new leaf and experiencing

drastic developments. Banking Sector has been dealing with only paper currency till the third quarter of 20th century. Excepting the mode of telegraphic transfer, the transfer of funds in banking has been either through currency or instruments like cheque, demand draft etc. The final phases of 20th century had witnessed plastic currency in the form of Credit cards, Charge cards, Money cards etc. Cards are gradually being used by a large number of people as it avoids carrying of paper currency and its connected risks. As the situation changes, the issues confronting the bankers are also new, unique and not experienced before. Though Cooperative banks are also operating in the same environment, they became mute spectators to rapid changes happening in the present banking sector as illustrated below:

Customer Focus:

Hectic competition in the banking sector put the customers on

the drivers seat by getting their required products and services. As the business environment changes across industries, the customers expectations are also growing. The facilities and options put forth by banks to customers made the

present customers demand more through customer service. Customer service is the main guiding factor to enhance banks reputation and ensure their survival in the competitive environment. Increased competition, technology driven services, lower entry barriers leading to new entrants, less protective regulation, increased autonomy for the banks etc are some of the features of the new trend. These characteristics have resulted in introduction of various reform measures. Thus in the bankers point of view, the customer service had undergone metamorphosis over the years beginning with Serving followed by Pleasing, Delighting and now the ultimate challenge for all is Retaining the customers. Shamrao Vittal Cooperative bank, Mumbai recently had taken a decision to send all the office assistants, attenders of its head office to its branches in order to give better attention to the customers.

Branch Banking: Expansion of branch network is one of the means to augment business. The new generation private sector banks and foreign banks have started exploiting business potential through other strategies as well. Traditionally public sector commercial banks have been able to augment the business level by increasing their branch network.

Transparency and Disclosures: With a view to ensuring meaningful disclosure of the true financial position of banks and to enable the users of financial statements to study and have meaningful comparison of their positions, a number of measures were taken by RBI. These disclosure norms covered aspects like capital adequacy, asset quality, profitability, country risk exposure, risk exposure in derivatives segment etc. In the context of implementation of Basel II norms, RBI has proposed enhanced disclosure norms for implementation by banks.

Capital Adequacy Norms: Norms stipulated by the Basel Committee on Banking regarding measures for capital augmentation and accepted by capital standards were

RBI and the same have been under implementation. The main

objective of capital adequacy norm is to strengthen the soundness and stability of the banking system, Capital adequacy ensures that the financial fundamentals of the banks are strong. Capital adequacy ratio is the ratio of capital fund to risk weighted assets expressed in terms of percentage.

Best Practices Code: The Best Practices Code represents detailed procedural rules for entering into transactional relations within the banks. The objective of BPC is to ensure that all procedures, especially in sensitive areas are well documented, compared with national and international best practices and improved upon in the light of the experience gained. Best practices Code involve examination of all procedures, products, activities and systems. It needs to be integrated with the over-all risk management strategies of the bank. RBI issued guidelines for ensuring minimum level of uniformity in content and coverage of Best Practices Code.

Business Process Re- engineering: Business Process Re-engineering represents transformation of select processes and procedures with a view to empower the bank with contemporary technologies, business solutions and innovations that enhances the competitive advantage. It is the fundamental reconsideration and radical redesign of organizational processes in order to achieve drastic improvement of current performance. It seeks to enhance the value of services to the customers. Four important aspects are (i) Customer (to give him enhanced value), (2) Competition (to meet successfully), (3) Change (to

meet it) and (4) Cost (to reduce). There are three key parameters (i) Customer Service, (ii) Product innovation and (iii) Operational excellence. BPR seeks to further the strategic goals of the bank.

Corporate Governance: Corporate Governance refers to conducting the affairs of a banking institution in such a manner that gives a fair deal to all the stakeholders, i.e.. Shareholders, bank customers, regulatory authorities, society at large and employees. Corporate governance is important for bankers as majority of them are in public sector, where they are not only competing with each other but with other players in the banking system. Corporate Governance is to create an environment to help the management to enhance the stake holders value.

Liberalized Branch Authorization Policy: RBI has liberalized and rationalized the policy for authorization of branches and it has put in place a framework for branch authorization policy which would be consistent with the corporate strategy of banks. While considering applications for opening branches, RBI shall give weightage to the nature and scope of banking facilities provided by banks to common persons, credit flow to priority sector, pricing of products and banks efforts towards promotion of financial inclusion and enhanced services.

The system of granting authorization for opening individual branches from time to time, is replaced by a system of giving aggregated approvals, on an annual basis, through consultative and interactive process. The authorization given would be valid for one year from the date of communication. Banks are not required to approach RBI for license and instead submit proposals for opening of branches and on the basis of consolidated authorization granted, they may proceed to open branches.

Insurance business by Banks- Banc assurance: Banks may undertake insurance business either on risk participation basis (underwriting) or do insurance business as an agent of insurance companies on fee basis. Insurance business offers an opportunity to banks to increase fee based income thereby improving profitability. Banks may undertake insurance business (underwriting) on fulfillment

of certain parameters relating to net worth, capital adequacy, continuous profit, low NPA etc. The insurance activity shall be undertaken by forming a subsidiary. Banks equity stake can be 50% of the insurance entity.

Banc assurance helps the banks to build synergy between insurance business and bank branch network to sell insurance products through banking channel. RRBs, Urban Cooperatives and DCCBs are also allowed to undertake banc

assurance business. With the tie up of HDFC Standard Life Insurance Company Ltd, Saraswat Cooperative Bank, Mumbai sells the life insurance products of HDFC. With the tie up with Bajaj Allianz General Insurance Company Ltd,

Saraswat Cooperative bank sells the general insurance policies of Bajaj Allianz.

Universal Banking: Universal Banking represents all kinds of activities of banking, development financing subject to compliance with statutory and other requirements prescribed by RBI, GOI and other enactment. Activities include

accepting deposits, granting loans, investing in securities, credit cards, project finance, remittances, payment systems, project counseling, merchant banking, foreign exchange operations, insurance etc.

Retail Banking: Increase in purchasing power and emergence of strong middle class, development of retail market have increased the scope for retail banking in India. Retail Banking has three main features; Multiple products - deposits, credit cards, insurance, investments etc Multiple delivery channels - call centers, branch, internet, Kiosk etc Multiple customer groups -consumer, small business, corporate etc.

Public sector commercial banks and new generation private sector banks have been successful in creating strong retail banking segment. Focus on retail

banking has contributed to increasing market share of private banks in total advances. Retail loan account for a significant portion of the loan portfolio of new

private sector banks. It formed 53% of HDFC banks and close to 65% of ICICI banks advances as on 31st March, 2007. Still there is wider scope for expansion of retail banking for other banking sector in India.

Retail loans have been a prime driver of credit growth in recent years, witnessing a growth of over 40% in 2004-05 and 2005-06. As a percentage of gross

advances, it increased from 22% in 2003-04 to 25.5% in 2005-06. The objective of retail banking is to increase penetration by providing increasing level of services and access, by offering value added services to customers. It consists of three elements, viz, deposit products, loan products and other products. Other value added services are also being offered by banks. The key retail loan

categories are mortgage finance, auto finance, personal finance, credit cars and consumer durable finance. Cross selling of various retail products also takes place.

Cross Selling: It represents additional services offered to existing customers, with a view to expand banking business. It results in reduction of cost and

enhances satisfaction level of customers. While public sector banks have not gone deep into the concept, new generation private sector banks are embarking upon cross selling to maximize income. The main benefit is reduction of cost as the cost of contracting a new customer is much higher than to serve an existing customer. Cross selling enables creation of brand value. The existing customer base of the banks is used for the purpose of cross selling. It is not a transaction based activity but is primarily a relationship building exercise.

Outsourcing of work by Banks: Outsourcing represent utilisation of services of another entity or outside service provider to perform certain functions/activities, continuously which otherwise would have been normally undertaken by the bank itself. This may be through an affiliated entity (say a subsidiary) or an external entity like a marketing agent. The outside service provider is an entity undertaking the outsourced function on behalf of the bank. Outsourcing enables them to

economise their cost of operations. It however involves certain risks like strategic risk, reputation risk, compliance risk, operational risk, exit strategy risk, counter party risk, contractual risk, access risk, concentration risk, systemic risk etc. The

failure

of

service

provider

in

providing

quality

service,

breach

in

security/confidentiality, non compliance with legal and regulatory requirement etc may lead to financial losses to the outsourcing bank and hence they should guard against such risks. There is need for adoption of proper risk management As per latest RBI guidelines, outsourcing of certain

practices in this regard.

functions like core management functions, internal audit, compliance, decision making etc is not allowed.

Business Facilitators Model : NGOs, Farmers' clubs, Cooperatives, Community based organizations, IT enabled rural outlets, post offices, insurance agents, panchayats, village knowledge centers, ACABC units, KVKs, KVIC/KVIB units may be involved in the models. Activities / Services Identification of borrowers and activities Collection and processing of loan applications Creating awareness about various bank products Advice on managing money and debt counselling Processing and submission of applications to banks Promotion and nurturing of SHGs and JLGs Post sanction monitoring Monitoring and handholding of SHGs/JLGs Follow up for recovery No approval of RBI is required for using intermediaries for these services

Business Correspondents Model: NGOs, MFIs, Societies registered under Cooperative Societies Act, Sec 25 companies, registered NBFCs and post offices are eligible to be covered. While engaging these agencies, banks may ensure that they are well established, enjoying good reputation and having the confidence of local population. Banks are to give wide publicity and avoid being

misrepresented. Services/activities all activities listed under Business Facilitators model disbursal of small value of credit recovery of loan

collection of small value deposits sale of micro insurance, mutual fund products, pension products receipt and delivery of small value remittances/other payment instruments

Computerization: Another segment which tries to revamp the various sectors in general and banking sector in particular, is the introduction of computers in the functioning of the banking system. Management Information System of the banks is fully utilizing the benefits of computerization. The controlling units of the bank offices are connected to the Head Office of the bank and also amongst themselves. All types of communications are now by way of computerized output of letters, statements etc.

One of the areas of computerization is total branch computerization. Under this package, all the sections of the bank branch, viz., cash, deposits, advances, minor heads of subsidiaries, day book, trial balance, etc. are computerized. The data given as input in one section is getting recorded in the contra section. The system normally does not admit any entry in which the amounts of debit and credit do not tally with each other. Thus the differences on account of transfers are totally eliminated.

Another package under branch computerization is called as ALPM which means advanced ledger posting machines. In this package, the deposit sections, current account. Savings bank, overdraft, day book etc. are computerized. This package does not cover cash, advances, etc for computerization.

ELECTRONIC BANKING One of the most exciting growth phases for the banking sector is the emergence of technology-enabled business models, which led to geographic expansion, wider product offerings and newer revenue streams. Perhaps no other sector has been affected by advances in technology as much as banking. Almost all

segments of the banking sector witnessed phenomenal growth. The share of private sector banks in total assets increased from 10% in 1998 to 23% in 2006. Electronic banking means banking done electronically. Transaction handling, cash management, account reporting are done through electronic media. Banks

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today reach their customers through ATMs, Point of Sale Devices, Telephone Banking, Internet banking etc. Thus, bank is getting itself presented as a

technology driven unit in the banking sector with the means of electronic banking. Customer visits are reduced and thereby human intervention and their consequences are avoided resulting in the reduction in the establishment cost to a greater extent. Electronic Banking comprises of the following:

a) Electronic Funds Transfer b) Electronic Clearing System c) Tele-banking d) Automated Teller Machines e) Shared Payment Network System f) Credit Cards/Debit Cards

g) Corporate Banking Terminals h) Point of Sale Terminal. i) Electronic Data Interchange

a) Electronic Funds Transfer: Transfer of funds has been made hither to in India by demand draft, mail transfer and telegraphic transfer. (EFT)SYSTEM TO RBI has devised Electronic Funds Transfer SPEEDER TRANSFER OF FUNDS

FACILITATE

ELECTRONICALLY. This will enable transfer of funds from bank accounts of one customer to the bank account of another customer. The sender and the receiver may be located in different cities or they may even bank with different banks. EFT is presently operative in Mumbai, Calcutta, New Delhi and Chennai. All the 27 public sector banks are participating under EFT System.

b) Electronic Clearing System This covers ELECTRONIC CREDIT CLEARING and ELECTRONIC DEBIT CLEARING services.

i) Electronic Credit Clearing: It is a simple, reliable and cost effective solution for bulk and repetitive payment transactions of Companies and Government departments. Companies who have

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to make bulk payments to a large number of beneficiaries prepare the credit instructions on the magnetic media and submit it to RBI. RBI processes the date, arrive at inter bank settlements and provide bank and branch-wise reports. This Credit Clearing services is available in 46 centres in India.

The institution who wants to avail this facility has to register with the sponsor bank. The sponsor bank will forward a copy of the registration to RBI after

allotting a registration number. The Institution has to prepare a magnetic media and submit to the sponsor bank. The sponsor bank would present it to the local clearing house. Clearing house debits the institutions bank account and credit the various destination bank accounts where the beneficiaries maintain their accounts.

ii) Electronic Debit Clearing: It covers payment to utility companies like telephone and electricity bills. The customer on getting the telephone/electricity bill approaches his banker and authorizes the bank to debit his account and transfer the amount to the bank account of the utility company. The bank branch prepares a floppy and sends it to the service branch which ultimately reaches the clearing house. RBI debits the individual bank/s and credit the sponsor bank of the utility company. This service is available in Mumbai, Chennai, Calcutta and Delhi.

c) Telebanking: The automatic voice recorder is used for simpler queries, which will get activated for certain specific and routine queries. Manned phone terminals are provided for answering complicated queries and transactions. The customer can actually do entire non cash related banking on telephone.

d) Automated Teller Machines: The customer is provided with an ATM card which enables him to have his routine banking transactions done without interacting with a human teller. holder can withdraw money 24 hours a day on all days. The card

Some cities are

interconnected under this service so that the cardholder can withdraw cash at one city by getting access to his account in another city.

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e) Shared Payment Network System: This is large network of ATMs spread in the city of Mumbai, Vashi and Thane. This is established as per the requirement of IBA. The participating banks issue universal cards to their customers for transactions. SPNS offers services like cash transactions, extended hours service, across the bank payments, utility payments, statements, cheque book request, standing instructions etc.

f) Credit Cards/Debit Cards : CREDIT CARDS : This is a facility of making post payment, viz., purchase now and pay later. The customer can use his credit card within the fixed limits

prescribed by his bank with various member establishments who display the acceptance of the cards in their office. The member establishments cover

airlines, hotels, railway stations, shops etc. Most credit cards carry the facility of cash withdrawals every month which can be availed with any or selective bank branch of the issuing bank.

DEBIT CARDS : This is a facility of prepaid system. Every time this card is used, the person who provides the service gets the money transferred from the account holders account. The buyer of the service who is the card holder, gets his

account debited at his branch. The individual has to approach the issuing bank for getting a debit card. The bank issues the card with a Personal Identification Number. The Card is normally operated through an electronic terminal and the transaction authority, approval etc. are known when the card is swiped through. The account holder can never overspend beyond the balance in his account because the system will reject the transaction simultaneously. Citibank and Times Bank have so far launched debit cards.

g) Corporate Banking Terminal: Large Corporate customers can log into the bank data base and have access to their accounts/transactions from their business places. Only some banks have so far provided this service to their corporate clients and that too to a limited extent.

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h) Point Of Sale Terminal : A computer terminal is linked online to a computerized customer information file in a bank. A plastic magnetically encoded transaction card identifies the customer to the computer. During a transaction, the customers account is debited and the retailers account is credited by the computer for the amount of purchase.

i) Electronic Data Interchange : EDI is the electronic exchange of business documents like purchase order, invoices etc. in a standard, computer processed, universally accepted format between trading partners. EDI can be used to transmit financial information and payments in electronic form. Recently some banks have provided the facility of using the standard formats for opening the accounts by downloading the same into the customers computer, generate the formats and use the same with the concerned bank for opening the account.

Real Time Gross Settlement (RTGS) Under the present system whenever any person wants to make payment to another person, he draws a cheque in favour of that person and delivers it t him. The recipient deposits the cheque in his account. He will receive the clear

payment after the cheque gets cleared for payment through clearing system. If both parties maintain account in the same city, the cheque is cleared in comparatively short duration. If the parties maintain accounts in different cities, the clearance time is longer. It may go beyond 7 days also. Under RTGS instead of cheque, the message is delivered to the banker of the remitter. Eg. If Mr. X who is maintaining account with SBI Chiplun Branch wants to make payment to Mr.Y who is maintaining account with Corporation bank, Mangalore branch then Mr. X will give instruction to his branch to debit his account and remit the money to Mr.Ys account., giving the account number and unique IFSC code (which is very essential) of the Ys account. The Chiplun branch will debit his account and send the instruction to the nodal branch. The treasury department in turn inputs the message in the RTGS system provided by RBI. The RTGS settlement account

of the SBI with RBI is debited and the RTGS settlement account of the Corporation Bank is credited. The message with full particulars will appear in the

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RTGS system of corporation bank.

Corporation bank in turn passes on the

message to Mangalore branch and the account of Mr.Y will be credited. The time required for all this process will not be more than few minutes. Thus the

settlement is now made on real time basis. Other than many commercial banks and private banks, Cooperative banks like Saraswat Cooperative Bank, Cosmos Bank are the members of RTGS.

Automation in Cooperative Banks: The recent developments in banking technology and expansion of

telecommunication network have ushered in new banking experience. Customers have benefited by way of quick and efficient service delivery. The increase in level of efficiency has been translated into higher profits for the banks. Most of the technology initiatives have been taken by new generation banks and the Public Sector Banks have also followed suits. Of late technology has penetrated into the Regional Rural banks as well. However, the cooperative banks have by and large remained in the periphery of this rapid technological development. Only a few cooperative banks have been able to adopt technology in a big way. Computerization is no doubt investment oriented and cooperative banks may not have the complete need or sources to go ahead with computerization. Nevertheless, when the entire country is marching ahead with computerization in the banking sector, cooperative banks cannot lag behind. Ernakulum DCCB in Kerala has implemented Core Banking Solutions. It also has mobile ATMs mounted on bus and boats. Lessons may be drawn from such banks and computerisation may be attempted by the cooperative banks. The revival

package of Vaidyanathan Committee advocates computerisation in a big way. The package has provisions for providing computers to the PACS. With the introduction of computerisation, efficiency will increase, staff can be deployed for more field work and new products can be introduced by the banks.

Cooperative Banks can consider using some of the software packages. Some are given below for adoption by cooperative banks:

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a) Deposit accounts module; Opening of deposit accounts will be standardized. Pension accounts can be segregated in a single ledger which will be convenient for operations. Term deposit accounts package can be used for generation of printed deposit receipts, which will be attractive to be depositor customers.

b) Back Office Package: Transfer waste entries can be captured under this system which will help tallying of debits with credits as a whole. The details will automatically be transferred to the respective subsidiaries. General Ledger

System and also for Day Book. Trial Balance can be generated at any point of time to find out the closing balance under the various assets and liabilities. c) MICR Clearing and clearing package: This system will help for MICR instruments clearing. The system will automatically segregate bank-wise details of receipts and payments. Generation of information for individual banks will bring down the manual labour and time. d) Establishment package: This system will help centralization of payment of salaries, Deduction particulars, and credits to the branches where the loan accounts are maintained, payments to Stores and Credit Society etc. Dearness Allowance calculations can be made automatic. Generation of increments to staff on the due dates can be programmed.

Position of Cooperatives Most of the developments taking place in the banking sector have bypassed cooperatives since they are financially not so strong and technically ill-equipped due to aging and not so qualified human resources. In order to remedy the situation and bring back the cooperatives to their glory a series of measures to Increase efficiency and ability of Cooperatives to give better services to rural clients had been initiated by Government of India and the following gives the package devised for revitalization of cooperatives:

Govt. of India Revival Package for STCCS (Vaidyanathan Committee) The Government of India (GoI) is committed to increasing the flow of credit to agriculture, especially to small and marginal farmers. The short term rural

cooperative credit structure (CCS), which should play a central role in this respect, is unable to do so. This structure is severely impaired financially and

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institutionally.

Its share in total credit flow to agriculture has been declining.

Concerned at this state of affairs, the GoI had set up a special Task Force in August 2004 under the Chairmanship of Prof.A.Vaidyanathan to suggest an implementable action plan for reviving the CCS. The Task Force submitted its report to the GoI on 04 February 2005. The Government, after due consideration, accepted their recommendations in principle. The recommendations are now being implemented.

The package is aimed at reviving the short-term rural cooperative credit structure (STCCS) and make it a well-managed and vibrant medium to serve the credit needs of rural India, especially the small and marginal farmers. It seeks to (a) provide financial assistance to bring the system to an acceptable level of health; (b) introduce legal and institutional reforms necessary for their democratic, selfreliant and efficient functioning; and (c) take measures to improve the quality of management. It is to be emphasised that all three components are equally important and should be treated and implemented as an integrated package.

Financial assistance under the package would cover accumulated losses in the CCS. This however, does not mean writing off of the loans which are yet to be repaid by the borrowers. The cooperatives will have to continue to make efforts to recover these loans and thereby improve their financial health further.

Financial Package Financial restructuring will start with first bringing the PACS to an acceptable level of financial health through cleansing of their balance sheets and strengthening their capital base and then move on to upper tiers. This step will enable PACS to clear their dues to the upper tiers and thereby reduce the accumulated losses of DCCBs. The DCCBs will thereafter be provided assistance to clear the remaining balance of accumulated losses, if any, and to reach a minimum norm of capital adequacy. The same process will apply to the SCBs.

Financial restructuring will include criteria for determining the eligible purposes and institutions, quantum of assistance required, pattern of sharing the liability, conditionalities attached and the time frame.

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Financial assistance under the package will be available for wiping out accumulated losses, covering invoked but unpaid guarantees given by the state governments and other dues to the CCS from them and increasing the capital to a specified minimum level. In order to ensure that the CCS continues on sound financial, managerial and governance norms. Technical assistance will also be provided to upgrade institutional and human resources of the CCS.

