021 Cooperative Bank Scams in India.pdf

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Cooperative Bank Cooperative Bank scam governed RBI Central Cooperative Bank deposit scam
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Cooperative Bank Cooperative Bank scam governed RBI Central Cooperative Bank deposit scam
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ICMR Case Collection 
ICFAI Center for Management Research 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
This case was written by Y. Aparna, under the direction of Sanjib Dutta, ICFAI Center for Management 
Research (ICMR). It was compiled from published sources, and is intended to be used as a basis for class 
discussion rather than to illustrate either effective or ineffective handling of a management situation. 
 
 
 
 
 
 
 
 
 
 
Cooperative Bank Scams in India 
F I N C  0 2 1  
 2003 ICFAI Center for Management Research. All rights reserved. No part of this publication may be 
reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means - 
electronic or  mechanical, without permission.  
For enquiries regarding bulk purchases and reprint permissions, please call 91-40-23430462/63 or write to ICFAI 
Center for Management Research, 49, Nagarjuna Hills, Panjagutta, Hyderabad 500082, India or email 
icmr@icfai.org. Copies of this case can also be purchased online from the ICMR website, www.icmrindia.org. 
 
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This case was written by Y. Aparna, under the direction of Sanjib Dutta, ICFAI Center for Management Research 
(ICMR). 
 2003, ICFAI Center for Management Research. All rights reserved. No part of this publication may be reproduced, stored in 
a retrieval system, used in a spreadsheet, or transmitted in any form or by any means – electronic or mechanical, without 
permission. 
To order copies, call 0091-40-2343-0462/63 or write to ICFAI Center for Management Research, Plot # 49, Nagarjuna 
Hills, Hyderabad 500 082, India or email icmr@icfai.org. Website: www.icmrindia.org 
 
                         
                                                                                                           
 
 
 
 
 
 
FINC//021 
 
 
COOPERATIVE BANK SCAMS IN INDIA  
 
“The objective of co-operative banking is to create enduring and sustainable financial institutions 
which remain responsive to the credit needs of weaker sections.” 
  
-RBI Report on Trend and Progress of Banking in India, 2000-01. 
 
“There has been a mushrooming of co-operative banks in the country. Low barriers to entry 
spurred individuals with vested interests to start such banking ventures with a view to milk the 
depositors funds.”  
 
-Suresh Hemmady, chairman of the Shamrao Vithal Cooperative Bank. 
 
“They are non cooperatives under the camouflage of cooperatives.” 
 
    -Rama Reddy, President of Hyderabad based Cooperative Development Foundation. 
 
INTRODUCTION 
 
Cooperative banks were established in India to facilitate rural credit, and to cater to the needs of 
small farmers and businessmen. They were popular with middle and lower income groups because 
of the  high interest rates they offered as compared to commercial banks.    
 
However, with the passage of time, most cooperative banks lost their purpose. Excessive state 
control and politicisation further led to their deterioration. By the 1990s, none of the public or 
private sector banks were willing to deal with cooperative banks and thus even otherwise healthy 
cooperative banks were facing a tough time.  
 
 
 
 
In 2001-2002, many cooperative banks were rocked by scams that exposed the malpractices in 
these banks. Many of these banks did not adhere to the prudential norms prescribed by the Reserve 
bank of India (RBI). The Madhavapura Mercantile Cooperative Bank (MMCB) had invested a 
huge amount in the equity market which was almost equal to its deposit base, thus, violating the 
RBI norms relating to exposure to the equity market. Another bank, the Krushi Cooperative Urban 
Bank (KCUB) had issued loans and advances amounting to Rs. 530 million as against its deposit 
base of Rs. 350 million. Not only that, most of its loans had not been secured. Similarly, the 
Charminar Cooperative Urban Bank (CCUB) faced liquidity problems due to  indiscriminate 
lending to big borrowers against worthless land. More recently the Nagpur District Central 
Cooperative Bank (NDCCB) was involved in fraudulent dealings in government securities through 
brokers.1 
                                                 
1 Government securities are certificates issued by the Government of India through the Reserve Bank of 
India confirming money received from an individual or institution in the form of debt. Deals in 
government securities trading can be wholesale or retail. Wholesale trading takes place when the 
transaction value is more than Rs. 50 million. Most wholesale deals are conducted through brokers who 
bring the two parties together. However, the broker is not involved in settling transactions.   
 
