What Budget has in store for regional rural banks

RRBs were formed under an Act to provide credit to small farmers, agricultural labourers and businesses in rural areas.

The government is working on a policy to bring regional rural banks (RRBs) under a holding company to better govern these lenders and help them raise equity from the market.

The intention to further reform the regional rural banking space may feature in the Union Budget.

Currently, there are 43 RRBs in the country.

The step would help centralise their functioning, improve efficiency and ensure they are run professionally.

Also, there would be a common strategy for the 21,871 branches of these banks, said a senior government official.

An internal committee has been formed by the government with members from National Bank for Agriculture and Rural Development (NABARD) and the Reserve Bank of India (RBI).

If the panel’s recommendations are accepted by the government, an announcement may be made in the Budget, said another official in the know.

Bringing RRBs under one umbrella entity or a holding company could be yet another reform in the regional rural banking space after the government consolidated such lenders to make them viable.

RRBs were formed under an Act to provide credit to small farmers, agricultural labourers and businesses in rural areas.

The ownership structure of such banks is different from other government-owned banks — 50 per cent is held by the central government, 35 per cent by sponsor banks and 15 per cent by state governments.

These lenders are supervised by NABARD and their annual plans and financials monitored by both the RBI and NABARD.

About a third of RRBs have a capital adequacy ratio of less than 9 per cent, and the government has infused Rs 670 crore to recapitalise these banks.

The collective losses of RRBs have widened to Rs 2,206 crore in fiscal 2019-20 (FY20) from a net loss of Rs 652 crore in FY19.

Earlier reform

In 2005, the government had initiated the consolidation exercise to improve financial inclusion and better credit flow to rural areas.

The number of RRBs has been reduced from 196 in 2005 to 43.

The exercise was done in three phases. In the first phase (in 2005), RRBs of same sponsor banks were merged.

The second phase (2012) saw RRBs being merged across sponsor banks within a state, while the third phase, in 2019-20, involved consolidation on the principle of ‘One State One RRB’.

The consolidation was carried out on the suggestions of the V S Vyas committee, formed by the RBI, which had also proposed forming one holding company that will have equity from sponsor banks and NABARD.

The holding company would return the share capital and additional share capital deposits contributed by the central and state governments at a price based on the book value, the committee had recommended.

A similar structure for the holding company could be explored now, said the official quoted above.

The proposed change may require amendments to The Regional Rural Banks Act, 1976, the official said.

Mixed reaction

Experts are divided on the benefits. Former Financial Services Secretary D K Mittal said it’s difficult to bring RRBs under a holding company structure unless the Centre buys equity of states and sponsor banks.

He said this would be similar to creating an artificial structure and will not help in running them professionally.

Pointing out that RRBs have outlived their utility, Mittal said rural lending has picked up and the government can consider merging them with sponsor banks or privatise them.

However, Prakash Agrawal, director and head of financial institutions at Ind-Ra, said the step can make supervision stronger.

As the RRB Act permits these lenders to raise equity from the market, various alternatives can be considered by the government, including such a proposal, to help them efficiently raise money from the market, said Harsh Kumar Bhanwala, ex-chairman of NABARD and non-executive chairman of Capital India Finance.

Weak investor appetite

In 2015, RRBs were allowed to raise capital from sources other than central and state governments, and sponsor banks, provided the combined shareholding of the Centre and the sponsor public sector banks does not fall below 51 per cent.

Capital raising ability of RRBs is likely to remain constrained on account of small scale and geographically restricted operation, said Anil Gupta, vice-president, financial sector ratings at ICRA.

Besides equity capital, the ability of these banks to raise debt has also been constrained by their weak capital position, reflected in intermittent breach on regulatory capital ratio which is a prerequisite for coupon payment on debt capital instruments, he said.

The holding structure could possibly improve the timeliness of capital raising which in turn will depend on shareholding structure of umbrella entity as well as the RRBs, Gupta said.

“Despite the legislative amendment to allow RRBs to raise capital, no bank has been able to raise equity capital from the market, possibly reflecting weak investor appetite for these RRBs,” Gupta said.

• Budget 2021

Photograph: PTI Photo