Should cooperative banks be exposed to home loans?

Along with the June 8 monetary policy announcement, the Reserve Bank of India increased the limits on individual housing loans made by co-operative banks.

For Urban Cooperative Banks (UCB) Tier 1/Tier 2, the limit has been revised upwards from ₹30 lakh to ₹60 lakh and ₹70 lakh to ₹1.40 crore respectively. Limits for Rural Cooperative Banks (RCBs) have been raised from ₹20 lakh to ₹50 lakh for those with a net worth of ₹100 crore or less, and from ₹30 lakh to ₹75 lakh for others. In addition, cooperative banks can now lend to commercial real estate developers dealing with residential projects.

The intention behind the move is clear. RCBs and UCBs remain the main pillars of financial support for the unbanked population and despite several attempts to push lending to affordable housing through traditional channels, the needle has not moved much.

These borrowers are committed customers of their local banks closest to their homes. They share a comfortable working relationship with cooperative banks. Other credit channels – NBFCs and smaller corporate banks – are constrained by the risk-based allocation of capital to the affordable housing sector. This seems to have prompted the RBI to turn to cooperative banks.

Cracks in the armor

But is the timing of this move ideal? Three years after the collapse of PMC Bank, cooperative banks continue to be restricted by the regulator for failures in operations that leave them short of capital and put depositors at risk.

Going back to 2019, the fall of PMC Bank was then linked to its link with the HDIL real estate group, promoted by the Wadhawan family (who were also the promoters of Dewan Housing Finance Corporation).

HDIL becoming a major shareholder and also a key borrower of PMC Bank, the company’s financial failure played a major role in the bank’s collapse. Given its size and relevance in the UCB space (₹10,000 crore in advances) after many struggles, RBI managed to chart a way forward for PMC Bank and a way out for its depositors.

After the PMC Bank debacle, the RBI imposed guidelines and monetary sanctions on a series of cooperative banks, to stave off similar crises.

In such circumstances, allowing cooperative banks to increase their exposure to housing loans and loans to developers could expose the system to additional risks. Cooperative banks and the real estate sector have an essential common characteristic: the political link.

While now under the oversight and supervision of the RBI, it is doubtful that the co-operative banks and their managements have severed political ties. As a result, the strength of their due diligence and risk underwriting practices remains below that of well-run regular commercial banks.

Among home loan products, affordable home loans with more than 2% gross non-performing assets (even in the case of a well-run NBFC) have the highest delinquency rates and are the most vulnerable to the vagaries of the income of the borrower who tends to be in the lower income brackets.

Although the increase in lending limits may seem small from a systemic point of view, it must be considered in the context of the size of the cooperative banks.

According to the latest RBI Banking Trends and Progress Report, of the 1,534 operational UCBs, only 3% have a loan portfolio of ₹1,000 crore or more and account for 51% of UCB’s total credit. With the business being highly fragmented, even a loss in asset quality as small as ₹5 crore can disrupt the balance sheets of cooperative banks.

Partnership with the SFBs

Instead of expanding UCBs’ leeway to lend directly to the affordable housing segment, perhaps the RBI can explore co-lending models that leverage the strengths of UCBs and SFBs.

In 2018, the RBI introduced the voluntary transition from UCBs to Small Financial Banks (SFBs).

The objective was to increase institutional shareholding and make UCBs widely owned entities. This was to help correct shortcomings in underwriting and risk management practices. The conversion was also to help unravel political ties.

However, so far only Shivalik Mercantile Cooperative Bank has managed to convert to SFB. Most UCBs are reluctant to convert given the regulatory changes they are expected to undergo.

As a precursor to the process, allowing SFBs to partner or co-lend with UCBs might have been a more viable route to expanding credit growth in the affordable housing market.

This way, SFBs would also gain a greater reach in the market and could look beyond the loan-for-property segment that remains their current comfort zone in the housing space.

Despite the stated objective of having to serve the unbanked and under-banked segments, the mainstay of SFBs remains credit products targeted at urban and semi-urban areas. Their penetration into Tier 3/4/5 cities has been uneven as customers resist migration from their local banks.

It is precisely for this reason that the co-lending model between SFBs and UCBs makes commercial sense. Now that UCBs are babies of the RBI, she should not waver on her long-term vision for these banks.

If the goal is to institutionalize and professionalize them, raising affordable housing credit limits is at best an interim alternative that will not serve their cause in the long run.

Published on

June 20, 2022

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