 
 
 
 
 
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Cooperative Bank Scams in India 
 
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COOPERATIVE BANKS – A PROFILE  
 
In the early 20th century, the availability of credit in India, more particularly in rural areas was non 
existent. There was no organized institutional credit for agricultural and related activities. People 
in the rural areas largely depended on money lenders who lent money at very high rates of interest. 
Thus, there was need to create an institution which would cater to the needs of ordinary people and 
was based on the principles of cooperative organisation and management. In 1904, the first 
legislation on co-operatives was passed. In 1914, the Maclagen committee suggested a three tier 
structure for cooperative banking i.e Primary Agricultural Credit Societies at the grass root level, 
Central Cooperative Banks at the district level and State Cooperative Banks at the State or apex 
level. Cooperative banks were expected to serve as substitutes for money lenders, and provide both 
short-term and long-term institutional credit at reasonable rates of interest. 
Cooperative banks operate both in urban and non-urban centers (Refer Table I for characteristics 
of Cooperative banks). The urban areas are served by the Primary (Urban) Cooperative Banks 
(PCBs/UCBs) whereas the rural areas are largely served by two sets of institutions, the PACSs and 
LDBs, dispensing short-term and long-term credit, respectively. UCBs have a three-tier structure 
with the State Cooperative Banks (SCBs) at the apex level, the District Central Cooperative Banks 
(CCBs) at the intermediate level and the Primary Agricultural Credit Societies (PACS) at the grass 
root level (Refer Table II). Under the long-term credit structure, State Cooperative Agriculture and 
Rural Development Banks (SCARDBs) are at the apex level and the Primary Cooperative 
Agriculture and Rural Development Banks (PCARDBs) are at the base level. UCBs are regulated 
by the RBI as well as the Registrar of Cooperative Societies of the state where they are located. 
District and state level cooperative banks also report to the National Bank for Agriculture and 
Rural Development (NABARD). 
TABLE I 
CHARACTERISTICS OF COOPERATIVE BANKS 
Cooperative banks are organized and managed on the principles of co-operation, self-help and 
mutual help.  
Cooperative banks function on “no profit, no loss” basis. Do not pursue the goal of profit 
maximisation. 
Cooperative banks perform all the main banking functions of deposit mobilisation, supply of 
credit and provision of remittance facilities. 
Some Cooperative banks are scheduled banks2, while others are non-scheduled banks3.  
Each Cooperative bank in each tier is a separate entity with definite jurisdiction and has an 
independent  management. 
Cooperative banks accept current, saving and fixed or time deposits from individuals and 
institutions including commercial  banks.  
Cooperative banks are required to maintain the CRR4 and SLR5 only at the level of 3% and 25% 
respectively.  
     Source:  www.banknetindia.com                                          
                                                 
2 Scheduled Banks are banks which are included in the second schedule of the Banking Regulation Act, 
1965. A scheduled bank must have paid-up capital and reserve of not less than Rs. 500,000 and must also 
satisfy the RBI that its affairs are not conducted in a manner detrimental to the interests of its depositors. 
 
3 Non scheduled Banks are banks which are not included in the second schedule of the Banking Regulation 
Act, 1965. They do not satisfy the conditions laid down by that schedule. They are further classified as 
Central Cooperative Banks and Primary Credit Societies. 
 
4 Banks are required to maintain with the RBI every fortnight a minimum average daily cash reserve. RBI 
uses the CRR either to impound the excess liquidity or to release funds needed for the economy from time 
to time.   
 
