RBI’s tightening grip: Urban co-op banks on edge

By letting RBI overrule state registrars, the 2020 law steps into territory traditionally reserved for state governments. Many states, especially Maharashtra, Gujarat, and Kerala, where UCBs have deep roots, see this as an unwanted power grab. Why does this matter? These banks serve local needs. If a small bank is forced to follow rules meant for much larger institutions, it may struggle to survive.

Urban cooperative banks (UCBs) play a key role in Indian banking, especially in small towns and cities. They’re built around the ideas of mutual help and local decision-making. But since the Banking Regulation (Amendment) Act was passed in 2020, leaders of many cooperative banks and state governments have started voicing worries.

They say the new rules put too much power in the hands of the Reserve Bank of India (RBI) and take away the control states and communities had for generations.

What led to this change? The collapse of Punjab and Maharashtra Co-operative Bank (PMC) in 2019, which left thousands of depositors out of pocket, made everyone worried about weak controls in cooperative banking. In response, the government strengthened RBI’s hand—hoping tighter regulation would prevent another scandal. These changes have already made life harder for many banks and are raising new questions about the very purpose of cooperative banking in India.

What changed with the 2020 Act?

The Union Government touted the 2020 amendment as a game-changer. Until now, cooperative banks were under a “dual control” system—RBI looked after banking operations, while state registrars of cooperatives handled day-to-day administration, elections, and governance. This allowed banks to run with local input and keep true to the cooperative model.

The amendment shifted several key powers entirely to the RBI for urban cooperative banks:

RBI can now supersede bank boards and appoint an administrator, even if local members disagree. The central bank picks the auditors and enforces audit norms for all cooperative banks.

Opening new branches now needs RBI approval, not just the state government’s okay.

Capital rules, loan policies, and even CEO appointments are under the RBI’s watch. This is similar to how commercial (private or public sector) banks are run.

State governments have lost authority to block mergers or close struggling UCBs; RBI is the final decision-maker.

All UCBs across India, except those handling only agriculture and land finance, now fall under these rules.

The major concerns- Threat to State powers and federalism:

Indian law is clear: “cooperative societies” are a state subject. States are supposed to make the rules for setting up and running societies, including banks. By letting RBI overrule state registrars, the 2020 law steps into territory traditionally reserved for state governments.

Many states, especially Maharashtra, Gujarat, and Kerala, where UCBs have deep roots, see this as an unwanted power grab. Why does this matter? These banks serve local needs. If a small bank is forced to follow rules meant for much larger institutions, it may struggle to survive-a real concern for rural and small-town communities.

Loss of democratic local control:

Cooperative banks are managed and owned by their members, not by outside shareholders. Normally, members vote in board elections, and major decisions—like mergers or winding up—need their approval. The new law lets RBI replace elected boards or push through major changes, even if members or state officials’ object.

Some experts worry this erodes trust and could discourage people from joining or supporting cooperatives. If members feel powerless, the very spirit of cooperatives-mutual help and community benefit-will fade.

Heavy compliance costs and “one size fits all” rules:

The RBI’s norms work well for large, profit-driven banks. But local cooperatives are different. They often have fewer resources and serve clients who might not fit the usual banking profile-small shop owners, daily wage workers, women’s groups.

Under the new regime, UCBs face stricter capital and audit rules, must hire expensive external auditors, and need prior RBI approval for many decisions. For small banks, especially in less prosperous states, these costs can eat up 15-20per cent of their budget. Many have shrunk their branch network and cut back on lending as a result.

Limits on innovation and growth:

Before the change, UCBs could adjust quickly to local needs like launching new schemes or loans, developing microcredit products or setting up new branches where demand was high. Now, getting approval from the RBI can take months, and many proposals get stuck or rejected. This slows down innovation and limits the banks’ ability to compete with bigger national banks.

Member interests overlooked:

By bypassing state rules and member votes on crucial issues—like board removal or bank mergers—the law risks ignoring the interests of the very people the banks were created to serve. Some recent amalgamations have happened despite strong opposition from affected members, who lost both influence and potential compensation for their stake in the bank.

Legal and constitutional issues:

Multiple High Courts are hearing cases challenging the law, arguing it goes against the Constitution’s protection of state powers over cooperatives.

The Supreme Court, in past cases on similar federal disputes, has favored a balanced approach where the Union Government guides banking, but states retain a major say in cooperative matters. The Banking Regulation (Amendment) Act 2020 pushes this balance toward the center, raising deep concerns about the erosion of India’s federal system.

What has reportedly improved?

The rules have reportedly reduced bad loans at many UCBs. According to RBI data, average Non-Performing Assets (NPAs) have fallen from more than 12% in 2020 to below 8% in 2024.

Fraud cases are down, thanks to closer audits and tighter qualification checks for directors and staff, claims RBI.

Some banks, especially larger urban cooperatives, are more stable and better able to keep up with technological changes.

The banking regulator claims the depositors, in general, feel safer knowing there is stricter oversight.

But at what cost?

Despite some improvements, the challenges are mounting:

Many UCBs have seen slow or negative growth as compliance costs rise, and expansion is restricted.

Smaller and weaker banks in states like Bihar, Odisha, and even parts of Maharashtra are at risk of closure. This will hit the poor and marginalized the hardest.

Members’ voices matter less, as key decisions are now made in Mumbai and Delhi, not in local communities.

The core idea that cooperatives are by, for, and of local people is being replaced by a top-down, one-size-fits-all model.

Where do we go from here?

To truly serve their members and the national economy, cooperative banks need a careful balance. Some suggest a “hybrid” model—where RBI ensures financial standards, but states keep a strong role in governance and daily management. Others advocate granting exemptions or lighter rules to small, community-based cooperatives who don’t deal with complex or risky products.

What’s clear is that real reform must be data-driven, include voices from the grassroots, and recognize the unique contribution of urban cooperatives to financial inclusion and local development.

Conclusion:

The Banking Regulation (Amendment) Act, 2020, may have been well-intentioned, but for India’s urban cooperative banks, it creates as many risks as it tries to solve. The amendments have inadvertently waged war on the cooperative sector's essence, member rights, and state prerogatives. Strong, local banks matter for the nation’s growth, and trust in their systems cannot be built if they are not allowed to run according to their own best traditions.

As India navigates economic ambitions, restoring balance through consultative reforms is imperative to safeguard these institutions' democratic legacy, cooperative vitality and state prerogatives, which in turn will define fiscal federalism’s future.

(The author is former Senior Editor, The Economic Times, and currently practising as an advocate at the Telangana High Court)