Sharing Pattern The liability for funding the financial package will be shared by the GoI, State governments, and the CCS based on origin of loss and existing commitments.

The Central Government will bear 100% of the losses arising out of direct credit business of PACS, 100% losses out of the agricultural credit business of DCCBs and SCBs and a portion of their losses out of non agricultural credit business, 50% of the losses due to PDS and input distribution undertaken in pursuance of national policy, the requirement of resources to raise CRAR to 7% and the full cost of technical assistance for human resource development, computerisation and improving accounting systems.

State governments will bear 50% of the losses on account of PDS and input distribution, all dues pertaining to invoked guarantees and other receivables, and a small portion of losses out of non agricultural business of DCCBs and SCBs.

The CCS will bear losses for activities like direct advances taken up on their own and losses due to frauds etc.

Regulation The fiduciary nature of relationship between the RBI and a cooperative bank which accepts public deposits entails, by definition, that the regulator should have the authority not only to lay down prudential norms but also in regard to those aspects of management which have a bearing on the financial health of the institution. It is also essential to ensure that the directives of the Regulator are implemented strictly and expeditiously. The BR Act and the respective

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Cooperative Societies Acts would accordingly be suitably amended to empower the RBI to lay down the guidelines for the fit and proper criteria for the CEOs and the professional Directors on the Boards of cooperative banks, prescribe a panel and the prudential guidelines requiring audit by Chartered Accountants. The RCS will implement and monitor these guidelines within a given timeframe.

Legal and Institutional Reforms A) Reforms in the Cooperative Societies Act : As making legal amendments is time consuming process, the state governments may issue Executive Orders under the existing powers to bring in the desired reforms which will relate to:

i.

Ensuring full voting membership rights on all users of financial services

including depositors in cooperatives other than cooperative banks ii. Removing state intervention in all financial and internal administrative

matters in cooperatives iii. Providing a cap of 25% on government equity in cooperatives and limiting

participation in the Boards of cooperative banks to only one nominee. Any state government or a cooperative wishing to reduce the state equity further would be free to do so and the cooperative will not be prevented from doing so iv. Allowing transition of cooperatives registered under the CSA to migrate

under the Parallel Act (wherever enacted) v. vi. Withdrawing restrictive orders on financial matters Permitting cooperatives in all the three tiers freedom to take loans from any

financial institution and not necessarily from only the upper tier and similarly placing their deposits with any regulated financial institution of their choice. vii. Permitting cooperatives under the parallel Acts (wherever enacted) to be members of upper tiers under the existing cooperative societies Acts and vice versa viii. Limiting powers of state governments to supersede Boards ix. Ensuring timely elections before the expiry of the term of the existing Boards x. Facilitating regulatory powers for RBI in case of cooperative banks as mentioned earlier xi. Prudential norms including CRAR for all financial cooperatives including PACS.

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B) Reforms in the BR Act 1949: Amendments to the BR Act would cover the following: i. All cooperative banks would be on par with the commercial banks as far as

regulatory norms are concerned. ii. RBI will prescribe fit and proper criteria for election to Boards of cooperative banks. Such criteria would however not be at variance with the nature of

membership of primary cooperatives which constitute the membership of the DCCBs and SCBs. iii. However, as financial institutions, these Boards would need minimum support at the Board level. Thus, the RBI will prescribe certain criteria for

professionals to be on the Boards of cooperative banks. In case members with such professional qualifications or experience do not get elected in the normal electoral process, then the Board will be required to co-opt such professionals in the Board and they would have full voting rights iv. The CEOs of the cooperative banks would be appointed by the respective banks themselves and not by the state. However, as these are banking

institutions, RBI will prescribe the minimum qualifications of the CEO to be appointed and the names proposed by the cooperative banks for the position of CEO would have to be approved by RBI v. Cooperatives other than cooperative banks as approved by the RBI would not accept non-voting member deposits. Such cooperatives would also not use words like bank, banking, banker or any other derivative of the word bank in their registered name.

If a State Government and the CCS units in that state are enthusiastic in implementing the package, fulfilment of all the above conditionalities and consequently release of the entire financial assistance could be completed even within a year.

Implementation Mechanism NABARD has been designated as the implementing agency for the scheme. However, for guiding and monitoring the implementation of the scheme at national, state and district levels, Implementing and Monitoring Committees would be constituted. At national level this committee comprises Secretary (Financial

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Sector), Secretary (Agriculture), RBI, NABARD, state governments under review in any meeting, and two eminent co-operators. This committee reports to the

Finance Minister on a quarterly basis. At the state level, the committee comprises the Secretary (Finance), Secretary (Cooperation), RCS, NABARD, SCB and a Chartered Accountant. constituted. At the district level, similar committees have been

With the implementation of the recommendations of Vaidyanathan Committee, it is expected that the rejuvenated cooperative credit structure will play a vital role in the banking sector of the country.

Banking services have penetrated only 68 million of the 192 million households (i.e. 35% of total households) indicating a huge untapped potential. The

cooperative banks have to utilize this untapped household by finding out their requirements and make the business in terms of mobilization of deposits and lending of loans. Better service quality, innovative products, better bargains are all greeting the Indian customers. An increasing size of the banking pie itself indicates that there is a lot of untapped potentials in the market for banking. Even though the challenges ahead are of great, the Indian banking system is optimistic in facing the challenges head-on, by adopting proactive changes. Positively, the new era beckons Customer Delight and builds up a new banking horizon.

Conclusion Due to stiff competition for other payers in the rural credit, cooperative banks are facing serious challenges at this juncture. The enhanced role of the banking sector in Indian economy and the increasing levels of competition have placed numerous co-operatives. demands on

Globalization has also resulted in improved risk management

practices. In such circumstances, the cooperatives shall have to shoulder greater responsibilities: 1. To step up their network of services to ensure sustainable growth in agriculture production 2. Generate potentials for rural employment in view of shifting policy of the government.

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The cooperative banks have to face the latest challenge in the form of technology adoption. Ironically to mention, many cooperative banks do not even have

computers in many of their branches. Presently, the role of cooperatives, no longer remains confined to their traditional activities, but expanded to new economic ventures as in the case of other enterprises in the public or the private sector. It is high time for the cooperative banks to understand the changing environment in banking and rise with suitable strategies to meet the future confidently. The revival package offered by the GOI is to rejuvenate the rural cooperative credit structure. The cooperatives which are the beneficiaries of the financial package, should therefore, utilize it effectively, change according to the present days requirement and offer according to the customers expectations so as to withstand the competition.

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CHAPTER 2

(Session 3)

CHANGE MANAGEMENT, LEADERSHIP DEVELOPMENT AND ROLE OF DIRECTORS Change Management

Introduction The only thing permanent in this world is change. This however does not stop people from resisting change. We tend to remain in the comfort of our present activity zone even when we are sure that the comfort will not continue. Once a child put a frog in the water kept in a vessel. Just as a childs play, he started heating the water on a stove. The frog first smelt danger but preferred not to change. Slowly it started feeling discomfort in the hot water. Gradually the heat became unbearable but it was too late to jump out because by that time the frog had lost all the energy to jump out. It thus died a slow death. The frog killed itself because of the resistance to change.

Readiness to Change Readiness to change emerges from our ability and willingness. Ability to change is acquired from our knowledge, skills and imagination. Willingness to change

comes from our perception which in turn is the result of our feelings and the angle from which we view things.

Perception is the sum total of the experience of our self enhancing and self destroying feelings. Our perception is also moulded from the goal we keep and

the commitment we show to the goal. It is told that Mahatma Gandhi once met Acharya Kriplani during one of his holiday trips. During their conversations Shri Kriplani mentioned to Mahatma Gandhi that there is no history of any nation getting its independence through non-violence. Mahatma Gandhi replied to Shri Kriplani Professor, you are a professor, you teach history, I shall make history. The perception of Mahatma Gandhi finally begot independence to us.

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Change the World

When I was a young man I wanted to change the world. I found it was difficult to change the world, so I tried to change my nation When I found I could not change the nation, I began to focus on my town. I could not change the town and as an old man I tried to change my family.

Now as an elderly person I realize that the only thing I can change is myself. And suddenly I realize that if long ago I had changed myself, I could have made an impact on my family, My family and I could have made an impact on our town, Their impact could have changed the nation. And I could have changed the world.

Positioning oneself in the changing scenario It is important to assess and evaluate, where we position ourselves in the changing scenario. This is brought out by the matrix on the next page. In the matrix, if my efforts are high, though I do not agree with the change, I am a follower. In extreme cases they become Yes boss! Men. Such people tend to become careerists. When my efforts and my agreement both are low, I am a dissenter and I will oppose the change. When my agreement with the change is high and my effort is low, I am a pretender. In such a case I do not put any effort to effect the change. When both my agreement with the change and my efforts to make the change are high, I will be the leader.

It is not that one has always to be the leader. If the perceived change is not going to meet the goals of the leader, the follower and the corporate or the society, one is justified in being a dissenter opposing the change. Similarly it is also possible that in the initial stages when one does not fully accept the impact of the change, one could be a follower or a pretender. But this should remain a passing phase during which one becomes a leader or dissenter.

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Change Management Matrix High LOW HIGH

M Y

Pretender

Leader

Pretends to agree with the change A G G R E E M E N T Will work against the change, We should be more practical attitude Dissenter and work for it

Capacity and Efforts to identify the Pretenders, Followers and Dissenters

Follower

Does what the boss wants, Career minded

Low MY EFFORTS

Role of a Leader One of the main roles of a leader is to create more leaders. Thus in a changing scenario, if the leader finds followers, the leader recognizes that the followers do put in efforts though they do not agree with the change. If the leader could make them agree with the change through suitable awareness programme, the followers will end up agreeing with the change and putting efforts automatically making the m leaders.

The pretenders on the other hand agree with the change, but do not put in efforts. The leader could participate with them and make them put in efforts when they also could be made leaders as in that process they too end up agreeing with the change as also putting efforts for the change.

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A dissenter could be made a leader for the change by first making him a follower or a pretender and then transform him into a leader.

Team Building
Leaders alone cant do the job. They may lead, but they need others to follow. It is, therefore, important to focus on how we work with others and build unity among them. Working groups have their own sense of identity and successful leaders understand that working groups have their own personality, power, attitudes, standards, and needs. Leaders who take these things into account can achieve success because they respond to those group needs. To meet group needs and to keep their morale high, leaders: set and maintain group objectives and group standards; provide regular opportunities for briefing groups on current plans and future developments; involve groups as a whole in the achievement of objectives; provide regular opportunities for genuine consultation before reaching decisions affecting groups; maintain the cohesiveness of groups and effectively deal with differences, arguments, and conflicts. To function effectively as a team, group members must also be aware of the factors that contribute to, or hinder, a teams functioning. Team members should have the opportunity to agree on the particular factors they need to work on in their own team. Below is a list of characteristics of effective teamwork, shown in ideal conditions.

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1. Group Goals/Objectives: All team members must clearly understand group, goals. Teamwork also requires ownership of team goals, therefore, members need to participate in setting team goals and commit to them. The effective coordination of a teams resources depends largely on leaders abilities to specify the objectives they want to achieve. They waste time and energy if: (a) the team does not clearly understand and agree on those objectives, or (b) they do not agree on the priorities. 2. Roles and Responsibilities: Who does What in the Team. When team members have clear understandings, acceptance of and commitment to team goals and priorities, the team next asks: Who is going to do what? What are our responsibilities? Do all members understand what they and others are to do to accomplish the task? As group members work together, they also build expectations of one another. Conflict over roles and responsibilities may occur because of differing expectations. Many problems arise simply because people are not clear about what they expect of each other. Beside differing expectations, overlapping roles and responsibilities create tensions, especially when two or more members see themselves as responsible for the same task. Discuss these role expectations and overlaps. Teams frequently waste energy because people have not developed clear and agreed-upon role definitions. 3. Group Procedures or Work Processes: This focuses on how the group works together. Effective teamwork requires clear and agreed-upon procedures in several key areas: How do we make decisions? Who is responsible for the decisions? How do all team members participate in the decision? Clearly define these answers so that teams make high-quality decisions that all members accept. Teams usually make

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decisions by consensus. However, leaders may reserve the right to make final decision after consulting with all or some part of the team. It is also necessary to be clear as to what should be communicated within the team, to whom, how frequently and by what method. Group members generally complain among themselves that team meetings are dull, repetitive, ineffective, too long, too frequent, dominated by a few, cover the wrong subjects and a waste of time. To help change this attitude, team meetings need to confront the questions such as - what is the team trying to accomplish in this meeting? what topics will we cover? who should attend? how will we conduct the meeting? Generally, we use group procedures or work processes as means to do things such as share information or to make decisions to assure coordinated team activity. 4. Interpersonal Relationships: When people have to work closely together to achieve a common task they naturally develop feelings toward each other. The extent to which they mutually trust, support, communicate, and feel comfortable greatly influences the way they work together. Teamwork requires trust and openness so that members can state their views and differences openly without fear of ridicule or retaliation. When group members have a strong sense of belonging and of mutual support, they get and give help from one another without setting conditions. They do not have to protect their roles against others. If there is a mutual support, the members dont have to guard their communication and can freely say what they feel and how they react to each other. When they communicate, they know the rest of the team listens and will work hard to understand. The groups ability to examine its process to improve itself characterizes teamwork. Group members accept differences as inevitable and sometimes desirable. They dont suppress them or pretend they dont exist. They work through them openly as a team. 5. Group leadership Needs: Teamwork requires that they share leadership needs (such as initiating or clarifying), among the group so that all grow through the group experience. Leadership styles used by group leaders greatly affect the teams communication and work processes. Team leaders must frequently

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examine the impact of their styles and be open to feedback from members regarding how such styles contribute to, or detract, from the teams effectiveness. 6. Using Member Resources: Teamwork requires the maximum use of the different resources of individuals in the group, such as abilities, knowledge, and experience. They accept and give advice, counsel, and support to each other, while recognizing individual accountability and specialization. 7. Organizational Environment: When groups have flexibility, sensitivity to each others needs, and they encourage differences, and members dont feel pushed to conform to rigid rules, they have achieved teamwork. Teamwork means they work hard at keeping their team climate free, open, and supportive.

Role of Board of Directors Some Dos and Donts

Board of Directors of the Cooperative Bank should ensure that proper loan policies are adopted and followed. It should be ensured that all circulars and other material relating to policies issued by RBI/NABARD/GoI/State Government are seen by every member of the Board and also placed before the Board for suitable action. A list of Dos and Donts for guidance of the directors of Cooperative Banks is given below. The list is illustrative and not exhaustive and is not to be regarded as a substitute to the specified duties, responsibilities or rights of the Board of Directors as enunciated in the cooperative law and / or Bye-laws of the respective banks.

Dos
Discipline & Involvement : The Directors should : i. Attend the board meeting regularly and effectively. They should work in a spirit of Cooperation. ii. Study the board papers thoroughly and use the good offices of the Chief Executive Officer for eliciting any information at the Board Meeting. iii. Ask the CEO to furnish the board papers and follow up reports on a definite time schedule. iv. Be familiar with the broad objectives of the bank and the policy laid down by the Central and State Government, Reserve Bank of India and NABARD.

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v. Involve themselves thoroughly in the matter of formulation of general policy and also ensure that performance of the bank is monitored adequately at board level.

Constructive & Development : i. Welcome all constructive ideas for the better management of the bank and for making valuable contribution. ii. Try to give as much of their wisdom, guidance and knowledge as possible to the management. iii. Analyse the trends of economy, assist in the discharge of managements responsibility to public and formulation of measures to improve customer service and be generally of constructive assistance to the bank management. iv. Work as a team and not sponsor or be prejudiced against individual proposals. Management on its part is supposed to furnish full facts and complete papers in advance.

Business Specific Contribution : The Directors should bestow attention on the following aspects of the banks working: i. Compliance with monetary and credit policies of Central and State Government, RBI and NABARD. ii. Observance of cash reserve and statutory liquidity ratio. iii. Efficient management of funds and improving profitability. iv. Compliance with guidelines on income recognition, asset classification, provisioning towards non performing assets. v. Deployment of funds to priority sector/ weaker sections. vi. Diversification in business vii. Overdues and recovery - ensure that recoveries are made promptly and overdues reduced to the minimum. viii.Review of action taken on NABARD inspection/ statutory audit reports. ix. Vigilance over frauds and misappropriation. x. Strengthening of internal control system and housekeeping viz. proper maintenance of books of accounts and periodical reconciliation.

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xi. Reviews on different items as prescribed by NABARD and other higher agencies. xii. Service to Members/Customers. xiii.Development of a good management information system. xiv. Computerisation.

Donts
Non-Interference : The Directors should not : i. Interfere in the day-to-day functioning of the bank. ii. Involve themselves in the routine or every day business and in the management functions. iii. Send instructions / directions to any individual officer/ employee of the bank in any manner.

No Sponsorship : The Directors should not i. Sponsor any loan proposal, buildings and sites of banks premises, enlistment or empanelment of contractors, architects, doctors, lawyers, etc. ii. Approach or influence for sanction of any kind of facility. iii. Participate in the Board discussions, if a proposal in which they are directly or indirectly interested, comes up for discussions. They should disclose their interest, well in advance, to the Chief Executive Officer and the Board. iv. Sponsor any candidate for recruitment or promotion or interfere in the process of selection/ appointment or in transfers of staff. v. Do anything which will interfere with a / or be subversive of maintenance of discipline, good conduct and integrity of the staff. vi. Involve themselves in any matter relating to personnel administration - whether it is appointment, transfer, posting, promotion or a redressal of individual grievances of any employee. vii. Encourage the individual officer/ employee or unions approaching them in any matter.

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Confidentiality i. The Directors should not reveal any information relating to any constituent of the bank to anyone as he is under oath of secrecy and fidelity. ii. The Directors are expected to ensure confidentiality of the banks agenda papers / notes. iii. The Directors should not directly call for papers/ files/ notes recorded by various departments for scrutiny etc. in respect of agenda items to be discussed in the meetings. All information/ clarification that they may require for taking a

decision should be made available by the CEO. iv. A Director may indicate his directorship of the bank on his visiting card or letter head, but the logos of distinctive design of the bank should not be displayed on the visiting card/ letter head. v. The Directors should ensure that the banks funds are utilised in a proper and judicious manner for the benefit of general members.

Note: The list is only illustrative and not exhaustive

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CHAPTER 3

(Session 4)

IMPORTANT PROVISIONS OF VARIOUS ACTS

BANKING REGULATION ACT, 1949 AS APPLICABLE TO COOPERATIVES

INTRODUCTION The Banking Regulation Act (1949) came into being in 1949. Prior to that, certain provisions of Companies' Act 1913 were applicable to Banking Companies. The need for the act was felt because there was little control and regulation over banks, with many banks getting into trouble due to poor management loan / investment portfolio and non-maintenance of adequate liquidity. This was also further complicated by mushroom growth of banks and closure and failure of some banks.

Strictly speaking the whole of BR Act is applicable only to Banking Companies or the Private Sector Banks. The sections of the Act applicable to nationalized

banks including State Bank of India and its subsidiaries, and RRBs are indicated in section 51 of the Act.

In 1965 considering the important role being played by cooperative banks in the banking system, certain provisions of the BR Act were modified and made applicable to cooperative banks. These are discussed in section 56 of the Act. The salient features of the act are discussed in following paragraphs.

BR Act is not applicable to PACS and LDBs.

Section-11

Requirement as to minimum paid-up capital and reserves

No cooperative bank shall commence or carry on the business of banking in India unless the aggregate value of its paid-up capital and reserves is not less than one lakh rupees. Value means "Real or Exchangeable Value" (REV) as approved by RBI / NABARD during the inspection of the bank. This is illustrated as under:

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For any bank balance sheet, Total Assets = Total Liabilities. Assets could be good or bad and Liabilities comprise Outside Liabilities and Owned Funds. i.e. Realizable Assets + Erosion = Outside Liabilities + Owned funds i.e. the Realizable Assets Outside Liabilities = Owned funds Erosion = REV In other words, The Real or Exchangeable value of the bank could be calculated as Realizable Assets less Outside Liabilities or Owned Funds less Erosion

Section-18

Cash Reserve

Every cooperative bank, not being a scheduled SCB, shall maintain by way of cash reserve with itself, or by way of balance in current account with RBI or SCB of the state concerned, or by way of net balance in current account a sum equivalent to at least 3 % of its Demand and Time Liabilities (DTL) as on last Friday of the second preceding fortnight. Scheduled cooperative banks will have to maintain CRR as per RBI Act.

Section 19

Restriction on holding shares in other cooperative societies

No cooperative bank shall hold shares in other cooperative societies except to such extent and subject to such conditions as RBl may specify. This does not apply to shares acquired through funds provided by the State Govt. on that behalf and DCCBs holding shares of affiliated SCB.

Section 20

Restriction on Loans and Advances

No cooperative bank shall make loans and advances on the security of its own shares or grant unsecured loans or advances to any of its directors or to any firm or private company in which the director has interest.

This above clause shall not apply to grant of unsecured loans or advances made by a cooperative bank against bills for supplies or services made or rendered or bill of exchange arising out of bonafide commercial or trade transactions or trust receipts furnished to the cooperative bank or Loans made by primary cooperative banks on terms approved by RBI.

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Section-22 Licensing of banking company All cooperative societies doing banking business in India except a primary credit society will have to hold a licence issued by RBI. This Section shall not apply to a cooperative bank which was carrying on banking business on 01 April 1966 at the commencement of the Banking Laws for a period of one year from such commencement. Cooperative banks functioning prior to the commencement of the Act were required to apply for licence to RBI and may continue to do banking business until they are notified by the Reserve Bank that licence cannot be granted.