5 Every bank is required to maintain at the close of  business every day, a minimum proportion of their Net 
Demand and Time Liabilities as liquid assets in the form of cash, gold and un-encumbered approved 
securities. The ratio of liquid assets to demand and time liabilities is known as Statutory Liquidity Ratio 
(SLR).  
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TABLE II 
STRUCTURE OF URBAN COOPERATIVE BANKS 
State Level 
District Level 
Primary Level 
State 
CooperativeBanks 
(SCBs) 
Central 
Cooperative 
Banks(CCBs)/The District 
Central Cooperative Banks. 
Primary Agriculture Credit 
Societies (PACSs) 
State Land Development 
Banks (SLDBs) 
Central Land Development 
Banks (CLDBs) 
Primary 
Land 
Development 
Bank 
(PLDBs) 
 
 
Branches of SLDBs. 
      Source: www.banknetindia.com 
 
PACS is an association of borrowers and non-borrowers residing in a particular locality. The 
sources of funds for PACS are share capital and deposits of members and loans from central 
cooperative banks. The members and the credit societies have fixed borrowing power. The loans 
are given to members for the purchase of cattle, fodder, fertilizers, pesticides, implements, etc. 
 
CCBs are federations of primary credit societies in a district. They are of two types: those having a 
membership of primary societies only and those having a membership of societies as well as 
individuals. The sources of funds for CCBs are share capital, deposits, loans and overdrafts from 
state cooperative banks and joint stocks. Financing member societies depend on the borrowing 
capacity of societies.  
 
 
 
 
 
 
 
SCB is a federation of central cooperative banks and is a regulator of the cooperative banking 
structure in the state. The sources of funds are share capital, deposits, loans and overdrafts from 
the RBI. SCBs lend money to CCBs and PACSs and not directly to farmers.  
 
LDBs (Land Development Banks) are organized at the state, central and primary (district) level. 
They meet the long term credit requirements of farmers for developmental purposes. SLDBs are 
governed both by the state government and RBI. The sources of funds are debentures subscribed 
by both central and state governments. SLDBs do not accept deposits from the general public.  
 
The number of UCBs increased from 1106 in the late 1960s to 2050 in March 2000. Almost 80% 
of UCBs were located in Gujarat, Maharashtra, Karnataka, Tamil Nadu and Andhra Pradesh and 
accounted for 75% of their deposit resources. In March 2000, the aggregate deposits and 
outstanding advances of UCBs were Rs. 285.45 billion and Rs. 172.85 billion respectively. 
 
Off late, cooperative banks have been subject to the influence of petty political scheming. 
Irregularity in financial activities and gross mismanagement have led to several problems. As 
borrowers and not depositors are members of cooperative banks, they can freely use the funds 
from these banks. Another problem associated with cooperative banks is that most of the members 
of these banks are from a single industrial sector. If the sector does not perform well, so do the 
banks. The dual control on cooperative banks also poses to be a hindrance  in regular functioning. 
Moreover, penalties are abnormally low in cooperative banks. For any scam the maximum penalty 
is Rs. 200 a day. Another problem with cooperative banks is that they can't be liquidated.  
 
 
In May 1999, RBI appointed a High Power Committee under the Chairmanship of Shri K. 
Madhava Rao, Ex-Chief Secretary, Government of Andhra Pradesh to review the performance of 
cooperative banks. The Committee identified five broad objectives: 
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1. Preserving  the cooperative character of UCBs. 
2. Protecting depositors' interest, reducing  systemic risks to the financial system. 
3. Ensuring strong regulatory norms at the entry level to sustain the operational efficiency and 
evolving measures to strengthen the existing cooperative banking structure. 
4. Aligning the cooperative banking sector with the other segments of banking sector. 
5. Applying prudential norms and removing the problems associated with dual control regime.  
 
RBI accepted most of the recommendations of the Committee but those requiring legislative 
action at the state level remained pending. Analysts feel that the regulation and supervision of 
cooperative banks is difficult as the administrative and management control is in the hands of the 
state government. Thus, to undertake corrective measures, the RBI and NABARD have to 
approach the state governments and any suggestion which does not go down well with  politicians 
or bureaucrates is often ignored.  
 
BACKGROUND NOTE  
 
MMCB was established on October 10, 1968 in Ahmedabad, Gujarat, to cater to the varied 
financial needs of wholesale grocery traders in Ahmedabad's Madhavpura spice market. The bank 
was awarded the status of a scheduled bank in 1999, which permitted it to expand its banking 
activities outside Gujarat. MMCB had 22 branches and was undertaking regular banking activities. 
It had a deposit base of Rs. 10.56 billion in 1999-00, of which Rs. 6 billion was from other 
cooperative banks and organizations, while the rest was from the public. The bank received huge 
deposits after being awarded the status of a scheduled bank by RBI.  
 
