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RBI cracks down on local area bank

Tamal Bandyopadhyay

The cancer in the Indian banking sector is spreading fast. From new private, old private and cooperative banks, the disease has spilled over to local area banks. The Reserve Bank of India is set to close Vinayak Local Area Bank Ltd in Sikar, Rajasthan.

According to sources familiar with the development, the bank had extended loans to companies in New Delhi, Madras and other places outside Rajasthan, violating the spirit of a LAB whose area of operation is supposed to be confined to a maximum of three geographically contiguous districts.

This will be the first case of a LAB being shut for large-scale funds diversion.

LABs were conceived by former finance minister P Chidambaram as a means of providing an organised source of finance for rural India in place of the traditional and unorganised funding sources. In his Budget for 1997, Chidambaram had announced that LABs would be set up. The Reserve Bank of India in August 1996 allowed the establishment of new local banks in the private sector to encourage rural and semi-urban savings and to provide institutional credit for viable economic activities in local areas.

The central bank has already slapped a show-cause notice on the bank and the bank may fold up over the next few weeks. An RBI spokesperson confirmed the development. However, depositors’ interests have been protected. The RBI has forced the bank to open an escrow account with the depositors’ money.

“The banks’ net worth has been wiped out as promoters resorted to large-scale funds diversion. RBI will cancel the licence of the bank,” sources said.

Earlier, the RBI had withheld licences from the three promoters who had received approval in principal to commence LAB operations. The approvals were issued in 1997 to Manipal Local Area Bank, Manipal (Karnataka); Priyadarshini Local Area Bank, Aurangabad (Maharashtra) and Krishna Bhima Samruddhji Local Area Bank (Karnataka and Andhra Pradesh).

Subsequently, the RBI gave approval in principle for the establishment of five more local area banks—Capital Local Area Bank Ltd, Nakodar, Punjab; Coastal Local Area Bank Ltd, Vijayawada, Andhra Pradesh; Local Area Bank of Kongunadu Ltd, Salem, Tamil Nadu; Central Gujarat Local Area Bank Ltd, Dabhoi, Gujarat; and Vinayak Local Area Bank Ltd, Sikar, Rajasthan.

Local area banks are suppose to cater to the credit needs of the local people and provide efficient and competitive financial intermediation services in the area of operations. It was believed that the establishment of LABs would pose a challenge to the commercial banks, particularly their resources based in rural and semi-urban areas which contribute about 33 per cent of total deposits.

The minimum paid-up capital for a LAB is Rs 50 million with the promoters’ contribution pegged at Rs 20 million. Individuals, corporate entities, trusts and societies are eligible to float LABs. Though the banks are governed by the provisions of the RBI Act 1934, the Banking Regulation Act 1949 and other relevant statutes in regard to liquidity requirements and interest rates are be governed by the provisions applicable to regional rural banks.

LABs are registered as public limited companies under the Companies Act 1956. They are licensed under the Banking Regulation Act 1949 and eligible for inclusion in the second schedule of the RBI Act 1934.

The LABs are required to observe the priority sector target of 40 per cent of net bank credit. Of this, 25 per cent (10 per cent of the net bank credit) needs to be given to the weaker sectors on an ongoing basis. These banks are also subject to prudential norms and accounting policies, including the maintenance of an 8 per cent capital adequacy of the risk weighed assets from the very beginning.

The norms for income recognition, asset classification and provisioning are also applicable as in the case of other banks. However, for liquidity requirements and interest rates, they are governed by the provisions applicable to the RRBs.

“The malaise has spread far and wide. It seems that the entire banking sector is affected with this. First, we saw Global Trust Bank taking a huge exposure in the capital markets. From the new private banks, it spilled over to the old private banks with banks like Nedungadi violating norms. In the cooperative sector, Madhavpura Cooperative Bank is the prime example. No sector has remained unaffected,” said a senior banker.

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