Section-23 Restriction on opening of new and transfer of existing places of business Without prior permission of RBI, no cooperative bank shall open a new place of business in India or change otherwise than within the same city, town or village, the location of an existing place of business;

Section-24 Maintenance of Statutory Liquid Assets Every cooperative bank, in addition to the cash reserve required to maintain under section 18 of the BR Act, shall maintain in India in cash, gold or unencumbered approved securities an amount which shall not, at the close of business on any day, be less than 25 % or such other percentage, not exceeding 40 % of the total of its Demand and Time liabilities in India, as on the last Friday of the second preceding fortnight. For the purpose of this section, cash maintained in India shall include any cash or balances maintained by a cooperative bank, other than a scheduled state cooperative bank, with itself or with the state cooperative bank of the state concerned or in the current account with the RBI or by way of net balances maintained in current Account in excess of the aggregate of the cash or balances required to be maintained u/s 18 of the Act.

Sections-29, 30 & 31

Balance Sheet

Cooperative banks to prepare the Year-end Balance Sheet and Profit and Loss Account and submit the same to RBI and NABARD within six months from the end of the year.

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Section-35

Inspection

NABARD has been empowered to inspect the cooperative banks other than primary cooperative banks, without prejudice to the powers of RBI, to conduct such inspection.

Section 53 Power to exempt The Central Govt. may, on the recommendation of RBI, can exempt any banking company or any class of banking companies from any or all provisions of this Act.

RESERVE BANK OF INDIA ACT, 1934

INTRODUCTION The most important section of RBI Act applicable to cooperatives is section 42. The salient features of this section are as under:

Section-42

Cash Reserves of Scheduled Banks to be kept with RBI

42(1) Every bank included in the Second Schedule shall maintain with the RBI an average daily balance the amount of which shall not be less than three per cent of the DTL in India of such bank. RBI may by notification, increase the rate which shall not be more than twenty percent of the DTL.

42(2)

Every scheduled bank shall send to the RBI a return signed by two

responsible officials showing the amount of DTL and amount of borrowings from banks in India and other relevant details.

42(3) If the average daily balance held at the RBI by a scheduled bank during any fortnight is below the minimum prescribed, such bank shall be liable to pay to RBI penal interest at the rate of three per cent above bank rate on the amount of shortfall from the prescribed minimum.

For default during next succeeding fortnight, penal interest shall be increased to five per cent above bank rate. For further defaults, every director, manager or secretary of the scheduled bank shall be punishable with fine which may

36

extend to Rs 500 and more stringent penalties also. prohibited to receive deposits.

The bank may be

42(6) (a) Inclusion in the Second Schedule The RBI shall by notification in the Gazette of India, under Section 42(6) (a) direct the inclusion in the second schedule of a bank which carries on the business of banking in India, provided it has a paid -up capital and reserves of an aggregate value of not less than five lakhs of rupees and satisfies the RBI that its affairs are not being conducted in a manner detrimental to the interest of the depositors, or it is a state co-operative bank or an institution notified by the Central Government in this behalf.

Any bank included in the second scheduled of RBI Act is generally known as scheduled bank. In 1966 when BR Act was made applicable to cooperative banks, RBI took a policy decision to include the then existing SCBs in the second schedule. However these banks were required to apply for license to RBI. There are some SCBs which are not considered eligible for issue of

license. These SCBs are thus scheduled banks but not licensed.

42(6) (b) RBI shall direct exclusion of any scheduled bank from second schedule

provided the aggregate value of whose paid-up capital and reserves becomes at any time less than five lakhs of rupees, or in the opinion of the RBI, after making an inspection under section 35 of BR Act, 1949, the conduct of the affairs of the bank is detrimental to the interest of its depositors.

Section 42(7) RBI may grant to any scheduled bank such exemptions from the provisions as it may deem fit.

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CO-OPERATIVE SOCIETIES ACT (The provisions given below are prior to the amendments suggested by Vaidyanathan Committee. The suggested amendments are given in the Annexure. Many of the states have already carried out the amendments mostly on the suggested lines)

IMPORTANT PROVISIONS Certain Definitions: Agricultural Credit society - means a credit society, majority of ordinary members whereof are primarily engaged in agricultural operations.

Credit society - means a society which has its primary objective of raising of funds to be lent to its members.

Authorities Matters relating to every co-operative society shall be subject to the supervision and control of the RCS of the state. Director of Cooperative Audit (DCA)

appointed by the State Govt. DCA is responsible for audit of the cooperatives.

Registration of coop. Societies A society which has as its objective, the promotion of the economic interest of its members, in accordance with co-operative principles; or a society established with the objective of facilitating the operations of such a society, may be registered under the Act. One registered the cooperative society becomes a legal person. It becomes a body corporate.

Application for Registration: In prescribed form and to contain certain information and specifications such as: three copies of bye-laws no of applicants , if individuals, not to be less than 10 individual member not to be below 18 years If a credit society, then the applicant should be ordinary members of the society.

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Amendment of bye-laws of a co-operative society:No amendment of any bye-laws of a cooperative society shall be valid unless such amendment has been registered under the Act. How the Registrar is satisfied about the proposed amendments ? Amendments sought are:not contrary to the provisions of the Act and rule does not conflict with cooperative principles will promote economic interest of the member is not inconsistent with the principles of social justice

RCS shall forward to the society a copy of the registered amendment together a certificate signed by him. Such certificate shall be conclusive evidence that

amendment has been duly registered. If the amendment sought is not desirable in the opinion of the RCS, the RCS may call upon the cooperative society to make amendments as proposed by him, in such a manner as may be prescribed and within such time as he may specify.

RCS has powers to direct amendment in bye-laws:Where the RCS is of the opinion whether on representation of a member of a cooperative society or otherwise, he may direct amendment of bye -laws.

In the event of failure of a society to amend as proposed by RCS, then what? If a society fails to make an amendment within the time specified, the RCS may, after giving the society an opportunity of being heard, register such amendment and issue the society, by registered post, a copy of the amendment certified by him as a copy.

MEMBERS OF COOPERATIVE SOCIETIES Persons who may become members? an individual competent to contract under section 11 of Indian Contract Act any other cooperative society the State Govt. the Central Govt. the state warehousing corporation.

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Classes of Members A cooperative society, in addition to ordinary members, may have following kinds of members-. a) b) c) Sympathiser members, Nominal members Associate members

Sympathiser Member A person may be admitted as a sympathiser member, if he is genuinely interested in the promotion of the objective of the society or the welfare of the member workers. Number of sympathiser members should not more than 5 percent of the total number of ordinary members.

Nominal Members A person with whom the cooperative society has or proposes to have business dealings may be admitted as a nominal member. A nominal member shall have no right to share in the profits of the society nor shall be eligible for membership of the Committee of Management.

Associate Member Associate member may hold shares but no right to share in profits otherwise than as wages and bonus. He will not be a member in the Committee of Management. An individual including a minor can be an associate member.

Member not to exercise rights till due payment is made No member of a cooperative society shall exercise the rights of a member unless he has made such payments to the society in respect of membership or has acquired such interest in the society, as may be specified in the bye-laws.

MANAGEMENT OF CO-OPERATIVE SOCIETIES Final authority in a cooperative society:Final authority of a cooperative society shall vest in the General Body of the members. An Annual General Body meeting of a cooperative society shall be held once in a year within a period of 3 months after the date fixed for making up

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its accounts for the year for the purpose of approval of the programme of activities, election, if any and consideration of annual report audit report and disposal of net profit

Committee of Management:Management of a cooperative society vests in a Committee Committee shall consist of not less than 9 members one reservation for women, one for SC/ST Term of office of the Committee three years Elections to be held for the entire committee other than the nominated members.

Nominee of the Government on the Committee of a Cooperative society:How the Govt. gets such right of nomination? Government has subscribed to the share capital assisted in formation or augmentation of the share capital guaranteed repayment of principal and payment of interest on debentures guaranteed debt repayments

How many nominees ? State Govt has the right to nominate as its representatives not more than 3 persons or 1/3 rd of the total number of members of the Committee of the Cooperative society, whichever is less.

Conditions for Suppression of the Committee In the opinion of the Registrar, If the committee is negligent, makes default, commits any act prejudicial to the interest of the society or society is not functioning in accordance with the provisions of the Acts, Rules and byelaws; then RCS may remove the said committee and appoint an Administrator for such period not exceeding one year. More than 70 % of total dues of any primary society, which is a credit society, against its members during any cooperative year remain unpaid at the end of such year;

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The number of defaulting members exceeds 70 % of the total number of indebted members of such society at the end of such year; then the chairman and all the members of the committee shall vacate their offices.

Appointment of Special Officer:Upon the report of the RCS or otherwise, the State Govt. may appoint a special officer Maximum period of 2 years can be extended by another year Special officer subject to control of RCS/State Govt shall perform all functions of the Committee Special officer shall before expiry of the term, arrange for constitution of a new committee

Powers with State Govt. to give direction In public interest affairs of the society being conducted detrimental to the interest of the members that will be binding on the society The above powers of the Govt. can be delegated to the RCS, by a specific notification.

PRIVILEGES OF COOPERATIVE SOCIETIES First charge of cooperative society on certain assets

Charge on land owned by members or held as tenants by members borrowing loans from certain cooperative societies Deduction from salary, to meet society's claim in certain cases- the employer shall be competent to deduct from the salary, or wages and pay, to the society in satisfaction of any debts Charge and setoff in respect of shares or interest of members in the capital of a cooperative society:- a cooperative society shall have charge upon the share or interest in the capital etc. payable to a member and may setoff any sum credited or payable to a member 42

It shall not be necessary for any member of a committee, secretary or any other officer to appear in person or by agent at any registration office in any proceedings connected with registration of any instrument

STATE AID TO COOPERATIVE SOCIETIES Direct partnership of state Govt in cooperative societies- subscribes to share capital, not entitled to any dividend at a rate higher than that is payable to any other share holder.

Indirect partnership of state govt in cooperative societies;-- state govt to provide moneys to Cooperative societies ( Apex society) for purchase of shares in other cooperative societies.

PROPERTIES AND FUNDS OF A COOPERATIVE SOCIETY Net profit and its disposal: Out of net profits, transfer an amount not less than 25 % to Reserve Fund. No society shall pay a dividend to its members on their paid up capital at a rate exceeding the prescribed limit. Balance of net profit to be utilised for all or any of the following purposes:Payment of dividend to members on paid up share capital at a rate not exceeding 9%. Payment of bonus to the extent and in a manner as specified in the Rules and bye-laws. Constitution of or contribution to bad debt fund, building fund, rural improvement fund or any other fund. Donation of amounts not exceeding 5 % or 10% for charitable purpose Payment of bonus to the employees of the society.

Investment of Funds in Government saving bank in trustee securities shares/ securities of any cooperative society any cooperative bank or scheduled bank approved by Registrar

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Restriction on Borrowings-> Government may prohibit or restrict the power to borrow from a credit agency Restriction on Loans cooperative society not to make loans to any person other than a member; with the general and special-sanction of RCS, a cooperative society may make loans to another cooperative society, a cooperative society may make loan to a depositor on the security of his deposits

AUDIT, INQUIRY, INSPECTION Audit RCS/Director of Cooperative Audit shall audit or cause to be audited the accounts of every cooperative society at least once every year;

Cooperative society to prepare and furnish within 2 months from the end of the year to RCS and DCA statements showing Receipts and Disbursements, P/L account and B/S and returns .

Inspection of books of cooperative society by credit agency: A credit agency shall have the right to inspect the books of any cooperative credit society which has applied to the credit agency for financial assistance or is indebted. Inspection may be made by an officer of the credit agency. Officer inspecting shall have free access to the books, documents, securities etc.

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Annexure Amendments Suggested by Vaidyanathan Committee

As recommended by the Vaidyanathan Committee, the State Cooperative Socities Acts are to be amended suitably to operationalise following provisions.

1. Ensuring full voting membership rights to all depositors/borrowers in cooperatives other than co-operative banks.

2. Providing autonomy to CCS in all financial and internal administrative matters, especially in the following areas : i. interest rates on deposits and loans in conformity with RBI guidelines, ii. borrowings and investments, iii. loan policies and individual loan decisions, iv. personnel policy, staffing, recruitment, posting, and compensation to staff, and v. internal control systems, appointment of auditors and compensation for audit.

3. Restricting the State governments equity to a maximum of 25% in any cooperative at any level and limiting State participation in the Board of a cooperative bank to only one nominee and not to have any State nominee on the Board of any primary agricultural credit society. Any State or a cooperative at any level wishing to reduce the State equity further would be free to do so and the cooperative will not be prevented from doing so.

4. Allowing transition of any cooperative registered under the State Cooperative Societies Act to the parallel Self Reliant Cooperative Societies Act, when enacted and permitting cooperatives under the Self Reliant Cooperative Societies Act (wherever enacted) to be members of federal structures registered under the .. Cooperative Societies Act, and vice versa.

5. Allowing freedom to any cooperative in the CCS to affiliate or disaffiliate with a federal structure of its choice.

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6. Allowing freedom of entry and exit for any unit of CCS at any level with no mandated restrictions of geographical boundaries for its operations.

7. Withdrawing any restrictive orders on financial matters like investments to be made by cooperatives and permitting them to invest funds, subject to the guidelines as may be prescribed by RBI.

8. Permitting any cooperative in all the three tiers freedom to take loans from any RBI regulated financial institution, and refinance from NABARD or any other refinancing agency directly or through any RBI-regulated financial institution of its choice and not necessarily from only the federal tier to which it is affiliated, and similarly, placing its deposits with or making investments in any regulated financial institution of its choice and not necessarily with only the federal tier to which it is affiliated.

9. Laying down guidelines for the purpose of payment of dividend by PACS in consultation with NABARD.

10. There shall be no compulsion on contribution to funds other than those required for improving the net worth / owned funds of the societies.

11. The Director representing a Society other than PACS on the board of a CCB or SCB shall get disqualified in the event of the society committing a default for a period exceeding 90 days.

12. The person who is a defaulting member or office-bearer of a defaulting PACS shall not be eligible to be elected to the Board of the society or the bank as the case maybe, or continue on the Board for more than one year unless the default is cleared.

13. Ensuring implementation of regulatory prescriptions of the RBI in the case of SCB and CCBs, including supersession of the Board of the SCB or a CCB or winding up of the SCB or a CCB and appointment of a liquidator, within one month of being so advised by the RBI.

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14. Supersession of the Board of the SCB or a CCB by the RCS under any other clause of the State Co-operative Societies Act shall be done only in consultation with RBI. The Board of a PACS shall be superseded by the RCS only under the following conditions:

14.1. if a society incurs losses for three consecutive years, or 14.2. if serious financial irregularities or frauds have been identified, or 14.3. if there are judicial directives or there is perpetual lack of Quorum.

15. Ensuring timely elections before the expiry of the term of the existing Board of any cooperative and within two months from the date of supersession of any Board. Also ensuring that members of the Board of a PACS which has been superseded due to a reason as in 9.14.1 and 9.14.2 above would not be entitled to contest again for a period of at least three years after supersession.

16. Ensuring approval of the bye-laws of the cooperatives within one month form the date of submission to the RCS.

17. Prescribing prudential norms, including CRAR, for all financial cooperatives other than co-operative banks, but including PACS, in consultation with NABARD.

18. Removing at the request of NABARD/RBI, director(s)/ CEO(s) who do not fulfil the fit and proper criteria stipulated by RBI in the case of SCB and CCBs.

19. Prescribing co-option of professionals on the Board of the SCB or a CCB with full voting rights, in case professionals as stipulated by the RBI do not get elected to the Board of the SCB or the CCB.

20. Auditing of SCB and CCBs by Chartered Accountants approved by NABARD.

21. Conducting of a special audit of a cooperative bank if requested by the RBI and for submitting of report to the RBI within the time stipulated by it. 22. Deregistering as societies, PACS which are using the word Bank, Banking, Banker or any other derivative of the word bank in their registered names.

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CHAPTER 4

(Session 5)

BUSINESS DIVERSIFICATION FINANCIAL INCLUSION LOAN POLICIES AND DOCUMENTATION

Business Diversification With liberalization of the economy, profit consciousness has come to all the Financial Institutions viz., Commercial Banks, Regional Rural Banks or Cooperative Banks. Commercial Banks have started broad basing the portfolio

for quite some time and were able to diversify to a great extent. RRBs which are coming to terms with the new profit consciousness and the professional way of lending are also making efforts to diversify their portfolio and spread their risk across various sectors. In case of Cooperative Banks, despite their large lending volumes, diversification of the lending portfolio has not yet taken a firm shape and all the tiers within the Cooperative System are catering to the age old sectors / activity and had not paid much attention to the developments that are taking place in the agriculture and rural development sectors which need substantial investments. In order to tap the business potential available in these sectors familiar to Cooperative banks and also increase the Net Interest margins / spread the time has come to look into the diversification by them seriously.

Diversification Diversification in agriculture can be broadly defined as producing increased number of agricultural commodities. Diversification becomes necessary for developing countries since growing of basic staples such as cereals alone cannot support the economic development notwithstanding the need to ensure food security to the people. In essence, diversification to commercial

crops/commodities becomes an essential strategy that can increase income levels in agriculture, reduce risks of crop failures and earn foreign exchange. Further, diversification can be designed to help poverty alleviation, employment generation and environmental conservation.

Diversification in agriculture can be achieved across the sub-sectors as well as within each sub-sector. In Indian agriculture, diversification has occurred across

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sub-sectors, viz. crop sector, livestock sector, forestry plus logging and fishing as well as within each of these sectors. In more recent times, diversification towards high-tech, innovative enterprises in the primary sector such as floriculture, horticulture and towards secondary (manufacturing) sector such as agro/food processing and rural non-farm sector have been gaining momentum.

Generally Cooperative banks Portfolio consists of more than 80% lending to crop loans and remaining to small, petty business and CC lending. While a big

opportunity is awaiting in various sectors, the banks have to diversify their credit portfolio and spread their risk so that even if one sector/activity fails due to extraneous reasons the other sector / activity will be able to ensure the cash flow to the system. In view of this, banks may look into the portfolios outlined below for increasing their diversification.

Agriculture In the field of agriculture, diversification can be thought of in encouraging farmers to take up cultivation of hybrid varieties of crops rather than the traditional ones. For example, Hybrid paddy which needs approximately Rs. 8000 per acre as cost of cultivation, would yield around 10 tonnes which is almost four times the normal yield of the paddy crop. Farmer therefore, will be able to make good money out of this activity and at the same time bank may be able to deploy more loan to the same activity. In this way, many other crops like cotton, oilseeds, tomato and others have got hybrid seeds evolved for the purpose and farmers are ready to take up the cultivation but credit being the constraint are taking up their cultivation in a big way. Hence, one may need to look into the areas specifically by taking into account local agro-economic factors and diversify their portfolio.

Horticulture In case of Horticulture, Cooperative banks stake in its development is very low and many of the CCBs had never given a thought to finance horticulture in a big way despite the encouragement being given by GOI under the mission mode of National Horticulture Mission (NHM). Under the NHM, GOI envisages to double the production of fruits and vegetables to 300 million tons from the existing 140 million tons by the year 2012. If the mission objective has to be achieved,

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investments need to be made in a big way in the horticulture development and the role of Cooperative Banks so far in promoting these activities is abysmal. There are many horticulture areas where banks can lend and at the same time increase the prosperity of the farmers like lending to fruit orchards such as mango, banana, grapes, citrus fruits, strawberry, etc. Of late, many scientific revolutions have taken place in the cultivation of horticulture crops and a new technique for high density plantation has come. In this High Density Plantation (HDP), the same variety of the fruit crop will be cultivated but the density of crop will go up by two / three times than the traditional ones which simultaneously hikes the unit cost for the activity. In the normal traditional plantation, if the unit cost for mango is

around Rs. 10,000 per acre, the unit cost for HDP works out to Rs. 90,000 per acre. By promoting such activities, the banks are not only increasing the credit portfolio but are also helping to generate substantial quantities of horticulture produce which may in turn give scope for promotion of processed industries and also other ancillary activities like cold storage, transportation, etc in the area. All these new activities that will come around this principal activity of horticulture would again give a great scope for the banks to increase their lending. Under NHM and also in AMI Programme, subsidies are available to take up activities and the banks should be able to promote these activities so that farmers and the area will get substantial investments which may lead to overall prosperity.

Of late, there is a surge in demand for vegetables and the cultivation of vegetables is being taken up mostly by borrowing money from moneylenders. Going by the quantum of vegetables being cultivated in the country i.e. 90 million tons every year, the estimated credit requirement for producing such a volume would be stupendous since banks and specifically Cooperative banks are not great players in extending credit. Vegetable cultivation may have to be looked into as business potential awaiting and also as a great profit churner by Cooperatives which otherwise is being financed by moneylenders at very high cost. Further, the demand for exotic vegetables and vegetables produced under controlled conditions is rising which again needs a sizeable investment from the banking sector. It is, therefore, necessary for the cooperative banks to look into this portfolio with clear insight so as to make a profitable diversification.

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In case of floriculture, the country produces substantial quantities of flowers for domestic consumption, extraction of essential oils and also manufacture of pesticides (Pyrethrums) but going through the portfolio of Cooperative Banks, one will wonder whether any time some attention has been paid to this most lucrative business. In view of this, the Cooperative banks may look into this portfolio for diversification.

Agro and Farm Forestry Demand for forest based raw materials for industrial purposes is growing at fast pace and that availability of the same from the traditional forest are dwindling day by day forcing the industry to look into avenues of getting the forest species cultivated on farm land to ensure continuous raw material supply. In this direction, good work has been done by various Government agencies as well as private forestry companies to promote various forestry species and the most important among them are Eucalyptus, Poplar, Bamboo, Acacia, etc,. With the availability of clonal multiplication as well as tissue culture technologies, the cultivation of forestry species have become very remunerative and the gestation period of the crops had also come down. Many farmers in some of the states are making good profit by cultivating clonal Eucalyptus, Tissue cultured bamboo, etc. Moreover, these crops can be cultivated on degraded farm lands which are needed to be put under green cover immediately, to ensure arresting of further degradation, ensuring income to the land owners and continuous supply of raw materials to the industry. Cooperative Banks may look into the option of extending finance to the forestry crops in a big way. Forestry crops can be cultivated either as block plantations or they can even be cultivated on bunds and in both the systems bankers are going to make brisk business which again will lead to successful diversification of their portfolio.