KCB, a Hyderabad based bank was registered on April 1, 1998. On March 31, 2000, the bank  had 
a paid-up share capital of Rs. 10.2 million. Its deposits comprised 92.41% term deposits, 5.42 % 
current deposits and 2.17 % savings deposits. The bank reported a deposit base of Rs 350 million 
as on June 30, 2001. The bank had targeted a deposit base of over Rs. 1 billion for the year ended 
March 31, 2001.  
 
CCUB was founded on September 7, 1985 in Hyderabad. One of the aims of the bank was to 
attract deposits from domiciles of Hyderabad working in Saudi Arabia and other Gulf countries. 
The bank had a deposit base of Rs. 3 billion in 2001.  
 
SCAMS IN COOPERATIVE BANKS 
 
In 2001, MMCB was rocked by a scam. The bank had lent Rs. 10.5 billion to the equity market. 
There was no security or collateral issued against the money taken as a loan. This exposure was 
almost equivalent to its deposit base of Rs. 10.56 billion in the financial year 1999-2000. Its 
advances during the year were Rs. 7.78 billion. The bank violated the RBI norms which stated that 
a bank’s exposure to the stock market cannot exceed 5 % of its outstanding loans. Panicky 
depositors began withdrawing money on hearing reports that the bank had lent heavily in capital 
markets and that these loans had turned difficult to deal with, due to a steep fall in share prices.  
 
 
 
 
 
 
Only three entities accounted for the 10.5 billion. No security or collateral was deposited with the 
bank. While Rs. 8.3 billion was lent to stock broker Ketan Parekh and his companies, Rs. 2 billion 
and Rs. 20 million were lent to Bombay Stock Exchange (BSE) broker, Mukesh Babu, and the 
Maniar group respectively. Ketan and his associate companies had siphoned off funds through 10 
accounts.  Mukesh Babu maintained five accounts while the Maniar Group had three accounts. 
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TABLE III 
 A PROFILE OF COOPERATIVE BANK SCAMS 
Bank 
Year in which the 
scam surfaced 
Nature of scam 
Money involved 
 
Madhavpura Mercantile 
Cooperative Bank. 
March 2001 
Diversion 
of 
funds 
from the banking sector 
to the stock market. 
Rs. 
10.5 
billion 
Krushi 
Cooperative 
Urban Bank 
August 2001 
Diversion of funds to 
non-banking 
sectors, 
Huge 
unsecured 
advances, 
bogus 
overdrafts, fake loans, 
heavy exposure to the 
capital market, fraud. 
 317.5 million  
 
Charminar Cooperative 
Urban Bank  
February 2002 
Irregular sanctioning of 
loans and advances, 
improper 
SLR 
and 
CRR ratios, erosion of 
71.4 per cent of net 
worth, 
huge NPAs, 
misuse of funds by 
chairman. 
 
2.71billion 
 
Nagpur District Central 
Cooperative Bank  
April 2002 
Irregularities in trading 
in 
Government 
Securities. 
1.5 billion 
 
 
    Adapted from: Business Today, June 9, 2002. 
 
In 2001, the KCB was also involved in a major scam. The bank had extended loans and advances 
of over Rs. 530 million as against the deposit base of Rs. 350 million. The non-performing assets 
of the bank were estimated around Rs. 330 million, which amounted to over 60 per cent of its total 
loans and advances. KCB extended large amount of advances to four of its directors, including the 
Chairman and Vice-Chairman, without obtaining sufficient security against the loans. Its exposure 
to the capital market was to the tune of over Rs. 20 million. 
 
There were also bogus overdrafts totaling to Rs.200 million, besides fake education and vehicle 
loans amounting to Rs. 60 million. Most of the overdraft accounts and loans were not adequately 
secured. Sixty seven per cent of loans and 53 per cent of net demand and time liabilities (NDTL) 
had not been secured, against RBI stipulated limits of 33.3 per cent of NDTL. Ironically, when 
RBI scrutinized the bank accounts in March 2001, it gave it a clean chit. The officials of Registrar 
of Cooperative Societies had categorized the bank as ‘A’ among cooperative banks and a penalty 
of over Rs. 3-3.5 million was waived for non-compliance with statutory liquidity ratio (SLR) 
norms.  
 