Bio-Fuels Bio-fuels have become the talk of the town and prominent crops among them are Jatropha and Pongamia. Oil extracted from both the crops is used for production of bio-diesel after subjecting it to esterification. Due to the produce price already fixed by Government of India, growing of these crops proved to be profitable to the farmers possessing marginal and sub-marginal lands which are otherwise not

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fit for cultivation of regular crops.

Keeping in view the vast stretches of

degraded/marginal and sub-marginal lands available in the service area of the Cooperatives, an effort should be made to make a roster of such lands and try to promote these crops in a mission mode. CCBs and PACS should take active interest in bringing such lands under green cover and this effort would lead to deepening of credit flow in those areas.

Medicinal and Aromatic Plants The demand for medicinal and aromatic plants is in the range of Rs. 3,00,000 crores and is growing @ 15% every year. Fortunately India is one such country which can produce almost all the medicinal and aromatic plants. However,

lending done in this area is still meagre due to unfamiliarity of the bankers with the concept. There are more than 30 varieties of medicinal crops and another 8-10 aromatic plants which can be successfully cultivated in the country and demands for their products is on the rise. Another special feature of these medicinal and aromatic plants is the ability to absorb substantial amount of credit which in turn may give considerable scope for increasing credit volume to the banks. Returns from the crops are also good and marketing channels have opened up at many places and therefore, the Cooperative Banks may look into this area with all seriousness and find out avenues to forge links with consuming industry and finance on a tri-partite agreement mode. Cultivation of these crops also entails the farmers for capital investment subsidy and banks can be sure of getting definite repayments because of back-ended nature of subsidy being given by National Medicinal Plants Board. Further, extraction of the alkaloids both from Medicinal and aromatic plants needs investments in processing plants / extraction units at the local level which again opens up scope for the bank to increase their lending in the agro-processing / non-farm sector activities.

Animal Husbandry Though India is ranked number one in milk production in the world, the scope for the activity is still very high because of the growing population. Dairy activity is being promoted by Cooperatives for quite some time, but their lending is mostly confined to one or two animal units only. Of late, dairying has become very

profitable and is emerging as a stand alone activity without linking it to any

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agricultural activity. In many places, farmers with 5 to 10 acres of land are taking up dairy as a main activity and are cultivating grass and legumes for the dairy activity exclusively without going for cultivation of other crops. Return on the investment from the dairy activity is substantial and promoting Mini dairy units of 10 to 20 animals is most profitable for a Cooperative bank to diversify into.

Poultry Poultry is another major activity which absorbs substantial amount of credit from the banking system. Giving loans to big units is well known but the recent initiative of the Veterinary Department of UP proved that backyard rearing of poultry birds (100 to 200 birds) by small and marginal farmers and people belonging to SC / ST categories can give substantial returns to those people. In view of the quick as well as definite returns the poor and marginal segments of the population are getting from this activity, Cooperative Banks may consider to diversify into this activity in a big way by giving small loans for backyard poultry to a large number of customers.

Diversification towards secondary sector Of late, diversification into secondary and tertiary sectors has been taking place in the rural economy. Rural non-farm sector, including, agro-processing is being promoted as this sector holds promise for absorption of surplus labour from agriculture and for improving living standards of the rural poor.

Overtime, there has been an expansion, accompanied by diversification, in the consumption basket. Consumption of agro-processed commodities has assumed importance among different income groups. Coinciding with such changes in consumption pattern, there has been an accelerated growth in the output of several agro-based industries in recent times.

Action Plan for Cooperatives Cooperative banks which are being revamped in a big way after GoI revival package may look into the opportunities of diversifying the portfolio into investment absorbing areas of agri-business. India is emerging as a global food major and the basket of trade contains varied products whose production can be

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beefed up only when investments are made. Role of Cooperative banks is very important since they have the maximum reach to the rural clients.

Financial Inclusion Introduction By financial inclusion, we mean the provision of affordable financial services, viz., access to payments and remittance facilities, savings, loans and insurance services by the formal financial system to those who tend to be excluded. It is important to recognise that, in the policy framework for development of the formal financial system in India, the need for financial inclusion covering more and more of the excluded population by the formal financial system has always been consciously emphasised. Even after decades of such emphasis, there are large segments of the society outside the financial system. Simultaneously, the growth of the NGO and the self-help groups has been significant and their linkage with banks has facilitated a greater financial inclusion. The SHG movement in India has enabled social and economic inclusion of women. The SHG-bank linkage movement, where SHGs are linked to banks in a gradual way - initially through savings and later through loan products - which has been able to ensure financial inclusion to a certain extent. The formal financial system has to recognise the huge business potential coming from the unmet demand for financial services from those who normally tend to be excluded. The focus on financial inclusion comes from the recognition that financial inclusion has several externalities, which can be exploited to the mutual advantage of those excluded, the banking system and society at large. Banks need to understand the markets and develop products suited to the clientele. They need to develop data sets to evolve risk assessment models for proper rating and pricing. Financial inclusion has to be viewed as a business strategy for growth and banks need to position themselves accordingly. The Reserve Bank of India has continued to lay stress on the need for financial inclusion of the ~ under privileged sections, which have hitherto remained outside

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the periphery of the banking system. In many banks, the minimum balance requirement and charges levied, although accompanied by a number of free facilities, deter a sizeable section of population from opening/maintaining bank accounts. Basic "no frills" bank accounts At the first stage, there is a need for lowering the entry barriers to the banking system and simplifying procedures. Thanks to developments in micro finance, one of the myths held earlier by the banking system that the poor cannot save, has been demolished. Experience has shown that the poor can and do save, may be by way of thrift, and all they need is an appropriate product and access to the banking system. Holding a savings product to a substantial extent reduces financial exclusion. Moreover, the act of saving, however little it may be, reinforces longer-term thinking and a sense of responsibility for ones future. Keeping in view the need for the banking system to take urgent steps to bring about financial inclusion in the country, the Reserve Bank of India, in the MidTerm Review of the Annual Policy for the year 2005-06, exhorted banks to make available a basic banking no frills account either with nil or very low balances as well as charges that would make such accounts accessible to vast sections of the population. The nature and number of transactions in such accounts would be restricted and would be made known to customers in advance in a transparent manner. Several banks, both in the public and private sectors, have responded positively to this measure and devised no-frills accounts for the lower income groups. Although such basic bank accounts are generally considered unprofitable, provision of such deposit accounts has been accepted the world over as a stepping stone to financial inclusion. In a somewhat different way, this requires bank branches to be aware of the surrounding areas in which they work and promotes a more outward-looking, customer-centric model to work alongside their usual profit-driven model. A basic 'no frill' account is just the beginning of a relationship and can pave the way to the customer availing of a variety of savings products and loan products for consumption, housing etc. The account can be

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used for sanctioning small overdraft facilities and making small value remittances at low cost. The same banking account can also be used by State Governments to provide social security services like health and calamity insurance under various schemes for the disadvantaged. Having such social security cover makes the financing of such persons less risky from the banks point of view and they can be financed for various purposes. Further, holders of the no-frills accounts who would be beneficiaries of the Employment Guarantee Scheme of the Government of India, can also be customers of banks over a longer time horizon. General Credit cards (GCC) It is almost a clich that rural credit should adhere to the basic requirements of timeliness, adequacy and hassle-free delivery, apart from taking care of the financial needs of the customer in a holistic manner, including consumption credit. To address these issues, several 'credit card' schemes have been devised and implemented by banks over a period of time. Such schemes have the flexibility of use and they fulfill the above requirements to a substantial extent. But all these schemes have so far been activity-specific, i.e. for farmers, artisans etc. The latest in the line is the General Credit Card (GCC) which does not target any specific functional group, but has the potential to address the credit needs of persons with small means having some income-generating activity, without bothering so much about the nature of the activity. Banks have flexibility in fixing the limit based on the assessment of income and cash flow of the entire household. The borrowers are eligible for availment of the credit facilities provided under GCC as per their requirement without any insistence on security and the purpose or end-use of the credit. To provide an incentive to banks for issuing the GCCs, fifty per cent of credit outstanding under GCC up to Rs.25,000 has been made eligible for being treated as indirect agricultural finance under the priority sector lending. While several banks have put in place schemes for issuing GCCs, the progress will have to be accelerated. As done earlier in the case of Kisan Credit Card Scheme, issue of GCC too can be made part of the corporate plans of all banks.

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Microinsurance More than credit, the poor need access to some form of insurance, as they are the most vulnerable to various types of risk to both life and property. They need suitably designed schemes offering health, life or property insurance: limited protection at a somewhat low contribution. It is heartening to know that insurance companies are coming up with schemes aimed at poorer sections of the population and designed to help them cover themselves collectively against risks, the delivery channels being banks, NGOs and SHGs working in rural areas. There is also a possibility of providing some kind of microinsurance to holders of the General Credit Cards, on the lines of the personal accident insurance cover available to Kisan Credit Card holders. Financial Inclusion by Extension of Banking Services Use of Business Facilitators and Correspondents With the objective of ensuring a greater financial inclusion and increasing the outreach of the banking sector, the RBI has decided to enable banks to use the services of NGOs/SHGs, micro-finance institutions (MFLS) and other civil society organisations (CSOs) as intermediaries in providing financial and banking services through the use of business facilitator and correspondent models as indicated below. Business Facilitator Model : Eligible Entities and Scope of Activities Under the Business Facilitator model, banks may use intermediaries, such as NGOs/Farmers Club, cooperatives, community-based organisations, IT enabled rural outlets of corporate entities, post offices, insurance agents, well functioning Panchayats, village knowledge centres, agri clinics/agri business centers, Krishi Vigyan Kendras and KVIC/KVIB units, depending on the comfort level of the bank, for providing facilitation services Such services may include (a) identification of borrowers and fitment of activities (b) collection and preliminary processing of loan applications including verification of primary information/data 57

(c) creating awareness about savings and other products and education and advice on managing money and debt counseling (d) processing and submission of applications to banks (e) promotion and nurturing self-help groups/joint liability groups (f) post-sanction monitoring (g) monitoring and hand holding of self help groups/joint liability groups/credit groups /others (h) follow-up for recovery As these services are not intended to involve the conduct of banking business by business facilitators, no approval is required from RBI for using the above

intermediaries for facilitation of the services indicated above. Business Correspondent Model : Eligible Entities and Scope of Activities Under the Business Correspondent model, NGOs/MFIs set up under the Societies/Trust Acts, societies registered under the Mutually Aided Cooperative Societies Acts or the Cooperative Societies Acts of States, registered NBFCs not accepting public deposits and post offices may act as business correspondents. In engaging such intermediaries as business correspondents, banks should ensure that they are well established, enjoying a good reputation and having the confidence of the local people. Banks may give wide publicity in the locality about the intermediary engaged by them as business correspondent and take measures to avoid being

misrepresented. In addition to activities listed under the business facilitator model, the scope of activities to be undertaken by the business correspondents will include: (a) (b) (c) disbursal of small value credit; recovery of principal/collection of interest; collection of small value deposits;

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(d)

sale of micro-insurance/mutual fund products/pension products/other third party products;

(e)

receipt and delivery of small value remittances/other payment instruments.

The activities undertaken by the business correspondents would be within the normal course of the banks banking business, but conducted, through the entities indicated above at places other than the bank premises. Accordingly, in furtherance of the objective of increasing the outreach of the banks for micro-finance in the public interest, the Reserve Bank hereby permits banks to formulate a scheme for using the entities indicated above as business correspondents. Payment of commission/fees for engagement of business

facilitators/correspondents: Banks may pay a reasonable commission/fee to the business facilitators/Correspondents, the rate and quantum of which may be reviewed periodically. The agreement with the business

facilitators/Correspondents should specifically prohibit them from charging any fee from the customers directly for services rendered by them on behalf of the bank. Other Terms and Conditions for Engagement of Business Facilitators and Correspondents As the engagement of intermediaries as business facilitators/Correspondents involves a significant reputational, legal and operational risks, due consideration should be given by banks to those risks. They should also endeavour to adopt technology-based solutions for managing the risk, besides increasing the outreach in a cost effective manner. The arrangements with the business correspondents shall specify the following: (a) Suitable limits on cash holding by intermediaries, as also limits on individual customer payments and receipts. (b) The requirement that the transactions are accounted for and

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reflected in the banks books by end of day or next working day. (c) All agreements/contracts with the customer shall clearly specify that the bank is responsible to the customer for acts of omission and commission of the business facilitator/correspondent. Redressal of grievances in regard to services rendered by business facilitators/correspondents (a) Banks should constitute grievance redressal machinery within the bank for redressing complaints about services rendered by business correspondents and facilitators and give wide publicity about it through electronic and print media. The name and contact number of designated grievance redressal officer of the bank should be made known and widely publicised. The designated officer should ensure that genuine grievances of customers get redressed promptly. (b) The grievance redressal procedure of the bank and the time frame fixed for responding to the complaints should be placed on the banks website. (c) If a complainant does not get satisfactory response from the bank within 60 days from the date of his lodging the compliant, he will have the option to approach the office of the Banking Ombudsman concerned for redressal of his grievance/s Compliance with KYC norms will continue to be the responsibility of banks. Since the objective is to extend savings and loan facilities to the underprivileged and unrepresented population, banks may adopt a flexible approach within the parameters of guidelines issued on KYC from time to time. In addition to introduction from any person on whom KYC has been done, banks can also rely on certificates of identification issued by the intermediary being used as banking correspondent, block development officer (BDO), head of village Panchayat, postmaster of the post office concerned or any other public functionary, known to the bank.

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Financial education One of the major hindrances in the way of delivery of financial services to the poor is the lack of basic knowledge and lack of awareness of the products and services available. In view of this, financial education assumes importance. The delivery of financial education would include (i) increasing knowledge of financial matters, (ii) developing understanding of financial products and (iii) building skills in financial management One of the pioneers in promoting the concept of financial inclusion, the United Kingdom, has established a Financial Inclusion Task Force, which has emphasized 'access to free face-to-face money advice' as an important component of financial inclusion, apart from access to banking and access to affordable credit. A Financial Inclusion Fund has also been established there to promote financial inclusion. Poverty is a well-known problem in most developing countries. But what is needed is development of mechanisms that ensure that poverty is not exacerbated by lack of access to financial services. People need information and advice when they get into debt. Such information and guidance can best be delivered by appropriate mechanisms and if such effective mechanisms are put in place, they in turn would reinforce the demand for credit. Some banks have on their own taken steps to provide such education, as in the case of the Debt Counseling Cells recently set up by some banks. However, any large scale delivery of financial education has to leverage on the presence of other agencies, such as private entities, non-governmental organizations, civil society organizations, outlets of the corporate sector etc., apart from Government initiatives. The use of information technology (IT) offers a lot of promise in providing financial literacy and education and experience in several parts of the country through the use of kiosks, mobile vans, etc. has shown to what extent IT can be leveraged to provide information on various products and services, production processes and markets for the products. While provision of connectivity for facilitating communication services in rural areas is still an issue,

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recent developments in wireless technology holds out a lot of promise for evolving an IT-based information dissemination system.

Joint Liability Group Approach - Financing Tenant Farmers and Oral Lessees Objectives:

To augment flow of credit to tenant farmers cultivating land either as oral lessees or sharecroppers and small farmers, who do not have proper title to their land holding, through formation and financing Joint Liability Groups (JLGs).

To extend collateral free loans to target clients through JLG mechanism. To build mutual trust and confidence between banks and tenant farmers and among group members.

General Features of JLG:

It is an informal group comprising 5 to 10 members. The JLG is primarily a credit group and savings by the JLG members is voluntary.

Each member will be jointly and severally liable for repayment of loans taken by all individuals in the group.

There has to be mutual agreement and consensus among all members about the amount of individual debt liability that would be created.

The groups shall be organised by the like-minded farmers and not imposed by the Bank or others.

Groups shall comprise members of same economic status and preferably running similar farm related activities.

The farmers joining the group should be cultivating lands in the same village or in a contiguous area and knows each other well and has interest and mutual trust to continue as group members.

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They should be engaged in agriculture and farm related activities for a period of not less than one year in the area of operation of the Branch.

Only one member from a family having genuine interest in agriculture and farm related activities should be included in the group.

Members may be encouraged to meet at a common place on a monthly basis to discuss about common problems, the improved package of practices and other matters related to farming & voluntarily contribute a small saving, which may be deposited in the group account to develop a corpus fund.

Financing Model:

Group would be eligible for accessing individual loans from the bank. All members should jointly execute Joint Liability Agreement making each member jointly and severally liable for repayment of loans taken by the individuals.

There has to be mutual agreement and consensus among all members about the amount of individual liability. For this purpose, group has to submit a resolution along with details of individual loans required by each member, as per Micro-Credit Plan (MCP) signed by all the members.

Branch has to assess the credit requirement based on the extent of land cultivated, crops grown, scale of finance, and credit absorption capacity of the individuals in the group.

Purposes for which credit can be extended under the scheme:

To meet the crop production requirements as per Micro-Credit Plan (MCP) of the group.

Other need based credit to meet the expenses, contingent to cultivation of crop.

Maximum ceiling: Rs. 2.50 lakh per group with a ceiling of Rs. 25000/- per member including a limit of Rs. 2500/- for meeting the expenses contingent to crop production.

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Rate of interest: As applicable for short term crop production loans. 7.0% per annum till the interest subvention scheme of GOI is in force and as per normal rate applicable to such type of advances afterwards. 6. Repayment period: Repayment shall be fixed based on the crops grown and possible time of harvest with some leverage for marketing and realization of proceeds. Other Conditions:

The farmers should not be indebted to any other financial institutions. Group members shall undergo one day orientation training in group dynamics by the branch in association with officials of SIRD / RUDSETI if operating in their area, with LDM, AGM/ DDM of NABARD and reputed NGOs in other areas.

At least two members of the group should have permanent residence within the operational area of the branch and all remaining members are having permanent residence within the district.

The eligible crops are to be covered under crop insurance scheme. The individual borrower shall be covered under Personal Accident Insurance Scheme.

Individual approach: Objectives: To extend collateral free loans to tenant farmers / oral lessees/ share croppers individually, under the following circumstances: i. ii. Farmers cultivating lands under registered tenancy rights. Farmers cultivating lands without registered tenancy rights, but their names appear as cultivators in the land records. iii. Farmers cultivating lands as oral lessees and land owner is ready to join the transaction as co-borrower. iv. Farmers cultivating lands as oral lessees, but land owner is not ready to join the transaction as co-borrower.

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Financing Model: a. In respect of the first three categories, tenant farmers will be financed by obtaining registered tenancy deeds, or records of rights as a proof of cultivation, or joining of land-owner to the transaction, as the case may be. b. In the case of fourth category, where there is neither documentary proof of cultivation nor the land owner willing to join the loan transaction as coborrower, branches shall adopt the following approach to extend need based credit. i. A letter from Revenue Officials / Village Pradhan / Village Panchayat or any Govt. Officials, confirming cultivation of lands by the applicant as tenant farmer, shall be obtained and kept as record. ii. In case the tenant farmer is not in a position to produce the letter as above, he explore the possibility giving a creditworthy third party guarantee, who is a land holder as guarantor. iii. In case the tenant farmer is not in a position to comply with the above, the Branch Manager shall make local enquiries so as to establish that the applicant tenant farmer is a true cultivator of the land. Purposes for which credit can be extended under the scheme: To meet the crop production requirements as per scale of finance.

Other need based credit to meet the expenses, contingent to cultivation of crop.

Towards any allied activity like dairy / sheep rearing etc. or a non-farm activity in which the applicant has the requisite skill. This shall be a separate loan in addition to the crop loan / SKCC to be extended to the tenant farmer, encouraging him to take up an alternate income generating activity.

Quantum of Loan:

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a. Quantum of loan: Quantum of loan shall be decided based on the crops to be cultivated and scale of finance for such crops and a small component for meeting the contingencies related to cultivation of crops. Some additional loan component towards alternate income generating activity, as per need.

b. Maximum ceiling: Rs. 25000/- per member including a limit of Rs. 2500/towards consumption expenses. Rate of interest:

For short term crop production loans: @ 7.0% per annum till the interest subvention scheme of GOI is in force and as per normal rate applicable to such type of advances afterwards.

For income generating activities under allied activities / non-farm sector: As per extant guidelines.

Other Conditions:

The applicant should be a permanent resident of the operational area of the branch. Branches shall establish the identity and permanent address of the tenant farmer / oral lessee.

The tenant farmer / oral lessee shall open SB A/c under SyndSamanya Scheme.

The applicant is not indebted to any other financial institutions. Eligible crops are to be covered under crop insurance scheme. The borrower shall be covered under Personal Accident Insurance Scheme.

In the case of subsidiary activity like dairy / sheep rearing etc. insurance of animals is compulsory.

Reaching the Unreached - the SHG way

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During last 50 years, many structural innovations have taken place in our banking industry which laid specific thrust to meet out social responsibilities. Branch

network increased in rural areas; credit was looked upon as tool to remove many perplexities of poverty; and a number of development schemes and credit packages were evolved keeping in view the needs of the poor. These schemes / programmes were reviewed regularly to achieve desired objectives. Special studies carried out by NABARD in eighties revealed that despite of sincere execution of poverty alleviation programmes and creating opportunities for selfemployment, impact was not visible. It was also found that :-

Formal banking services were out of reach to sizable segment of rural and poor population; Banking products, services, policies and procedures were unable to cater to immediate needs of the poor; and Poor were in favour of availing quality banking services instead of cash subsidies, and were ready to pay higher price in the form of higher rates of interest, etc.

Keeping in view the above observations, a need was felt to formulate suitable policies for poverty alleviation, implement alternate credit delivery mechanism and design newer banking products and financial services responsive to the needs of poor, particularly the women in rural households.

A new mechanism to dispense credit to the poor and forgotten lot of population has evolved over a period of time keeping in view the above complexities. The new format essentially takes care of thrift, savings; need based small loans, nonrigidity about the loan usage, flexible repayments depending on the familys cash flow rather than project based cash flow etc. Since poor are bankable but cant afford any collateral, method of reckoning Social Collateral had been considered and to achieve this Self Help Group approach was adopted.

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What is a Self Help Group :A Self Help Group is a small (upto 20), economically homogeneous and affinity group of the rural poor, voluntarily coming together for the following reasons: -

To save small amounts of money regularly to contribute to a common fund To meet their very small but emergent needs To have collective decision making To solve conflicts through collective leadership and mutual discussion To provide collateral free loans to its members with terms decided by the group at market driven rates

Formation Stage The process through which selected people, usually poor, representing a specific economic strata of society, with some specific identity are encouraged to form small homogeneous groups for the purpose of participating in development activities i.e., savings, credit, income generation etc. is called Group Formation or 'Group Promotion' or 'Group evolution'. In this Stage, it is important that SHG

promoter visits the village frequently, gathers information about various facets of the village life, its environment and people. During this stage the promoter also builds up rapport with the villagers.

Promotion Stage There are four stages in this phase: i. Forming: In this stage, people come together informally and meet. They

are encouraged to talk about their problems and solutions. During this stage, based on the felt need, homogeneous groups emerge naturally. ii. Storming: During this stage conflicts between individual interest and group

interest surface and are dealt with. The leadership emerges, The procedures, rules and roles are established. iii. Norming: Trust develops among group members leading to cohesiveness

in the group.

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iv.

Performing: This is the final stage when the group becomes operational

and starts functioning for the benefit of its members.

The SHGs can be formed for any common cause or development activity. Normally it is found that initially though the groups are formed for a specific activity, gradually they diversify and take up more than one development activity in the area. Various types of possible groups are: (i) Savings and Credit Groups, (ii) Joint Farming Groups, (iii) Social Forestry Groups, (iv) Water Users' Groups, (vi) Watershed Development Groups, (vii) Farmers' Interest Groups, etc.

GROUP FUNCTIONING Formation of a group is only the beginning. The group has to function vigorously with the active participation of its members in the development process. For the group process to be effective, the group has to have some characteristics, as discussed below : a. Group Meeting The periodicity of the meeting could be weekly, fortnightly or monthly. The time and place of the meeting should be such that it is convenient to majority of the group members. Evolution of Norms The group has to decide on a set of rules and decision-making arrangements for its functioning. The bylaws could include criteria for membership, saving loans, fines, sanctions etc. Saving Mobilisation The group has to decide on the amount as also the periodicity of saving of the members. The members of the group must save accordingly. Loaning Activity The group must decide the purposes for which loan will be given, in addition to the rate of interest, repayment period and the loaning process. Recycling of Funds The recovery of both principal and interest on loan is essential The rotation of the capital is also important. The capital is formed by the savings of the group members. as also from contributions from outside.

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Leadership Generally there are 2 to 3 group leaders with different designations, such President, Secretary and Treasurer. The election process also varies from weekly rotation to as long as 5 year period. Maintenance of Books The books maintained by SHGs are Saving Registers, Loan Registers, Meeting proceedings and attendance books. Individual pass books in some cases are also maintained. The books are to be maintained by Group members themselves.

Management of funds and operation of bank account The group is to manage its own funds as also the fund it receives from outside. Normally the sources of funds for the group are membership fees, savings, fines, donations, interest on loans, bank loan, bank interest, and contribution from outside. The fund is used for normal loaning as decided in the meetings as also for meeting emergencies faced by the group members. The cash is handled at three stages. 1. 2. 3. Secretary / treasurer holding cash meet emergencies. Secretary / treasurer holding the savings before depositing in the bank. The office bearers who are authorised to withdraw cash/loan from bank for disbursement among members. All the members of the group must be gradually exposed to operating the bank account. Group Discipline The group must function democratically and in disciplined manner. The repayment ethics, effectiveness of peer pressure, implementation of norms and sanctions reflect the discipline and dynamics of the group.

Participation of various agencies It may not be untrue if it is said that not even a single Banking & Non- Banking Financial Institution has been left out which is not participating in the microfinance activities. Major players in the microfinance sectors can be categorised as under :

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1. Formal Financial Institutions - Public sector Commercial Banks, Pvt. Sector Commercial Banks, Regional Rural Banks and Cooperative Banks 2. Micro Finance Institutions (MFIs) - NGO promoted, Section 25 companies, registered under Societies Act etc 3. Government - GoI in association with all the State Governments in implementing the one of the largest microfinance programme i.e., SGSY

How Cooperatives can benefit from SHGs / Microfinance? Self Help Groups can act as extended arms of the bank for reaching the clients. It is a very cost effective way of covering the excluded populations and enroll them as business clients. Further, some of the banks are using SHGs in their recovery efforts, deposit mobilization and also in technology transfer related areas. Some of the CCBs in the country had totally changed their business plan and had turned around with the SHG lending.

NABARD's Farmers' Club Programme Background Agriculture is the backbone of the Indian Economy as nearly 60% of the population of the country depend on agriculture and contribute 23% to the GDP. Tenth Five Year Plan and National Agriculture Policy documents envisage a growth level of 4% in Agriculture as against the average growth of less than 2% in the last 50 years. The last decade commencing from 1990s was marked by postGreen Revolution fatigue and plateauing yield levels in many parts of the country. For sustained 4% growth in agriculture there is a need to improve productivity and cut down on costs by improving efficiency. There is, therefore, an urgent need to provide package of initiatives for transfer of technology, improving input use efficiency, promoting investments in agriculture both in private and in public sectors and creating a favourable and enabling economic environment. The emerging needs in agriculture sector now are adoption of location specific skill and knowledge based technologies, promote greater value addition to agriculture produce, forge new partnerships between public institutions, technology users and

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the corporate sector, harness IT more effectively to realise financial sustainability and complete in the international market. For transmitting the latest agriculture techniques to the Farmers field, orienting them to establish better relationship with banks, adoption of latest post-harvest handling technology, value addition, etc. and enjoy the benefits of collective bargaining power both for procuring inputs and select their produce . The Farmers Club Programme is an appropriate and most suitable strategy initiated by NABARD in late 1982. What are Farmers' Clubs? Farmers Clubs are grassroots level informal forums. Such Clubs are organised by rural branches of banks with the support and financial assistance of NABARD for the mutual benefit of the banks concerned and rural people. The broad functions of the Farmers Clubs would be to:

coordinate with banks to ensure credit flow among its members and forge better bank borrower relationship,

organise minimum one meeting per month and depending upon the need, there would be 2-3 meetings per month. Non-members can also be invited to attend the meetings,

interface with subject matter specialists in the various fields of agriculture and allied activities etc., extension personnel of Agriculture Universities, Development Departments and other related agencies for technical know how upgradation. For guest lectures, even experienced farmers who are non members from the village/ neighbouring villages could be invited,

liaison with Corporate input suppliers to purchase bulk inputs on behalf of members,

organise/facilitate joint activities like value addition, processing, collective farm produce marketing, etc.; for the benefit of members. They can also sponsor / organise SHGs,

undertake socio-economic developmental activities like community works, education, health, environment and natural resource management etc.

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What is Farmers' Club Programme? National Bank for Agriculture and Rural Development (NABARD) encourages banks to promote Farmers' Clubs in rural areas under the Farmers Club Programme, earlier known as Vikas Volunteer Vahini (VVV) Programme. The Programme was launched by NABARD in November 1982 to propagate the five principles of Development through Credit. The five principles are:

Credit must be used in accordance with the most suitable methods of science and technology.

The terms and conditions of credit must be fully respected. Work must be done with skill so as to increase production and productivity. A part of the additional income created by credit must be saved. Loan installments must be repaid in time and regularly so as to recycle credit.

The VVV Programme was rechristened as Farmers Club Programme in 2005 by revisiting its earlier mission. Mission Development in rural areas through credit, technology transfer, awareness and capacity building. Uses of Farmers' Club to Bank Branch The formation of Farmers Club lead to better Banker-Borrower relationship in the area.

Mobilisation of deposits. Increase in the credit flow and diversification of lending. Generation of new business avenues. Increase in the recoveries and decline in the non-performing assets. Reduction in the transaction costs of financial institutions/ Banks.

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Socio Economic Development of the village. A win-win situation both for the Banker and borrower. Besides these benefits, the Farmers Club has also been instrumental in certain social welfare measures like free eye check-up camp, Animal Health Care Camp, Mass vaccination camp, community works like road, check-dams, aforestation, etc.

Who can organise Farmers' Clubs ? Any bank operating in rural area, including Commercial Banks (CB), Regional Rural Banks (RRB), & Cooperative Banks (SCB, SCARDB, PCARDB, DCCB and PACS) can sponsor and organise Farmers Clubs. They can hire services of NGOs/ KVKs /Agriculture Universities, if required, for promotion of the clubs. All the clubs should have savings bank account with the bank. Set Up Farmers Club is an informal forum in the villages. It can be promoted in a village/ cluster of villages, generally in the Operational Area of a Bank. While Farmers Club should have minimum of 10 members, no upper limit in the membership is envisaged. Every Club would have two office bearers - One 'Chief Coordinator' and the other 'Associate Coordinator'. The office bearers would be elected by Club Members on a democratic basis for a term of two years. The office bearers should be residents of the area of the operation of the club. No NGO representative can be office bearer of the club. The main functions of the office bearers would be convening meetings, arranging meetings with experts, maintenance of Books of Accounts, Coordination with Bank, Line Departments of the State Governments, maintaining proper liaison with Bank Membership All villagers except willful defaulters can become members of the club. The club must make endeavour to raise their own resources by way of contribution from members, undertaking certain business services such as bulk procurement of inputs and collective marketing of agricultural produce, etc.

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Formation of Farmers Club by bank branches

Bank branch can promote the clubs directly or engage Farmers Club promoting agencies like Krishi Vigyan Kendras (KVKs), Agriculture Universities, NGOs, Corporates, etc.

Select a village/ cluster of villages suitable for launching Clubs in the operational area of the bank branch.

Identify a few borrowers with good track record of proper loan utilisation, aptitude and capacity for team work. (Success of the Club hinges on the right choice of members).

Encourage the members to select a Chief Coordinator and an Associate Coordinator. This will ensure collective leadership and continuance of the Club.

Provide orientation training to them with the help of NABARD (RO/ DDM or trained officers from the bank) before launching.

Encourage members to convene monthly meeting regularly, guide them to have meaningful discussion and take necessary follow up action.

Motivate them to identify credit and non-credit needs (training, socioeconomic, village infrastructure, etc.), prepare a plan of action and accordingly arrange for expert talks, counselling, need-based activities, etc. with the help of Government Departments and other agencies concerned.

Maintain Membership Register, Minutes Book and accounts Register. Evolve a performance parameter and measure the Clubs contribution annually.

Use Club as a tool in aid of branch not only in the matter of credit and recovery but also in facilitating promotion of SHGs, micro credit and convergence of services.

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CHAPTER 5

(Session 6)

UNDERSTANDING HEALTH OF COOPERATIVE BANKS THROUGH FINANCIAL STATEMENTS

Performance Analysis The performance analysis of a bank may be undertaken in various ways. When we recruit a new employee, apart from other things, we subject him to a medical test to assess his fitness for the job. Likewise, the fitness of a bank may be judged from time to time by analyzing the financial statements of the bank. The basics

financial statements which can be referred are the balance sheet and the profit and loss account. What is a balance sheet? : A balance sheet is a statement of financial position as on a particular date. It has two sides: Liabilities representing the things owned by the bank to others and Assets representing the things owned by the bank. The balance sheet is prepared as per certain acceptable accounting standards. The liabilities include the funds contributed by the owners, accumulated profits in the form of various reserves, deposits collected from the customers, borrowings from other financial institutions and other amount payable by the bank. The assets include cash and bank balances, investments, loans given, fixed assets of the bank like land, building, furniture and fixtures etc and amounts receivable from others. It may be noted that the assets and liabilities must tally. What is Profit & Loss Account? : The profit and loss account contains the details of income received and expenditure incurred by the bank during a period. Income will be mostly from interest earned from investment loans and advances and commission received on various baking services. Expenditure will be on interest paid on deposit and borrowings, salary and other allowances paid to staff, rent for building, postage, stationery etc. One of the important items of expenditure is the provision made for loan losses (NPA). If the income exceeds the expenditure, there will be a profit and if the expenditure exceeds the income, there will be a loss.

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The above two statements reveal the financial health of the bank. But mere reading of the statements may not reveal much. The statements are required to be analysed to reach meaningful conclusions about the performance of the bank. Comparison: It is observed that performance of each bank depends on various internal and external factors. Over the years, it is found that some banks are comparable to some other in their performance. The normal comparison is made with reference to national averages, state averages, average of adjacent banks. Also, the comparison of similar size banks in terms of branch network, assets size and deposits size could bring out the differences. Statements may be developed on the basis of averages which may be called benchmarks. This benchmarking helps to evaluate the performance of a bank. Vertical and horizontal analysis: The assessment of institutional performance is made based on the information contained in annual reports, financial statements, etc for a given year. The analysis made for a given year in the compositions of assets and liabilities and the performance in terms of income and expenditure is called Vertical analysis. For the purpose of judgment, the comparison can be made with a chosen benchmark. However, the analyst may also be interested in seeing how the bank has performed over a period. This requires a time series information/data. Such analysis over a period is called Horizontal Analysis. Here also judgment on the performance can be made based on the chosen benchmark. Yet another way of analyzing the performance is to see the incremental performance of the bank. This analysis reflects the happenings during the current year. For the purpose of incremental analysis, changes in the parameters during the year are calculated and then the ratios are calculated. This analysis will bring out the position of the bank vis--vis the market developments and the internal situations without giving the benefit or disadvantages of the past years, which is concealed in the analysis based on the averages. This could become an effective tool for realistic performance planning. Ratio Analysis An assessment of the bank performance may be made by comparing the values under various heads of account and the number of business portfolios. However,

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for easier understanding and to enable comparison of some parameters with other similar institutions the data need to be converted into convenient ratios. A few such ratios are presented below: Group I: Financial Sustainability Ratios Ratio Financial Return Assets Financial Cost Ratio on Formula Financial Income ____________________ Average Assets Indicates productivity Indications the of financial credit and

investment activities

Shows cost of funds; affected by Financial Costs _____________________ mix of net worth, deposits, and Average Assets borrowings. Asset Loss Provision ___________________ Total Assets Indicates requirements current period on provisioning Assets for

Risk Ratio

Cost

Operating Cost Ratio

Key indicator of efficiency of Operating Expenses _____________________ operations. Average Assets

Capital Adequacy Ratio

Indicates the risk adjusted capital Shareholders Equity _____________________ adequacy Risk Weighted Total Assets Shows ability of institution to Financial Income _____________________ cover costs of operations with internally generated income Fin and opr. Costs + Provision + imputed CC

Operating Selfsufficiency Ratio

Financial Selfsufficiency Ratio

Shows ability of institution to be Financial Income _____________________ fully sustainable in the long run by covering all operating costs

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Average Assets

and maintaining value of capital

Group-II Operating Ratios Owninvolvement in Credit Cash Ratio Cash & Current a/c balance Average Deposits Cost Deposits of Interest paid on deposits Average Deposits Disbursed (Gross credit-Borrowing) Average Loan Assets Indicates the own

involvement of the bank resources in lending Indicates the inefficiency of the bank in managing funds Gives the average cost per Rs. 100 of the savings mobilized

Cost borrowing

of

Interest paid on borrowings Average Borrowing Average Credit outstanding Average Deposits

Gives the average cost per Rs. 100 of the borrowings Indicates the expansion of the credit with reference to deposits mobilized

Credit Deposit Ratio

Yield Loans Loan Efficiency Yield Investments

on

Interest received on loans Average loans outstanding Interest received on loans Total effective cost of loan funds

Gives the average return per Rs. 100 of the loans Gives the recovery of cost of funds deployed in loans Gives the average return per Rs. 100 invested

on

Income on Investments Average Statements

Investment efficiency

Income on Investments Total effective cost of Invested fund

Gives the recovery of cost of funds deployed in

investments

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Income Ratio

Loss

Interest not-received Gross Interest Due

Indicates the proportion on interest income not

collected out of total Cost per unit of business Operating Expenses Average business Indicates efficiency in

business operations

Group-III: Portfolio Quality Ratios Ratio Default Ratio Formula Payment in arrears Value of loan outstanding Portfolio Risk Credit Ratio NPA) Net Risk NPA) Reserve Ratio Credit Non-performing loans-provision Measures the proportion on (net Total value on loan assetsprovision Loan loss reserve Value of Loans Outstanding non-performing provided for Indicates the adequacy of reserves portfolio in relation to loans not Risk (gross at Number of loans in arrears Number of loans outstanding Non-performing loans Total value of loan assets Indications Indicates the amount of loan payment past due Measures the amount of default risk in portfolio Measures the proportion of non-performing loans

Group-IV: Staff Productivity Ratio Operating Expenses per staff (Rs. Operating Expenses Total no. of staff Indicates total expenses per staff

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Lakh) Financial Margin Staff Business Per Staff (Rs. Lakh) Portfolio staff per No. of loan and deposits accounts Total no. of Staff Number Active per staff of clients No. of Active borrowers+depositors Number of Staff Indicates staff and performance efficiency of of Indicates number of Deposits Advances Total no. of Staff Indicates total size of per Financial Margin Total no. of Staff Gives the gross earnings per staff

business per staff

clientele accounts per staff

methodology (in terms of No. of clients)

The analysis of performance on the basis on financial statements helps us in knowing our financial strength and the areas requiring improvement. This facilitates planning for the future.

RISK MANAGEMENT Risk and its management have assumed greater significance in recent years due to changing financial risk exposures of the institutions. Risk has always been present in the banking business but the discussion on managing the same has gained prominence only recently. Four risks confront financial institutions viz., credit risk, interest rate risk, foreign exchange risk and liquidity risk. In any bank, credit-risk cannot be eliminated unless the bank chooses to be over cautious about lending. Therefore, in addition to above strategic and operational measures, there should be a policy that can measure and control the risk-return function in a bank. This involves measurements of risk, establishing a manageable risk levels

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and measures to cope with the risk. RBI has set out detailed guidelines for credit risk management, although it may not be entirely applicable for a RFI (Rural Financial Institution) situation. Nevertheless, each bank should have a credit risk management system in place. Some of the tools of risk management are discussed in the following paragraphs. Replacement of Loans Out of court settlements/compromise with borrowers Calling up the advances and filing of civil suit/certificate cases Settlement of claims with DICGC Establishment of Assets Recovery branches and liaison with

courts/Recovery officers Prevention of downgradation of existing NPAs Upgradation of Assets quality Fixing up of suitable repayment schedule Write-off the outstanding The credit risk remains the predominant risk for most banks, despite changes in banking over the last few years. The credit risk depends on both internal and external factors. The external factors are the state of the economy, swings in commodity prices and equity prices, foreign exchange rates interest rates, etc. The internal factors are deficiencies in loan policies and administration of loan portfolio which would cover weaknesses in the area of prudential credit concentration limits, appraisal of borrowers financial position, excessive dependence on collateral and inadequate risk pricing, absence of loan review mechanism and post sanction surveillance, etc. Such risks may extend beyond the conventional credit products such as loans and letters of credit and appear in more complicated, less conventional forms, such as credit derivatives or trenches of securitized assets or outstanding commitments. The second category of risk that has gained prominence is interest rate risk. Interest rate risk arises because banks fix and re-fix interest rates on their resources and on the assets in which they are deployed at different times.

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Changes in interest rates can significantly impact the net interest income, depending on the extent of mismatch between the times when the interest rates on asset and liability are reset. Any such mismatches in cash flow (fixed assets or liabilities) or reprising dates (floating assets or liabilities) expose banks net interest margin to variations. Third important category of risk pertains to foreign exchange risk. The risk inherent in running open foreign exchange positions has become pronounced in recent years owing to the wide variation in exchange rates. Such risks arise owing to adverse exchange rates movements, which may affect a banks open position, either sport or forward, or a combination of the two, in any individual foreign currency. The final major category of financial risk is liquidity risk. The liquidity risk arises from funding of long-term assets by short-term liabilities or resources, thereby making the liabilities subject to rollover or refinancing risk. Those banks that fund their domestic liquidity risk when sharp fluctuations in exchange rates and market turbulence make it difficult to retain sources of financing. How do we try to manage these risks? Irrespective of the nature of risk, the best way for banks to protect themselves is to identify the risks, accurately measures and price it, and maintain appropriate levels of reserves and capital, in both good and bad times. However, this is often easier said than done, and more often than not. Developing a holistic approach to assessing and managing the many facets of risks remains a challenging task for the financial sector.

ASSET LIABILITY MANAGEMENT (ALM) Meaning & Objectives Assets Liability Management is concerned with strategic balance sheet management and it is used to achieve objective managing the following risks: Credit Risk Interest rate risk Foreign Exchange risk

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Liquidity risk Importance of ALM: There are several reasons for growing importance of ALM function. More important are the exposures of the institution directly and indirectly to the risk situations and the need to safeguard the position proactively. The following trend also necessitates the ALM function in banks: Financial volatility Explosion of new financial products Regulatory initiatives Heightened awareness of top-management ALM Strategies: Asset Liability management can be done in three different ways. i. On-Balance sheet: Business strategies involving product mix and pricing of loans, deposits and other borrowers. ii. On-Balance sheet: Investment strategies involving maturity mix and rate characteristics of investment securities iii. Off-Balance sheet: Use of derivatives to manage Asset-Liability risks

The cost of off-balance sheet strategy and on-balance sheet strategy need to be considered as both involve costs.