Noticing that the bank's advances were much more than the stipulated levels, RBI issued 
instructions to reduce its NPA levels and advances to its directors to less than 10% before 
September 30, 2001. The bank had not followed any of these directions. It diverted its funds to 
`non-banking' sectors such as real estate, cinema, and stock markets. The bank's directors 
especially the Chairman seemed to have used the bank as a convenient vehicle to amass wealth.  
 
CCUB was into a serious crisis after its Chairman, Almdar Hussain Sajjad Aga committed suicide 
in February 2002. The chairman and directors of the bank had committed several irregularities in 
sanctioning loans and advances. People were lured with an offer of 14.5% interest in contrast to 
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the meagre 6 to 7 % interest being offered by public sector banks. The bank advanced a huge 
amount of Rs. 2.71 billion, nearly 1.85 billion of it without sufficient securities and guarantees. 
The bank was not maintaining its CRR ans SLR requirments adequately. As per RBI guidelines, 
the bank should have had a CRR of Rs. 180 million, but it only had Rs. 10.4 million. It should 
have Rs. 842 million as SLR but it had only Rs. 47 million. The bank should have maintained Rs. 
38.6 million as cash in hand but it had only Rs. 20 million. There were serious lapses and 
deficiencies in its functioning. The financial position of the bank was unstable since March 2001. 
Its net worth had depleted by 71.4 per cent. Its gross NPAs were estimated at Rs. 632 million 
which accounted for 23.2 per cent of its total loans and advances of Rs. 2.71 billion. The bank's 
loan policies and credit appraisal systems were also unsatisfactory. Most of the advances were 
extended against land and buildings for construction purposes to a limited number of borrowers. A 
large number of properties offered for mortgage were said to have been overvalued at the time of 
sanctioning loans.  
 
 
The NDCCB came into limelight in April 2002, with the Government securities scam which 
involved the stock trading portal, Home Trade.6 Home Trade, and a few cooperative banks  entered 
into certain transactions  on government securities. Home Trade and its affiliates lured a few 
cooperative banks including the NDCCB, by promising them 2 to 7% higher returns on investment 
in Government securities. According to RBI norms, the purchase of government securities through 
a single broker should be limited to 5 % of the total value of such purchases and no money should 
be credited to the broker's account. Having violated these norms, Home Trade claimed to have 
bought government securities for the bank which was never delivered. In April 2002, NDCCB 
lodged a complaint against Home Trade and four other brokers on charges of cheating. Home 
Trade was operating illegally and did not have wholesale debt market memberships as required 
under the law. The money was used  in the stock market  to trade in shares of companies in which 
Home Trade had a stake.  
 
TABLE IV 
THE ROLE OF HOME TRADE IN GOVERNMENT SECURITIES SCAM  
Step I 
Home Trade offers to sell Government securities at attractive rates to 
cooperative banks and provident funds.   
Step II 
Cooperative banks transfer money to Home Trade 
Step III 
Home Trade either doesn't buy securities or buys them and instead of 
registering them with RBI for transfer, pledges them as collateral with 
banks to raise funds to play the market.  
       Source: Business Today, June 9, 2002. 
 
REVIVING COOPERATIVE BANKING  
 
Cooperative banks have for long been the back bone of rural banking. Since their inception, they 
have been doing excellent work in the field of rural and cooperative banking. The recent scams in 
cooperative banks have been a jolt to cooperative banking system. Many analysts have suggested 
that cooperative banks should be brought under the complete control of RBI ending the dual 
control by the State governments and RBI-NABARD. According to N. Patel, Vice-Chairman of 
Gujarat Urban cooperative Banks Federation, control by a single authority will ensure smooth 
governance of cooperative banks. Some analysts also feel that interference from the registrar of 
cooperatives should be minimized. 
                                                 
6 According to the RBI regulation, UCBs were to maintain a certain statutory liquidity ratio. The banks 
achieved this by investing in Government securities. 
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Though various committees have conducted in-depth studies of different aspects of the co-
operative credit structure (Madhavarao Committee on UCBs, 1999, Jagdish Capour Task force on 
Cooperative credit system, 2000, and U. S. Vyas Group on Rural Credit, 2001), none of these 
committees seemed to have addressed the basic issues ailing the cooperative banks.     
 