KNOW YOUR CUSTOMER (KYC) & ANTI MONEY LAUNDERING (AML) Know Your Customer Standards: The objective of KYC guidelines is to prevent banks from being used, intentionally or unintentionally, by criminal elements for money laundering activities. KYC procedures also enable banks to know/understand their customers and their financial dealings better which in turn help them manage their risks prudently. Banks should frame their KYC policies incorporating the following four key elements: (i) (ii) (iii) (iv) Customer Acceptance Policy Customer Identification Procedures: Monitoring of Transactions; Risk management

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For the purpose of KYC policy, a Customer may be defined as:

A person or entity that maintains an account and/or has a business relationship with the bank; One on whose behalf the account is maintained (i.e. the beneficial owner); Beneficiaries of transactions conducted by professional intermediaries, such as Stock Brokers, Chartered Accountants, Solicitors etc. as permitted under the law; and

Any person or entity connected with a financial transaction which can pose significant reputational or other risks to the bank, say, a tele transfer or issue of a high value demand draft as a single transaction.

Customer Acceptance Policy (CAP): Banks should develop a clear Customer Acceptance Policy laying down explicit criteria for acceptance of customers. The Customer Acceptance Policy must ensure that explicit guidelines are in place on the following aspects of customer relationship in the bank. (i) (ii) No account is opened in anonymous or fictitious/benami name (s). Parameters of risk perception are clearly defined in terms of the nature of business activity, location of customer and his clients, mode of payments, volume of turnover, social and financial status etc. (iii) Documentation requirements and other information to be collected in respect of different categories of customers depending on perceived risk (iv) Not to open an account or close an existing account where the bank is unable to apply appropriate customer due diligence measures (v) Circumstances, in which a customer is permitted to act on behalf of another person/entity, should be clearly spelt out in conformity with the established law and practice of banking and (vi) Necessary checks before opening a new account so as to ensure that the identity of the customer does not match with any person with known

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criminal background or with banned entities such as individual terrorists or terrorist organizations etc. Customer Identification Procedure (CIP): The policy approved by the Board of banks should clearly spell out the Customer Identification Procedure to be carried out at different stages i.e. while establishing a banking relationship; carrying out a financial transaction or when the bank has a doubt about the authenticity/veracity or the adequacy of the previously obtained customer identification data. Customer identification means identifying the customer and verifying his/her identity by using reliable, independent source documents, data or information. Banks need to obtain sufficient information necessary to establish, to their satisfaction, the identity of each new customer, whether regular or occasional, and the purpose of the intended nature of banking relationship. Monitoring of Transactions: Ongoing monitoring is an essential element of

effective KYC procedures. Banks can effectively control and reduce their risk only if they have an understanding of the normal and reasonable activity of the customer so that they have the means of identifying transactions that fall outside the regular pattern of activity. However, the extent of monitoring will depend on the risk sensitivity of the account. Banks should pay special attention to all complex, unusually large transactions and all unusual patterns which have no apparent economic or visible lawful purpose. KYC & AML Role of Board: The Board of Directors of the bank should ensure that an effective KYC programme is put in place by establishing appropriate procedures and ensuring their effective implementation. It should cover proper management oversight, systems and controls, segregation of duties, training and other related matters. Responsibility should be explicitly allocated within the bank for ensuring that the banks policies and producers are implemented effectively. Banks may, in consultation with their boards, devise procedures for creating Risk Profiles of their existing and new customers and apply various Anti Money Laundering measures keeping in view the risks involved in a transaction, account or banking/business relationship. Management of Non-Performing Assets and Recovery Management

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Meaning: Any asset which is yielding desired income is a performing asset. When assets stop earning the desired income, they are termed as NPAs. A loan is a financial asset. When we stop receiving interest on the loan amount or the repayment of principal instalment on due date, we classify them as NPAs. It is true that loans do not become NPA immediately if a payment of interest or repayment of principal instalment is missed. For example, we wait for a period of 90 days from the date of default before classifying the defaulted non agricultural term loans as NPAs. The criteria for classifying different types of loans are different. Without going into the details of the criteria, it would be sufficient to say that default leads to NPA. Not only the defaulted amount of interest or principal but the entire amount of outstanding is classified as NPA. If any one account of a borrower is classified as NPA, all other accounts of same borrower, even performing, will also be classified as NPA. When an account becomes NPA, we can not recognize the accrued income on the loan as our income. In addition, we are required to make provision for losses from the NPA account leading to reduction in profit. It is therefore essential to monitor the recovery of the bank to maintain sustainable profit. There are a number of internal and external factors which are responsible for low level of loan recovery and mounting NPAs. For bringing about improvement in recovery, it is essential that banks explore all the possibilities such as timely follow-up action, timely rehabilitation, sale of assets, pursuing claims with the surety, compromise and as the last resort, legal recourse. Need & Relevance: The relevance of NPA management can be gauged from the following extract from Narasimham Committee II Report: NPAs constitute a real economic cost to the nation in that they reflect the application of scarce capital and credit funds to unproductive uses. The money locked up in NPAs are not available for productive use and to that extent that banks seek to make provisions for NPAs or write them off, it is a charge on their profits. To be able to do so, banks have to charge their productive and diligent customers a higher rate of interest. It thus becomes a tax on efficiency. It is the customer who uses credit efficiently that subsidizes the inefficiency represented by NPAs. This also raises the transaction costs in the system this denying the

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diligent credit customers the benefit of lower rates which would help them to be more efficient and competitive. NPAs, in short are not just a problem for banks. They are bad for the economy Management of NPAs need action in three dimensions. Preventive action Remedial Action Credit Risk Management Preventive Action: To reduce or to avoid creation of NPA, a bank must have a well-defined credit policy and procedure in place. A good credit policy and procedure will have the following elements: Banks should have written credit policies that define target markets, risk acceptance criteria, credit approval authority, credit origination and maintenance procedures and guidelines for portfolio management and remedial management. Banks should establish proactive credit risk management practices like annual/half yearly NPA studies and individual obligor reviews, periodic credit calls that are documented, periodic visits to borrowers, and quarterly management reviews of troubled exposures/weak credits. Managers in banks will be accountable for managing risk and in conjunction with credit risk management framework for establishing and maintaining appropriate risk limits and risk management procedures for their businesses. Banks should have a system of checks and balances in place around the extension of credit which are: An independent credit risk management function (branch level) Multiple credit approvers (Area Office level) An independent audit and risk review function (HO level) The Credit Approving Authority to extend or approve credit will be granted to individual credit officers based upon a consistent set of standards of experience, judgment and ability.

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The level of authority required to approve credit will increase as amounts and transaction risks increase. Every obligor and facility must be assigned a risk rating or some such norms Banks should ensure that there are consistent standards for the origination, documentation and maintenance for extensions of credit. Banks should have a consistent approach toward early problem recognition, the classification of problem exposures, and remedial action. Banks should maintain a diversified portfolio of loan assets. Credit risk limits include, but are not limited to, obligor limits and concentration limits by activity type or geography. In order to ensure transparency of risks taken, it is the responsibility of banks to accurately, completely and in a timely fashion, report the comprehensive set of credit risk data into the independent risk system. In order to prevent accumulation of NPAs and to ensure proper recovery of loans, the following measures are suggested. Remedial Action: The management of NPA and recovery needs strategic framework as also an operational framework. These should be imbibed appropriately into a well-documented Loan Recovery Policy of a bank. It is strategic, because of its analytical content of the borrowers, borrowing units vis-vis its own internal arrangement for handling credit portfolio. Some successful strategic measures for reducing NPA s are: Thorough and individual analysis of NPA accounts / branches Recovery volunteers Branch Adoption by HO officials or special recovery cells at AO / HO Recovery Teams Compromise/Write off/Rescheduling policy

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Incentives for payments Incentives to staff Working with borrowers Legal engineering and effective use of legal provisions Good rapport with government machinery Involvement of Trade Unions in Recovery Effective use of insurance facilities

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CHAPTER 6

(Session 7)

FUNDS AND INVESTMENT MANAGEMENT

In the banking parlance, the term Funds Management encompasses raising of resources and application of resources in different forms of assets. The profit of a bank depends primarily on the utilization of its funds in loans and advances, investments. Effective and efficient management of the funds and investment will bring prosperity to the banks.

Management of CRR

As per section 18 of the BR Act, every non-scheduled cooperative bank shall maintain in India by way of cash reserves with self of by way of balance in current account with the RBI or the State Cooperative Bank of the State concerned or by way of net balance in current account, a sum equivalent to at least 3.0% of the total of its demand and time liabilities (DTL) in India, as on the last Friday of the 2nd preceding fortnight, and shall submit to RBI, before the 20th day of every month, a return showing the amount so held on alternative Friday during a month.

Since no income accrues out of the amount maintained under CRR, banks should endeavor to maintain exactly 3.0% so that the statutory obligations are fulfilled while not losing any interest income.

Management of Statutory Liquidity Ratio (SLR)

In terms of Section 24 of BR Act, 1949 (AACS), a CCB/SCB or RRB. In addition to the CRR banks shall also maintain in India in cash, or in gold or in unencumbered approved securities, or in account with SCB, an amount which shall not, at the close of business on any day, be less than 25% of the total of its demand and time liabilities in India, as on the last Friday of the 2nd preceding fortnight. Unencumbered approved securities are securities in which a trustee may invest money under clause (a) to (c) of Section 24(2).

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The SLR portfolio includes non-earning assets like cash and balances in C/A and earning assets like investments in Government and other approved securities. In order to optimize the returns, the banks have to:-

i. ii. iii.

Minimize the cash / balance in C/A portion to the extent possible Restrict the SLR investments up to 25% or slightly more than that Divert the non-SLR funds for investing in more lucrative avenues

Investment Management Permissible investment Avenues S L R N Govt Securities, T Bills Cash, gold, deposits with SCB 25% of NDTL

Shares 5 % of incremental

Debentures

Deposits at the end of Preceding financial

Mutual Fund

year

Public Sector Undertaking

No ceiling

All India Financial Institutions

NON-SLR INVESTMENTS 1. Holding of Shares & Debentures in Private Sector Companies or

Institutions other than Cop Sector. The Cooperative banks should not subscribe to the initial or subsequent issue of shares / debentures of private sector companies or bodies or organizations other than in cooperative sector unless specifically permitted by the Reserve Bank.

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2. 2.1

Deposits with other institutions and other cooperative banks Scheduled Cooperative banks should not place deposits with any other

cooperative banks. 2.2 Non-scheduled cooperative banks may place deposits with strong

scheduled cooperative banks, fulfilling the following norms:2.3 The Cooperative banks should not park their funds as deposits with

other institutions / companies / corporations etc. 2.4 Cooperative banks may, however, maintain balances in current

accounts with other banks for meeting their clearing and remittance requirements.

3.

Investment in Certificate of Deposits (CDs)

All cooperative Banks are permitted to make investments in CDs issued by scheduled commercial banks and other financial institutions approved by the Reserve Bank of India, subject to the fulfillment of certain conditions.

4. 4.1

Fixing of prudential limits The Board of Directors of banks should fix a prudential limit for their total

investment in non SLR securities and sub limits for the following debt securities. i) bonds of public sector undertakings, ii) bonds / equity of All India Financial Institutions iii) infrastructure bonds floated by All India Financial Institutions iv) unsecured redeemable bonds floated by nationalized banks v) units of UTI and vi) certificate of deposits issued by scheduled commercial banks and other financial institutions approved by RBI 4.2 The total investment in (i) to (vi) above should not exceed 10 per cent of

the banks total deposits as on 31 March of the previous year, with a sub-ceiling of 5 per cent of incremental deposits of the previous year for investment covered under (v).

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4.3

Banks should ensure that exposure, to a single issuer of debt securities is

within the individual exposure ceiling prescribed by RBI for grant of advances, based on the capital funds of the bank. 4.4 Banks which have exposures to investments in non-SLR securities in

excess of the prudential limit prescribed above as on 31 March 2003 should not make any fresh investment in such securities till they ensure compliance with the above prudential limit. 4.5 As a matter of prudence, banks should stipulate entry-level minimum

ratings/ quality standards and industry-wise, maturity-wise, duration-wise etc, limits to mitigate the adverse impacts of concentration and risk of liquidity.

5. 5.1

Role of Board of Directors Banks should ensure that their investment policies duly approved by the

Board of Directors are formulated after taking into account all the relevant issues specified in these guidelines on non-SLR investment. Banks should put in place proper risk management systems for capturing and analyzing the risk in respect of non-SLR investment and taking remedial measures in time. 5.2 The board should devise a system to ensure that the limits prescribed in

paragraph above are scrupulously complied. The Boards should appropriately address the issue of ensuring compliance with the prudential limits on an ongoing basis, including breaches, if any, due to rating migration. 5.3 Boards of banks should review the following aspects of non-SLR

investments twice a year: i. ii. Total business (investment and divestment) during the reporting period Compliance with the prudential limits prescribed by the Board for non-SLR investment iii. Rating migration of the issuers/issues held in the banks books and consequent diminution in the portfolio quality. iv Extent of non-performing investments in the non-SLR category and sufficient provision thereof.

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Manner of Holding Mandatory Investments

The Securities may be held in any of the three forms, viz, (a) Physical scrip form, (b) Subsidiary General Ledger (SGL) Account and (c) in a dematerialized account with the depositories (NSDL/CSDSL, NSCCL). In respect of securities with SGL facility, the SGL account can be maintained in the banks own name directly with the Reserve Bank of India, or in a Constituent SGL Account (CSGL) opened with any scheduled commercial bank/State Cooperative Bank/Primary Dealer (PD) or Stock Holding Corporation of India Ltd (SHCIL). The Cooperative Banks are not permitted to open and maintain CSGL Account of other Cooperative Banks / other entities like charitable institutions trusts etc.

General Guidelines regarding Investments

1.

The Cooperative Banks should not undertake any purchase/sale

transactions with broking firms or other intermediaries on principal to principal basis.

2.

No sale transaction should be put through by the cooperative banks without

actually holding the securities in their investment accounts, i.e., under no circumstances should banks hold an oversold position in any security.

3.

For purchase of securities from the Reserve Bank through Open Market

Operations (OMO), no sale transactions should be contracted prior to receiving the confirmation of the deal / advice of allotment from the Reserve Bank.

4.

Only scheduled banks are at present permitted to become members of

NDS and participation of DVP III mode for settlement of Government securities transactions.

5.

Scheduled Cooperatives Banks may undertake retailing of Government

securities with non-bank clients, such as provident funds, non-banking financial companies, high net worth individuals, etc, subject to the following conditions.

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Banks may freely buy and sell Government securities on an outright basis at the prevailing market prices without any restriction on the period between sale and purchase.

Retailing of Government securities should be on the basis of ongoing market rates/yield curves emerging out of secondary market transactions.

No sale of Government securities should be affected by banks unless they hold securities in their portfolio either in the form of physical scrip or in the SGL account maintained with the RBI.

Immediately on sale the corresponding amount should be deducted by the bank from its investment accounts and also from its SLR assets.

These transactions should be looked into by the concurrent / statutory auditors of the bank.

Scheduled Cooperative banks should put in place adequate internal control

checks / mechanisms as advised by the RBI from time to time. 7 Banks may take advantage of the non-competitive bidding facility in the

auction of the Government of India dated securities provided by the RBI. Under this scheme, banks may bid up to Rs two crore (face value) in any auction of Government of India dated securities, either directly, through a bank or through a primary dealer. For availing this facility, no bidding skill is required as allotment up to Rs two crore (face value) is made at the weighted average cut-off rate which emerges in the auction. Cooperative Banks may also participate directly or through a bank or a primary dealer in the auctions of State Development Loans, where coupon is mostly fixed in advance and notified by the RBI. An advertisement in leading newspapers is issued 4 5 days in advance of the date of auction. Half yearly auction calendar of GOI securities is also issued by the RBI. 8. CSGL Accounts should be used for holding the securities and such

accounts should be maintained in the same bank with which the cash account is maintained. For all transactions delivery versus payment must be insisted upon by the banks.

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9.

In case CSGL account is opened with any of the non-banking institutions

indicated above, the particulars of the designated funds account (with a bank) should be intimated to that institution.

10.

All transactions must be monitored to see that delivery takes place on

settlement day. The particulars of the designated funds account (with a bank) should be intimated to that institution.

11.

Officials deciding about purchase and sale transactions should be separate

from those responsible for settlement and accounting.

12.

All investment transaction should be pursued by the Board at least once a

month.

13.

The banks should keep a proper record of the SGL forms received/issued

to facilitate counter-checking by their internal control systems / NABARD inspectors / other auditors.

14.

All purchase/sale transactions in Government securities by the banks

should necessarily be through SGL Account (with RBI) or constituent SGL Account (with scheduled commercial banks/SCB/PD/SHCI or in a dematerialized account with depositories (NSWDL/CDSL/NSCCL).

15.

No transactions in Government securities by a cooperative bank should be

undertaken in physical form with any broker.

16.

The entities maintaining the CSGL/designated funds accounts are required

to ensure availability of clear funds in the designated funds accounts for purchases and of sufficient securities in the CSGL Account for sales before putting through the transactions.

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17.

The security dealings of banks generally being for large value, it may be

necessary to ensure, before concluding the deal, the ability of the counter-party to fulfill the contract, particularly where the counter-party is not a bank.

18.

While buying securities for SLR purposes, the bank should ensure from the

counter parties that the bonds it intends to purchase have and would continue to have SLR status. The bank should also verify this from independent sources in case of doubt.

19.

In other to avoid concentration of risk, the banks should have fairly

diversified investment portfolio. Smaller investment portfolios should preferably be restricted to securities with high safety and liquidity such as Government securities.

20.

The Cooperative banks may seek the guidance of Primary Dealers

Association of India / Fixed Income and Money Market Dealers Association (FIMMDA) on investment in Government securities. Management of Investment Risks Investments are not risk free. It is important that the banks as well as IOs understand the various risks that are natural to investment banking. Some of the important risks are: Default risk Interest rate risk Reinvestment risk Purchasing power risk Liquidity / marketability risk Option risk

Default Risk

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Default risk refers to the probability of default in repayment of principal or the payment of interest. Presently, Government Securities alone are considered default risk free. Though the inter bank deposits are treated similarly, still they have an element of default risk. In respect of other investments, credit rating of higher grade has to be selected so as to lower the default risk. Interest Rate Risk The possibility that a charge in the market rate of interest in a security will affect the price of the security adversely is known as the Interest Rate Risk. Reinvestment Risk Reinvestment risk arises in the event of a decline or fall in the interest rate. In such case, investments/interest on investments which mature will have to be reinvested at a lower rate of interest, resulting in reduction in the income. Purchase Power Risk Interest rate has two components, Real Interest Rate and inflation. In respect of fixed income security the coupon or interest rate remains fixed during the tenure of the instrument. However, if the inflation is on rise during this period, the real rate of interest may gradually decline, reducing the purchasing power of the bank. Liquidity / Marketability Risk A securitys liquidity is defined at the ease with which an investor can exit the instrument. Liquidity is ensured by availability of secondary market. Liquidity is also dependent on the issue size. Option Risks Call and Put options are sometimes regular features of some of the instruments. Under Call option, the issuer may redeem the instrument much before its maturity period, particularly in a falling interest rate scenario.

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CHAPTER 7

(Session 8)

BOARD MEETINGS AGENDA WITH REFERENCE TO NABARD GUIDELINES

Board of Directors represents the general body. Though general body is the

supreme body in the Cooperative democracy, it is the Board, which plans, takes important policy decisions and ensures the implementation of the policies framed. It draws its power from the members and acts on behalf of the members. As all the members cannot participate in the decision-making and management, the Board of Directors as the representative body of the members discharge the responsibilities entrusted to them. The Board meets more often than the general body. Usually it meets once in a month and more times when required. The decisions are taken jointly by the Board and all directors are expected to abide by the joint decision.

FUNCTIONS OF THE BOARD: The main functions of the Board with reference to meetings are to frame policies, review the results and ensure maintenance of good-relations between the management and the members.

Framing Policies: As the Cooperative banks are expanding their activities, they are required to improve the quality of their working and must be competent. The directors must be competent enough to frame pragmatic policies to satisfy the needs of the organization and its members.

Reviewing Results: After the policies are framed, the directors are expected to entrust the responsibility of implementing them to the management appropriately and delegate powers accordingly to achieve the results. In the meanwhile, the progress must be reviewed by the Board at important stages. If the policy is apparently not a success, the Board must decide, after weighing all the evidence, whether to extend the trial period even at some cost or modify the policy, if necessary.

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Maintaining Cordial Relations: It is the responsibility of the Board to see that cordial relations exist between the management and the members and it should act as a bridge between the two groups.

The Boards of Directors of cooperative banks have the responsibility of overseeing the performance of the respective bank's operations and ensure that they function in accordance with the guidelines issued by the

RBI/NABARD/GoI/State Government, and achieve the objectives set before them. To enable the Boards of Directors to discharge this responsibility, the CEO/Secretary to the Board are expected to submit periodical reviews to their respective Boards on various operational aspects of the banks, particularly in respect of developmental objectives set before them. Periodical reviews are also placed before the Boards which throw light on the internal health of the institutions such as those relating to inter-branch reconciliation, vigilance, recovery of dues, etc. 2. The Board of Supervision (for SCBs, DCCBs and RRBs) constituted by

NABARD reviewed the agenda items being placed before the Board of Directors of SCBs and DCCBs and observed that no uniform periodicity is observed by the banks in the submission of such reviews and that these notes do not encompass all the major aspects of banking operations. Such reviews, therefore, did not enable the Boards to take an overall view of the performance of the banks and identify the problems that the banks may face in specific areas to facilitate adoption of timely rectification measures. In short, a view emerged that the scope and content of some of the prescribed reviews did not meet the intended objectives and required suitable changes in the light of recent developments in the banking sector. The Board of Supervision also noted the need for division of the reviews into three parts, viz., reviews to be put up to (i) Board, (ii) Managing Committee and (iii) Audit Committee, so as to ensure that the deliberations get focused. 3. Accordingly the revised calendar of reviews to be put up to the Board,

Managing Committee and Audit Committee are indicated below. SCBs/DCCBs should initiate necessary steps to submit specific reviews to the Board/Managing Committee/Audit Committee in accordance with the calendar. The calendar

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outlines the critical minimum requirements for review and the bank Boards will have discretion to prescribe additional reviews to suit their requirements. 4. The revised schedule may please be brought into force with immediate

effect. If for any particular reason it is not possible to place a memorandum as per the calendar before the Board in the month it is due, a note should be put up to the Board giving reasons for the delay, indicating when the review is proposed to be placed before the Board. A. Calendar of Reviews to be put up to the Board of Directors of SCBs

and DCCBs I. Every Board Meeting

1. Funds Management

i. Information about funds position of the bank ii. Compliance with CRR/SLR requirements iii. Details of investments in call deposits, non-SLR investments made, Securities traded and income earned / loss incurred, if any. iv. Compliance with RBI instructions in regard to maintenance of investments in Government Securities. v. Details of borrowings availed of from higher financing agencies

(SCB/NABARD/State Govt., etc.) under various lines of credit limits vis-a-vis the Maximum Borrowing Power. vi. Position of deposits mobilised, amount invested in various avenues and advances made. The report should not be a fact sheet but should capture qualitative data on the important market trends, market developments, regulatory initiatives, etc. between the review periods and should stimulate constructive suggestions and discussions on critical appraisal of the strategies followed presently and the need for changes. vii. Concurrent audit report by internal auditors and compliance report thereon (to be placed before the CEO and Chairman every month).

2. Loans and advances

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i. Review of various credit limits sanctioned by Managing Director/ Chairman/ Executive Committee. ii. Sanction of term loans (for setting up / modernisation of sugar factory / spinning mill / ginning press, etc.) and follow up. iii. Participation in Consortium Finance. iv. Adherence to exposure norms prescribed by RBI/ NABARD.

3. General

i. Compliance in respect of outstanding observations of the Board. ii. Review compliance with various Sections of Banking Regulation Act /RBI Act/ Cooperative Societies Act / Rules / Bye-laws of concerned banks. iii. Circulars received from RBI, NABARD, DICGC, RCS and Apex Bank. iv. Implementation of the instructions/directives/ guidelines issued by RBI/NABARD/Govt. v. Submission of Statutory returns including OSS returns.

II. Quarterly

1. Business Plan: Targets and Achievements

i. Performance reviews vis-a-vis business goals such as deposit mobilisation, credit disbursal, recovery of loans, etc. The reviews should be comprehensive and cover specifically the bank's structural / organisational requirement. It should lead to initiation of business strategies of growth and profitability. The review should also contain bank's performance under special programmes of credit assistance like SHG, SGSY, etc. ii. Review of high yielding advances sanctioned by the bank. iii. Review of progress in implementation of Government sponsored programmes. iv. Recoveries effected under NPA accounts. The report should be

comprehensive and cover requisite details on the deficiencies observed, systemic controls required for avoidance of incidence of NPAs, etc. The review should also look at loan policy caveats on exposure thresholds, borrower-wise/industry-wise, etc. and other credit risk management initiatives on ongoing basis.

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v. Details of OTS / waiver of irrecoverable loans / interest. vi. Recovery under legal action (cases of ABN filed, decree/awards obtained and EPs filed/ executed).

2. Branch performance

i. Branch-wise targets and achievements under various business parameters. ii. Review of branch profitability with suggestions measures to improve the position of loss making branches. Need for branch expansion and branch rationalisation. iii. Progress in inspection of branches and important observations of branch inspections. iv. Review of discussions held during Branch Manager's review meetings.

3. Working Results

An analysis of the working results of the bank on a quarterly basis along with an analytical note and proposals for future course of action. The banks comparative position should also be highlighted.

4. Others

i. A comprehensive review of the Vigilance Cell including position of vigilance cases and disciplinary cases initiated against the bank's staff and secretaries of affiliated societies. ii. Review of cases of frauds, misappropriations, embezzlements, defalcations, etc. together with action for recovery thereof. Review of cases of dacoities and security arrangements in the bank. iii. A review of customer services rendered by the bank with analysis of complaints received and action taken. iv. Review of Development Action Plan / Memorandum of Understanding. Progress in implementation of the Action Plan prepared for recompliance with Section 11 of the B.R. Act, 1949 (AACS) - (For Sec.11 non-compliant banks). v. Observations of the Audit Committee. 104

III. Half-yearly

i. Half yearly review of investment portfolio (as on 30 September and 31 March); copy of review report put up to the Board should be forwarded to RBI/NABARD by 15 November and 15 May. ii. A review of operations of the banks non-fund business. iii. A review of the banks HRD policy, training programmes, etc. iv. Comprehensive status notes separately on Income Recognition, Asset Classification and Capital Adequacy regarding compliance with the policy guidelines laid down by RBI from time to time. The review should be a progress report on the steps initiated on the policy guidelines of RBI on prudential regulations, risk management, etc. v. Review of implementation of Risk Management guidelines in the bank. vi. Review of all aspects relating to the computerisation of branches/Regional Office/Head Office and also look into Information Technology related needs. vii. Review of cost of funds, yield on deployment of funds, interest rates revision, etc. viii.Position of imbalance- society-wise. ix. Review compliance of the Fair Practices Code and the functioning of Grievance Redressal Mechanism at various levels of controlling offices. x. Review of viability of affiliated DCCBs / societies. Position of Cadre Fund, share capital contribution / share linking at different tiers.

IV. Yearly

i. Working results- Comparison of various parameters with working results of other banks and should include analysis of Balance Sheet prescribed by RBI. ii. Audit Report- Long Form Audit Report (LFAR) of the bank along with banks comments on the auditors observations. iii. Review of all policies- An annual review of all policies formulated by the bank like Loan Policy, Investment Policy, Recovery Policy, Funds Management Policy, Risk Management Policy, ALM, etc.

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iv. Corporate Budget- Review of budget proposals made for various expenditure vis-a-vis actual expenditure and reasons for large scale deviations, if any. v. Review of working of Head Office Departments. vi. Statutory inspection Report and compliance report thereon (to be submitted to NABARD). vii. Review of findings of inspection conducted by SCB and action taken thereon. viii.Review of reports submitted by Audit Committee and action taken thereon. ix. Cash retention limits of HO and branches. x. Note on Man-power Planning and Development and periodical review in respect thereof. Policy relating to recruitment/promotion/transfer/staff welfare

B.

Calendar of Reviews to be put up to the Management Committee of

SCBs and DCCBs

I. Every Meeting

1. Compliance on observations by the Management Committee. 2. Credit proposals sanctioned by Chairman / Managing Director/ Branch

Managers.

II. Quarterly 1. Compromise proposals/bad debts written off, if any General

Manager/Executive Director/Chairman.

2.

Review of top 20 loan accounts in each category of NPA i.e., Sub-

standard/Doubtful/Loss. After deliberations, a status report giving macro level analysis of NPAs (trend, movement, sector-wise, suit-filed cases, recovery, etc.) should be put up to the Board.

III. Yearly

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Review of Corporate Budget includes review of publicity expenses, capital expenditure vis--vis capital budget, donations made during the year, etc. deviations to be put up to the Board.

C.

Calendar of Reviews to be put up to the Audit Committees of SCBs

and DCCBs

I. Quarterly 1. 2. 3. Inter-branch reconciliation. Performance of Concurrent Audit/Inspection Department. Inspection reports of poorly rated branches Progress in rectification of

deficiencies. 4. Review of arrears in balancing of books, clearing differences,

sundry/suspense items).

II. Yearly 1. Compliance with observations made by the statutory auditor. 2. Compliance with observations made in NABARD's Inspection Report.

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CHAPTER 8

(Session 10)

PROFIT PLANNING AND DEVELOPMENT ACTION PLAN

What is profit? Profit is the net balance of income over all expenditures of an organisation (Bank) earned and incurred during a particular period of time (accounting period). The simple formula for understanding the profit is; Profit = Total Income - Total Expenditure This is the common meaning of the word profit. However, profit is defined at different levels. In banks, three words are used to elaborate profit. A. Spread or Financial Return is the financial return on funds less financial cost of funds. B. Operational profit is the profit before making provisions, and C. Net profit is after deduction of all the expenditure and provisions. In view of introduction of prudential norms, the concept of operating profit has also gained significance. Why Banks should earn PROFIT? This is a very relevant question since this has been asked quite often in the cooperative sector. The answer could be manifold. One, the profit is necessary for survival and growth of the organisation. Two, unless profit is earned i.e. unless the bank is strong enough, how could it serve the rural clientele? And third, profit is the major indicator of efficiency and competitiveness of the operations of the organisation. Therefore, PROFIT is not a dirty word and every business organisation including cooperative banks must ensure decent profit to serve the members and public better.

Profit Planning
With the liberalisation of Indian economy and financial sector reforms, there is lot of competition in the banking industry. The business of banking has more and more become complex and profits are hard to come. Profits in banks are not an accident but the result of a careful planning and strategy. The viability of banks cannot be

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ensured without profit and so viability is gaining importance. In the liberalised environment, it is realised that unless an institution is viable and stands on its own feet, it wont exist to serve the market for a long. Adopting appropriate development plans and strategies, the Cooperative Banks could become sustainable/viable. It is important to understand the source of income and areas of expenditure while planning for profit. Source of Income of Cooperative Banks: Income in banks comes from following four sources: Interest earned on advances Interest earned on investment Interest earned from bank balances Miscellaneous income is the income from non-fund business including exchange and commission, etc and the gains in disposal of assets, if any.

The income from first three sources is known as financial returns. Areas of Expenditure of Cooperative Banks: Expenditure or costs in banks are the following four: A. Financial costs Interest on deposits Interest on borrowings Salary and payments to staff known as wage bill or cost of management Other operating expenditure Provisions for Non Performing Assets (NPAs) Investment depreciation reserve

B. Transaction costs

C. Risk costs

D. Equity costs Normally, the payments made out of profit to the shareholders is called dividend. Though dividend is not expenditure in real sense, it is considered as cost here as it is also to be earned from the business and paid. Most of the Cooperative banks do not pay dividend for the present but in future, it will be expected by the shareholders. Thus, profit planning has to encompass all these areas. Figure 1 indicates 6 components of profit planning viz. resource planning and management, business development, funds management, non-fund business (miscellaneous income), control

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of income leakages and cost control and management. These items will be discussed briefly.

Figure 1: Components of Profit Planning

RESOURCES PLANNING AND MANAGEMENT

BUSINESS DEVELOPMENT

PROFIT COST CONTOL AND MANAGEMENT

FUNDS MANAGEMENT

CONTROL OF INCOME LEAKAGES

NON-FUND BUSINESS (Miscellaneous income

Through Human Resources Management and Development

The sub-areas under each of these and the broad action areas for the banks are presented in Table- 1.

Table 1 Dimensions and action areas in profit planning Key Result Area Sub area Action areas Is the deposit growth (on the total and types) satisfactory? Is it possible to reduce cost of deposits by altering deposit mix? If so, how? Is it possible to reduce cost of deposits by altering interest rates? If so, how? Is the market share satisfactory? etc.

1.Resource and 1. Deposit management planning mobilisation

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2. Borrowing What is borrowing to advances management ratio? Is it satisfactory? How early the refinance is availed? Is the bank borrowing from all the possible refinance agencies (wherever it is profitable) to the extent allocated? etc. 3. Share capital Whether the bank received the entire and Reserves share capital and recapitalisation amount from the shareholders ? 2. Resource Allocation 1.CD Ratio What is the CD ratio? trend? And the

What is the trend in comparative yield on loans and investments? Which is profitable - investments or lending?

2.Advances

What is the mix in terms of types, interest rates, district/block etc by amount and % share? What is position NPAs under each of this category? Is the recovery level adequate? Is the NPA under control? What is yield on advances of different types? Is there a system of product review, etc.

3. Funds management

1. Cash What is the ratio of average cash to average deposits? management Is the cash retention limit system reviewed periodically? What are the seasonality factors in cash?

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2. Current account What is the ratio of average c/a and bank balance balances to average deposits? management What is the return on bank balances? Is the maximum balance system reviewed periodically? limit

Is the utility justifying the balance ? How efficient it is? 3. Investment What is the yield on investment ? management Is the bank utilising all the policy relaxations for investment? Is the investment portfolio adequately diversified in terms of term and types of investment? Is there a tendency to park all funds with only sponsor bank 4. Non-fund business (miscellaneous income) Issue of Demand What is the growth of the business? Draft (DD), Is the income from DD issue justifies the income loss in keeping the balance in current account? Lockers facility What is occupancy rate? Whether the charges are adequate and collected regularly? Issue Guarantee of What are different types of guarantees issued? Whether the fees are charged correctly and collected promptly?

Discounting of Bills Whether the discounting facility is offered? Whether the discount rates are justifiable in terms of time, risk, and amount? What is the composition of non-fund income? What is the growth rate in this? 5(a). Income leakage 1. Inadvertent Is the interest rate change is made charging lesser timely and communicated to the

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interest rate on advances and paying higher interest on deposits

branches? Does the manager check the computations of the clerk? Is there a system of Revenue audit of the branches and HO

2. Deliberate Frauds is audit system OK? income leakage Whether the culprits are punished or let loose? Is some staff member obliging some of his relatives/friends? 5(b). Under estimating Assessment of provisions and NPA depreciation Depreciation Investment of What is the return on performing Assets? Does that indicate consistency between income recognition and classification? on Whether the bank valued the investment as per requirement? Whether the provision is made as per NPA classification norms? Whether Depreciation is made as per valuation norms? 6. Cost control management and Non salary costs What is the growth in the other are more expenses? amenable for What are specific areas where cost control can be controlled? Like repairs, maintenance etc What areas can be simplified? Where are the duplications ? What areas can be sub-contracted? What areas can be computerised? A fine balance between austerity and customer service and image has to be achieved.

Role of Human resources in Profit Planning All the items discussed above need efforts on the part of all the staff and the Chief Executive Officer. Even the sensitivity of the Board of Directors is very necessary on

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these issues because they are often criticised for not being committed enough for the development of the bank. For enabling the staff to play a positive role in this regard, they should be able (sensitised and oriented) to provide adequate guidance in the area of profit planning and ensure strict follow-up. The board members are blamed for not being adequately professional in the areas of pricing, product development and documentation, fund management etc. Further, they need to be made accountable for the role and tasks assigned. This will motivate them to perform their role more effectively. It is obvious that without proper orientation and involvement of human resources no bank can achieve and improve profitability. Role of Branches in Profit Planning: Branches are the basic functional units of a bank. Therefore, orienting branch managers and other staff towards profitability and profit planning is of utmost importance. For this purpose, introduction of profit centre approach is very necessary under which every branch prepares balance sheet and profit and loss account. If the branch lends funds to the Head Office of the bank, it is paid a transfer price i.e. a rate on the balance, which is generally the rate, earned on the investment. On the other hand, if the branch borrows from the Head Office, then it has to pay the transfer price. The profitability of branch also motivates the manager and branch staff. The outcome of Profit Planning Profit planning should result in improved planning and management of the income and expenditure items so that better financial margins are achieved resulting in the improved profits and profitability. Even reduction in losses is a positive outcome of the profit planning. The development action plan (DAP) discussed below is one of the powerful tools for the cooperative banks towards a sound profit planning system and strategy.

Development Action Plan Concepts and Definitions

Introduction NABARD had initiated the Development Action Planning exercise in co-operative banks in an attempt to induce them to a planned and targeted effort to improve their profitability. The basic philosophy of DAPs is to enable banks to prepare institution 114

specific plans taking into account their strengths and weaknesses and implement the same. The DAPs aim at achieving Break-Even Level (BEL) of business by identifying the BEL and goes beyond to earn profit for the cooperative banks.

The preparation of DAP involves three stages i. Assessment of present status of viability on the basis of existing cost of funds, yield on funds, spread or margin available, etc. and computation of BEL at current level of efficiency ii. Planning for the future based on the potential and prospects identified (branchwise) and an in-depth analysis of various parameters, viz., financial, organisational and HRD for improving efficiency and productivity and computation of revised BEL iii. Breaking the DAP into branch wise and Head office Department wise plan for actual implementation. CONTENTS OF DAP Critical comments on all-important items and action areas are incorporated as a part of the DAP. The broad framework of such plans is as under: (a) Business and Operations Status/ Viability of Branches (with transfer price mechanism): Classification according to size of deposits and loan business, identifying medium/high business/potential branches for quantum jump Deposits: Deposit mix, existing and proposed (with a view to tap the existing potential and reducing the cost of deposits) Borrowings: Source, extent, cost, eligibility to draw refinance and its utilisation, various limits sanctioned by NABARD and their utilisation, availability of matching refinance from higher financing agencies Loan & Advances: Analysis of loans issued and outstanding (separately), interest rate wise, clientele-wise (target group and non-target group), purpose-wise, region wise, size-wise, etc, credit potential, scope and strategy for stepping up of loan business and diversification

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Management of Funds: Compliance with statutory requirements such as Cash Reserve Ratio, Statutory Liquidity Ratio, Cash and Current account management, utilisation of permissible avenues for enhancing investment income, etc Non-fund based Business: Present position and potential for providing locker and other facilities, collection of cheques, issue of draft, issue of guarantee, discounting of bills, bill payments for customers like electricity, telephone etc. Recovery Performance: Comments on recovery (under arrears and current dues), in depth analysis of overdues, amount-wise, purpose-wise, region-wise, age-wise, activity -wise, constraints (internal and external), measures for improving recovery performance (branch-wise/staff -wise targets, accountability, follow-up, monitoring plans etc.), details of legal action taken, Government support available and required, filing of claims with DICGC etc Managing Non-performing Loans: Comments on NPA level at gross and net terms, in depth analysis of NPA accounts- category-wise, activity wise, amount-wise, purpose-wise, region-wise; Constraints (internal and external), measures for improving performance (branch-wise/staff -wise targets, accountability, follow-up, monitoring plans etc.); details of loan compromise/ negotiated loans, guidelines, etc. Viability Analysis: Trends during the past three years and out look for the future; this in terms of current cost of funds, yields on funds, financial margins, transaction costs, risk costs, net margin, profit/loss, accumulated losses, amount involved in misappropriation, fraud, embezzlements, etc.; Steps for improving profitability, BEL at existing margin, its multiple with the present level of working funds/ per employee business, etc. (b) Systems and Procedures: Loan Policy and Procedures: Delegation of powers to branch/Area/Senior Managers/General Manager, internal checks and controls, effectiveness of supervision over branches, comments on vigilance set-up Investment Policy and Procedures: Formulation of a sound fund and investment policy with well defined objectives, risk levels and cut loss framework, safe guards, MIS and review mechanism, etc

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Risk Management Policy: Understanding the various types of risk in banking business and estimation of the levels of risk credit, interest rate etc. particularly NPA, accountability and responsibility to deal with NPA, Write-off policy, etc Management Information System (MIS): Efficacy of existing MIS, scope for improvement, scope for improvement through computerisation at Head Office. Information is the key to the success of business in a competitive environment. The bank that has more information is in an advantageous position to take quality decisions. (c) Management and Organisation HRD efforts: Organisational set-up, staff position, details of staff on deputation, details of technical staff, TME cell, training arrangements and data on trained staff (category-wise); Transfer policy, incentive system, motivational areas, grievance handling system, industrial relations climate, number of suspended staff, number of ongoing departmental inquiries/ court cases, etc Monitoring and Review Mechanism Each DCCB enters into a Memorandum of Understanding (MOU) with the Apex Bank for the implementation of DAP and achieving a committed results. The Apex Bank also enters into a MOU with NABARD which inter-alia contains the obligation of their DCCBs. The success of DAPs depends on their effective implementation. Proper mechanism for monitoring the performance of the branches as also the individual employees at various levels of the hierarchy has to be evolved. This culminates at the level of the CEO reviewing every month the progress under the plan in regard to the parameters and performance indicators of the bank and the targets for the individual branches. The progress also should be invariably discussed in every meeting of the board, which should be apprised also of the corrective actions in regard to the nonperforming units. Calculation of Various costs for DAP: A. FINANCIAL RETURN The financial return is also called return on working fund. This is the return generated by the bank by deploying its funds in loans and investments. The financial return is calculated using the formula:

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Interest income realised/realisable on the Asset * Return on Fund = -----------------------------------------Average Amount of Asset** X 100

*This figure has to be taken from the profit and loss a/c. ** This figure is the average of 12 monthly positions as in General ledger

B. FINANCIAL COST The bank raises its resources through various forms, particularly the deposits and borrowings. These resources are cost to the bank. Typically, these are interest costs payable / paid on deposits and borrowings during a particular year. The efficiency in resource mobilising depends not only on the interest payments but also on the size of cost free resources like own funds, interest free deposits, etc. It is calculated using the following formula. Interest paid or payable on Deposits and Borrowings for the year * Cost of Funds = -----------------------------------------Average Working Fund *This figure has to be taken from the profit and loss a/c. X 100

C. FINANCIAL MARGIN While the financial return is the income earned per Rs. 100 of the total average resources deployed, the financial cost is the cost spent on mobilising total average resources. The difference between the financial return and the financial cost is called the financial margin.