A large number of cooperative institutions accept sizable deposits from non-members. In  some 
states they use the word 'bank' as part of their name, to give the public an impression that keeping 
deposits with them was as safe as keeping deposits with other banks. Analysts feel that there 
should be an ammendment in the Banking Regulation Act to prohibit this practice. 
 
Analysts also feel that periodical review of interest rates offered by cooperative banks in 
comparision with the market trends should be taken up by the state governments. Cooperative 
institutions should be allowed to diversify their activities to cross supplement their lending 
activities. 
 
According to the suggestions given by the RBI, the Government should set up a new apex 
supervisory body which would be under the control of a separate high-level supervisory board 
consisting of representatives of the Central Government, State Governments, RBI, as well as 
experts. It would ensure the cooperative banks' conformity with prudential norms, capital 
adequacy and risk-management norms laid down by RBI. Rehabilitation of sick and ailing 
cooperative banks would involve strategies like directing cooperative courts to undertake speedy 
recovery  process, executing decrees, relocating or closing down unviable branches, exploring 
avenues for additional capital, or merging with a well managed bank.  
 
The norms of capital adequacy, when applied to cooperative banks will make cooperative banking 
move closer to commercial banking with respect to the regulatory mechanisms. The various 
initiatives being adopted to strengthen the competitive edge of cooperative banks in the market 
include total quality control initiatives, management initiatives and cost reduction initiatives.  
 
The cooperative banking sector has come to occupy a formidable place in the Indian financial 
system. However, sustenance of its growth depends on the professionalism of its management, 
inculcating good corporate governance, technology absorption and scrupulous adherence to 
regulatory framework. Elements of good corporate governance, sound investment policy, 
appropriate internal control systems, improved credit risk management, focus on  areas like micro 
finance, efficient customer service and adequate mechanisation will help cooperative banks 
withstand  these challenges. 
 
QUESTIONS FOR DISCUSSION: 
 
1. Cooperative banks were established to contribute to the development of rural economy in 
India. However, these banks do not seem to have contributed much to the development of the 
rural economy. What according to you are the reasons for the failure of cooperative banks and 
their mismanagement? 
2. In 2001-02, many scams surfaced in cooperative banks. What were the reasons for scams in 
different cooperative banks? What measures do you suggest to prevent such scams happening 
in the future? 
3. Cooperative Banks are under the dual control of the RBI-NABARD and the Registrar of     
Cooperative Societies. Do you think the end of dual control would result in proper 
administration and management of cooperative banks? Explain with reasons. 
 
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ADDITIONAL READINGS & REFERENCES: 
 
1. Kaur. Suneeta, The- Get- Poor- Quick Trick, Business India, March 19 – April 1, 2001. 
2. Sinha Suveen. K, How The Cookie Crumbles, Business Today, May 6, 2001. 
3. Move To End Dual Control of Co-op Banks, The Hindu, August 25, 2001. 
4. Kaur Suneeta, Banking on A Bailout, Business India, October 1 - 14, 2001. 
5. Maharashtra To Handle G-Sec scam, The Hindu, May 15, 2002. 
6. Ravi. A.B, A New Can Of Worms, Business India, May 13 -26, 2002. 
7. Weighed Down by Gilt, Business World, May 20, 2002. 
8. Jaykar. R, Pal. A, and Nayak. S, G-Secs, Lie and Co-op Banks, Business Today, June 9, 
2002. 
9. Cooperative Banking System -Free it From Government Shackles, Hindu Business Line, 
June 18, 2002.  
10. Majumdar. N.A, What Ails Cooperative Banking?, Hindu Business Line, June 26, 2002. 
11. Joshi.N.C, Consolidating Urban Cooperative Banks, Daily Excelsior, July 8, 2002. 
12. www.rbi.org 
 
13. www.nabard.org 
14. www.site.securities.com 
15. www.banknetindia.com. 
16. www.capitalmarket.com. 
17. www.ficci.com 
 
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