Financial Margin = Financial Return Financial Cost

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D. TRANSACTION COST The transaction cost consists of costs of management (staff related cost) and all other overhead costs incurred by the bank such as salaries, other payments made to staff, expenses on stationery and printing, postage, rents, taxes, depreciation on assets, provisions made for expenses, gratuity, bonus etc. It is as a percentage of working fund. Total transaction * Transaction Cost = --------------------------------------------- X 100 Average working fund**

*This figure has to be taken from the profit and loss a/c. ** This figure is arrived as given in the previous illustration

E. OPERATING MARGIN (PROFIT): The operating margin (profit) is the result of financial margin minus transaction cost (operating cost). Finding of operating margin (profit) is very important for any bank because it represents the financial results of the core business of the bank. F. MISCELLANEOUS INCOME Banks derive income from various non-fund businesses and by charges, commission, etc. These incomes can be clubbed together under miscellaneous income. This income is also worked out as a ratio of working fund as below: Total non-fund income * Miscellaneous Income = ------------------------------Average working fund** *This figure has to be taken from the profit and loss a/c. ** This figure is arrived as given in the previous illustration X 100

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G. RISK COST The risk cost is the cost to the bank due to business risks. This includes provisions made against all types of assets during the year like provisions made towards bad debts, overdue interest and other loss assets. Major part of the risk in banks business comes from loans and advances. Risk Cost can be quantified as: Provisioning made during the year * Risk Cost = -------------------------------------------Average working fund** *This figure has to be taken from the profit and loss a/c. ** This figure is arrived as given in the previous illustration X 100

H. NET MARGIN Net margin represents the net profit ratio earned on the working fund. Thus, it is the difference between the Operating Margin and the Risk cost added with the Miscellaneous Income. It is calculated as: Net Margin = Operating Margin +Miscellaneous Income Risk Cost

SUMMARY: Net Financial Margin is derived by netting risk cost with financial margin and miscellaneous income taken as a percentage to working funds. It can be calculated as under: 1. Financial Return 2. Financial Cost 3. Financial Margin 4. Transaction Cost 5. Operating Margin 6. Miscellaneous Income as % of WF 7. Risk Cost as % of WF 8. Net Margin 9. Cost of Intermediation H= E= C= A B A-B D C-D F G (E + F) - G D+G

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BREAKEVEN LEVEL (BEL) OF BUSINESS: Break even level of business is the level of business at which the bank earns a financial spread, which is just sufficient to meet all its intermediation costs. It is calculated as follows: Transaction Cost + Risk Cost Misc. Income* Break Even Level = ----------------------------------------Financial Margin** *This figure is the absolute amount ** This figure is to be in percentage X 100

A negative net financial margin means every 100 rupees of business is producing a loss. Therefore, in case of negative financial margin, planning should first concentrate on improving the yields, reducing the cost and bringing the margin to the positive side before any estimate of breakeven level of business is made.

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CHAPTER 9

(Session 11)

ISSUES OF GOOD GOVERNANCE IN COOPERATIVE BANKS AND INTERNAL CONTROL SYSTEMS

Changes in cooperative law are being adopted which will lead to operational flexibility. There is need to develop business through business development planning for doing varied business in order to earn profit in the post reforms era. For this to happen, the one major aspect required is the good governance to take the organisation towards its goals. Let us now see the role of good governance.

Governance structures - the President, Board and the General Body:

Cooperative banks are democratic organisations. They are governed as per the provisions of Cooperative Societies Act / Rules and bye-laws. Cooperative banks are basically societies. The members are owners of the society. They elect the Board of Directors for providing directions to the affairs of the Society. The Board of Directors, in terms of Vaidyanathan Committee Recommendations (VCR), will consist of elected members and there will be only one nominated member. The elected Members would in turn elect one among themselves as President of the Society. It is the responsibility of the President to direct and run the Society in a proper and constructive manner. The Board functions within the boundaries of the by-laws, policy decisions taken by the General Body and as per the provisions of the Cooperative Societies Act /Rules. The General Body is the highest / supreme authority of the society. Important policy directions are given by the General Body only. Thus, the President, the Board of Directors and the General Body are the important components of governance structure. Carrying out the day-to-day work of the society and also the implementation of the decisions taken by the Board is the responsibility of the Secretary, who is also the CEO of Society.

The General Body Meetings of General Body The General Body comprises of all the members of the society. The society (Board of Directors) should convene a meeting of the General Body at least once

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a year or as directed by the provisions of State Cooperative Societies Act. The annual meeting to approve the accounts, etc. is called the Annual General Body Meeting (AGM). In case the Board fails to conduct AGM as per the act provisions, the directors may lose their right to continue in office thereafter.

The notice for AGM should be issued to the members at least 15 days prior to the meeting, either by post or by person. Alternatively, an AGM could be requisitioned by not less than a specified number of members of the society (the number may vary from state to state) or could be requisitioned by the RCS. In such a case, the AGM should be convened within 30 days from the date of requisition and the fact that the meeting was requisitioned should be clearly mentioned in the notice. In case any amendment to any bye-law of the society is proposed as part of the agenda of any AGM, the existing bye-law and the proposed amendment should be specifically mentioned in the notice to the meeting. In addition to AGM, special meetings of the General Body may also be convened whenever necessary.

Functions and Responsibilities of the General Body As per the model Cooperative Law proposed in VCR, the following and such other matters as are considered necessary by the Board shall be dealt with by the general body at every annual general meeting: a. Action taken on resolutions of the previous meeting; b. Consideration of the long term plan and budget, when required; c. Consideration of the annual business plan and budget for the current financial year; d. Appointment of auditors for the current financial year; e. Consideration of the annual report of activities for the previous financial year; f. Consideration of the annual audited statements of accounts and the audit report relating to the previous financial year; g. Consideration of the report on deviations, if any, from the approved budget relating to the previous financial year and the appropriate action to be taken; h. Disposal of surplus, if any, of previous financial year and dividend payment; 123

i. Management of deficit, if any, of previous financial year; j. Creation of specific reserves and other funds, when required;

k. Review of actual utilisation of reserves and other funds; l. Review of the report on the attendance at meetings by directors;

m. Review of remuneration paid to any director or member of any committee or internal auditor in connection with his/her duties in that capacity or his/her attendance at related meetings; n. Review of quantum and percentage of services provided to non-members vis-a-vis services provided to members; o. Appeal of a person whose application for membership has been rejected by the board; p. Appeal of a person who has been expelled from membership, by the board; q. Report of activities and accounts related to member education and board and staff training.

The following and other matters when considered necessary by the board shall be dealt with by the general body at its annual or other general meeting: a. Election of directors; b. Amendments to bye- laws; c. Removal of directors; d. Elections/appointments to casual vacancies on the board; e. Removal, and consequent appointment of auditors; f. Partnership with other cooperatives; g. Amalgamation, division, merger, transfer of assets and liabilities; h. Consideration of the Registrars report of inquiry, if any. i. Consideration of write off of bad debts.

The quorum for general body meeting shall be as specified in the bye-laws, but shall not be less than 1/5th of the members eligible to vote at the meeting.

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Accountability of Board members to General Body/ Members The Task Force had recognized that financial impairment is not a cause, but an effect. The causes lie in impairment of governance and management. It had felt that the only way out was to link financial restructuring with regulatory and institutional reforms. Therefore, under the revival package, the responsibility for governance has shifted from the hands of the RCS and state government, to selfgovernance by the members/general body, through their elected boards. This puts a lot of responsibility on the Board in terms of its accountability to the General Body / Members.

Role, Responsibilities and Accountability of Board Members The Board of Directors consists of 11-17 elected members (The number may vary from State to State) and its functions are: a. To review deposit mobilisation and resource position of the bank. b. To review crop loan portfolio, MT /LT loan portfolio, consumer loan/personal loan portfolio, etc in all Board meetings c. To review recovery and NPA position and follow-up done by the staff in every Board meeting d. To review the monthly income and expenditure, last trial balance and budget utilisation in every Board meetings e. To interpret the organisational objectives, set up specific goals to be achieved and make periodic appraisal of operations; f. To finalise annual business plan (BDP) and targets for MoU and direct the business of the cooperative in accordance with the plan and targets of the MoU. g. To prepare the BDP in January / February and enter into MoU with SCB in April every year. h. To finalise the budget, income & expenditure, etc and direct the affairs in accordance with the budget approved by the general body.

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i. To frame, approve and amend policies relating to services to members, funds, accounts, accountability of staff and others, and information and reporting systems; j. To elect and remove office bearers and specify their roles and responsibilities; k. To appoint and remove the chief executive and specify his/her roles and responsibilities; l. To make arrangements for mobilisation of funds; m. To authorise acquisition and disposal of immovable property; and n. To frame regulations for the appointment of employees of the bank and decide their scales of pay, allowances and other conditions of service including disciplinary action.

Every director is expected to act honestly and in good faith, and in the best interests of the bank and exercise due care, diligence and skill as reasonably prudent, in performance of his functions and responsibilities. Any director, who is guilty of misappropriation, breach of trust or any other omission or commission, resulting in loss or shortfall in revenue to the bank, shall be personally liable to make good that loss or shortfall, without prejudice to any criminal action to which the director may be liable under law.

At least four meetings of Board of Directors will have to be held in a financial year, and the period between two consecutive board meetings shall not exceed 120 days. However, the President, may call a meeting of board at any time or more frequent than 4 times, if necessary. In the absence of President, Vice President will preside over the meetings and in his absence, any member nominated by the directors can chair the meeting. The quorum of Board of Directors shall be as specified in the bye-laws, but shall be more than half of the total number of directors on the board. All matters will be decided by a majority vote. The

President will have the casting vote in case of a tie. Any member of the Board who has any personal interest in the issues being discussed by the Board should not participate in such meetings.

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In times of urgency, the Secretary can take the approval of the Board by circulation of the Resolution. The approval obtained through Resolution by

circulation will have to be put up to the Board for information in the next Board Meeting.

Conducting Election / Audit / AGMs in time In addition to their regular roles and responsibilities, it is the responsibility of Board of Directors / Managing Committee to conduct the elections to the next Board, to enable audit of the bank and hold Annual General Body Meeting in time. The Board is solely responsible for this and penalties could be imposed on the Board or the individual member responsible for the non-compliance of the same.

Systems and procedures The day-to-day management of the bank, should be the responsibility of the Secretary or CEO. If the Board interferes in these things, it would, create fuzziness /ambiguity between governance and management. The Board as a whole as well as Board members should therefore keep off from the day- to- day management of bank, leaving that job to be attended by the paid Secretary appointed for the purpose. There are laid down systems for the day to day operations of the bank. These functions are required to be attended by the secretary/ other officers/ staff. The board only has to oversee these functions through internal checks and control systems, Management Information System (MIS) returns to the board at regular intervals, etc. The Board / Board members should concentrate on governance issues like policy, direction and control.

Good Governance and role of Board Members in managing the change process in the organisation The basic principles of good governance are accountability, transparency, informed decisions, decisions based on facts, non corrupt ways of doing things respect for the merit of each case and regulatory reporting to higher bodies. While taking decisions in the Board meetings and directing the secretary to do or not to do certain things like sanction of loans, non-recovery of dues, non attachment and discharge of the attached assets, the interest of the bank should be kept uppermost in their mind. The duality of the role of the Board Members as

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part of governance structure and as borrowers / customers, should not cloud and vitiate their decision. All members should be treated as equal and each case / proposal should be considered based on merit, without fear or favour.

Change brings fear and uncertainly. The fear of the unknown and uncertainty of the future. Therefore, the people and organisations resist change. It is the

responsibility of the leaders to interpret and explain the change to the employees and to the members. The vision of bank under the changed environment may be created by the leaders and explained to the followers and employees. This helps in reducing uncertainty and consequent reduction in the resistance for change. Some employees are likely to resist change because, it may unsettle them from their comfort zone, i.e. the old ways of doing things for which they are used to. To adjust to the change, they may have to acquire new skills, new ways of doing things as also learn the skills for using the technology being adopted. The

employees should be able to appreciate this and accept the change, to meet the demands of the changing times. It is the Board's responsibility to discuss these issues with the employees, encourage them to appreciate and adopt change, get them the required training / exposure, so that they don't fear the change and do not resist or sabotage the same.

Member Involvement in the activities of bank & Customer Meets The banks have to be built as member-centric and member-driven organisations and all members should have equal rights. Since the members, through their voting rights, are going to decide the nature of the Board, they need to be involved in running the affairs of the bank. They can help the bank in several ways, viz.,

1.

They can help in increasing the membership of the PACS by canvassing among villagers about the services being offered by the society and benefits of becoming members of PACS.

2.

The members can also be involved in the governance /management of bank by broad basing management committee or by constituting subcommittees to attend specific tasks like business diversification, business development, plan preparation, deposit mobilisation, promotion of SHGs/ JLGs, formation of Farmers Clubs, recovery groups/ volunteers, etc.

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3.

The bank may hold Customer Meets to facilitate member involvement, which besides helping in getting feedback from them on the quality of services being provided by the bank. The members may also provide information on their needs/requirements which may help the bank to improve its services/business. Further, holding of customer meets at

suitable regular intervals (say quarterly) will also help in establishing close contact with members.

Internal Checks and Control Systems

Introduction Every bank has its own internal control processes in the form of durable mechanisms for reducing instances of frauds, misappropriation and errors of omission and commission by the bank's employees or customers or others. With the increase in volume of business and banking transactions, the internal control systems have to become more extensive addressing various risks faced by banks. Proper internal controls ensure that the bank's business is conducted in an orderly, prudent manner in accordance with established policies. A sound internal control system consists of : a. b. c. d. e. Management review and the control culture in the bank. Risk assessment system and follow-up action. Routine control activities based on sound banking norms and practices. Flow of information and communication at all organizational levels. Monitoring activities being ensured by supervisory and management levels without negligence or incompetence Internal control system in Banks- Scope The scope of a good internal controls and checks system comprises a. b. c. d. Risk assessment and control Accounts controls Administrative controls Internal/concurrent audit

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e. f. g.

Internal inspection including computer audit Vigilance cell and monitoring of frauds Review by Board of Directors

These must be in place in any bank as all internal control systems needs to be continuously evaluated and updated to meet changing requirements. These are discussed below in brief.

Risk assessment and control Banks perform various types of intermediation functions which involve various types of risks. Risk may be simply defined as probability of loss or damage. The banks are generally exposed to the type of risks such as Credit risk, Interest rate risk, Liquidity risk, Capital risk, Market risk, Exposure risk, etc. The bank should identify the risks, evaluate and monitor them to minimize their effect on bank's financial health.

Accounts controls It is the duty of the management of a bank comprising the Board of Directors and senior management to implement a sound system of accounting control based on a complete and integrated system of accounting, written manuals, set of forms and documentation, loan/investment/expenditure sanction standards, controls to verify accuracy of accounting inputs and outputs as also by operational results. Apart from the basic accounting system of bank, income and expenditure statements as also the balance sheet statements, the NPAs and provision, a bank has to have updated information on crucial aspects of its operations to enable it to prepare its books of accounts and statutory/ other control returns for NABARD, RBI, RCS/sponsor bank. An accounting manual, register and formats for maintenance of accounts, ledgers and others registers are a must with daily ledger postings, verification of entries by officers from the vouchers, balancing of ledgers at least on a weekly/ monthly basis and reconciliation of entries in inter branch and inter bank accounts at least on a quarterly/half yearly basis. Long outstanding entries in sundry debtors and sundry creditors also have to be settled

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monthly/quarterly basis. An important element of the bank's profitability is the funds management strategy with special emphasis on cash management. These control returns need to be analyzed for warning signals by the Head / Area office of the bank as an off site supervisory system. Abnormal changes in ratios are to be investigated without delay; many banks treat these control returns as part of information system and are unable to realize the need for such returns as part of the banks control system. Balancing of banks ledgers especially deposits, loans and general ledgers are to be completed at least on a monthly basis.

Administrative controls Rotation of staff, keeping vigil on the style and expenditure of bank officers, periodical transfer of staff between branches/bank, are some of the common methods needed for administrative control. Also, staff members and officials whose integrity is in doubt should not be posted at sensitive desks. Suspect staff members must be kept under vigilance. Feedback from anonymous sources, complaints should also be followed up to the extent possible.

Staff Accountability In view of the social responsibility cast on banks and to keep the incidence of corruption and malpractice under check, there is a need for fixing staff accountability for irregularities and malpractices at all levels, at the appropriate time. Inspectors/auditors failure detects or report serious irregularities should also be viewed seriously. Clear guidelines for delegation of financial powers to different staff levels, sanction of advances, post-sanction monitoring etc. should indicate what constitutes abuse of authority, negligence in compliance to terms of sanction, monitoring etc. should be drawn up so that officer taking genuine

business decisions are not victimized. In the process of fixing staff responsibility, the possibility of loss of employee morale should be carefully considered and balanced. The aim of internal controls is basically to strengthen the banks and its operations on sound lines.

Concurrent audit While the volume of operations in most cooperative banks and RRBs do not warrant concurrent audit, the main branch/HO branch and other major branches

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may need to have concurrent audit so also provide checks and controls on key areas of branch functioning on a day to day basis. During concurrent audit of bigger branches having huge volume of transactions test-check of 10-25 % of income expenditure items, inter -branch and inter-bank accounts, interest paid, interest received on deposit accounts and clearing transactions should preferably be done by the bank's own staff. The smaller branches will not be able to have concurrent audit system. Hence the audit function may have to be merged with the internal inspection system. The findings of concurrent audit need to be put up to the Board of Directors and compliance followed up by the Inspection Department.

Internal Inspection /audit Banks often tend to use audit and inspection as interchangeable terms. To understand the scope of these terms, it is necessary to define these terms. Audit is a quantitative analysis of the operations of an organization with correct and honest record keeping in accordance with sound accounting principles and statutory requirements. The basic purpose is to assess the integrity of books of accounts and other records, to ensure that they reflect the assets and liabilities, income and expenditure, correctly. The scope of inspection is broader than that of audit and also includes elements of audit as it is fundamentally a qualitative review of the affairs of an organization. Its objective is not only to verify observance of prescribed procedures and guidelines but also to promote and maintain safe and sound operating practices and conditions. Some banks have in internal inspection department often only on paper and some do not carry out any effective inspection of the bank's branches. The basic duties of inspection /audit are prevention and detection. The inspection schedule is to be finalized by the HO and periodicity, duly maintained. The follow-up of compliance is to be done by the Inspection Department at HO and depending upon irregularities, special audit of problem branches should be taken up by the inspection Department from HO. Disciplinary action is to be taken against officers deputed for internal inspection, for perfunctory inspection reports and for not having reported on problem accounts and areas in specific branches inspected by

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them. All internal inspection reports as also compliance reports are to be put up to the Audit Committee /Board of Directors.

Vigilance Cell and Monitoring of frauds Frauds in banks are acts of criminal deception resorted to by persons singly or in collusion with other to derive gains to which they are not entitled. Bank frauds are generally cases of misappropriation or criminal breach of trust, encashment of forged instruments, manipulation of books of accounts, operation of fictitious accounts and conversion of properly, unauthorized credit facilities extended for renewal or for illegal gratification, cheating and forgery and irregularities in forex transactions. Frauds in cooperative banks and RRBs are generally perpetrated by bank staff by flouting established systems and procedures. The 'primary responsibility for preventing frauds is that of the bank management. All frauds need to be followed up and monitored. Police action, as also internal inquiries need to be initiated so that the bank recovers its funds along with interest and is not put to pecuniary loss. Speedy action to plug operational loopholes has to be initiated and fraud cases have to be put up to the Board of Directors for information. Weak follow-up action on frauds by the bank will send wrong signals to other staff members of similar inclination and invite further desertion. While some banks have set up Vigilance Cells, these have not developed into effective instruments for curbing the growing trend of vigilance cases in banks. The Vigilance function in banks concentrates on the punitive role rather than on preventive or detective vigilance. Vigilance tends to concentrate only on action after complaints are received or after detection of frauds, malpractice and irregularities at a very late stage. The role of vigilance needs no emphasis especially in rural areas where non-repayment of bank dues is often linked by borrowers to rent-seeking officials. These vigilance cases should be vigorously followed up by the top management.

Review by Board of Directors Follow-up of all audit/inspection reports and monitoring follow up action, need to be initiated by the Board of Directors as under: I. To review follow-up action on audit/inspection reports whether internal or statutory

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II. III.

To ensure compliance on statutory inspection /audit reports To ensure accountability for unsatisfactory compliance of inspection report, delay in compliance and non-rectification of deficiencies

IV.

To take periodical review of accounting policies/system to ensure greater transparency in bank accounts and adequacy of accounting controls

V.

To give directions in respect of lacunae observed in performance reports wherever necessary

VI.

To review all frauds and vigilance cases with a view to reducing their occurrence

VII. VIII.

To review progress in inter-branch and inter-bank reconciliation To monitor process in balancing of books, clearing adjustment amounts, sundry/suspense items, balance sheet items and other house-keeping items

IX.

To review funds management with specific reference to maintenance of CRR/SLR

X.

To review investment policy particularly investments in non-SLR securities like shares and debentures

XI.

To review the compliance with various sections of BR Act/RBI Act/Cooperative Societies Act/Rules / bye-laws as applicable to the concerned banks

Unless steps are taken immediately to review the internal controls systems in the bank and initiate measures to promote better house keeping, accounting systems and maintain control over the banks operations, the cooperative banks cannot expand their business levels and compete with other banks. Computerization also needs to be reviewed as a measure to have competitive edge, maintain customer services and have control over operations.

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Common Audit and Inspection Observations

Some of the important observations which generally find place in the Inspection/Audit reports of cooperative banks are listed below which require compliance/follow up. 1. Wrong identification and classification of NPA accounts 2. Charging of Interest to NPA accounts and taking it to Profit and Loss account 3. Provision for Standard Assets as required under NPA norms not booked in the prescribed head 4. Under-stamping of Security Documents 5. Security Documents in respect of loan accounts lying unfilled with branches 6. Processing fees in respect of loans not charged/less charged 7. TDS not deducted in respect of payment of branch rent, contractor fees etc. 8. Share Linkage of societies as compared with credit is less 9. Unclaimed dividend not forfeited by the bank even after three years 10. AGM is not held in time 11. Profit allocation is not done in time 12. Deviation in profit allocation not got approved from Joint Registrar 13. Interest calculation differences found both in deposit and loan accounts 14. Service charges not levied as per rules 15. Transit entries (like cash in transit etc) not settled in time 16. Precautions in creating charge on assets not properly followed 17. Business targets not achieved 18. In case of societies under liquidation, recovery expenses are more than the amount recovered 19. NCL/ Land Record Register not maintained and not verified 20. Staff not rotated frequently 21. Cash flow statement not prepared quarterly 22. Overnight Retention limit/ Bank Balance limit not properly observed 23. Cash Reserve Statement not submitted in time to the head office 24. Important registers like Cash Register, Key Movement Register, Safe Custody Register, Bond Register and Token Register not maintained

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25. Insurance of assets under charge of bank in loan cases not renewed in time 26. Shares of other societies purchased in contravention of BR Act not retired 27. Non Banking Assets not discharged 28. Excess interest paid in case of staff deposits without proper approval

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