Double whammy for Kerala's Cooperative banks as RBI rate cuts, deposit rules weigh in on profit

The Reserve Bank of India's interest rate cut last month has delivered another setback to Kerala's cooperative banking sector. In response to the RBI’s move, Kerala Bank, which was formed through the merger of 14 district cooperative banks, was compelled to reduce its interest rates on deposits.

Bankers in the cooperative sector said the rate cut would have a cascading effect, forcing the cooperative banks across the state to follow suit, potentially reducing their revenues and severely impacting their profitability.

Kerala’s Department of Cooperation mandates that service cooperative banks in the state deposit their surplus funds with Kerala Bank, limiting their ability to invest in other financial institutions that may offer higher yields. As per the regulation, only 70 per cent of total deposits can be disbursed as loans, while the remaining 30 per cent must be parked with Kerala Bank.

Following the RBI rate cut, Kerala Bank now offers an interest rate of 7.10 per cent on deposits for a tenure of one to two years, down from the previous 7.75 per cent. This new rate is significantly lower than the 8 per cent typically offered by cooperative banks to their customers. They also offer the senior citizens an additional 0.50 per cent.

Consequently, the reduction in interest rates is likely to diminish the attractiveness of investing in cooperative banks, potentially driving away depositors seeking higher returns. "There is no other option but to reduce the interest rate on deposits," said an official of the cooperative bank secretaries forum, who declined to be named. "At present, we are uncertain about the exact rates we will need to follow, as the final decision rests with the Registrar of the Cooperative Department," the official added.

"Slashing the interest rates will significantly reduce our profitability," said a secretary of a cooperative bank in Kottayam district, who also declined to be named. "Kerala Bank has cut its interest rates by nearly 65 basis points, that’s a substantial reduction. Now, we’re being forced to follow suit," the secretary added.

Last month, the Reserve Bank of India cut its key interest rate by a more-than-expected 50 basis points, bringing it down to 5.50 per cent. This followed earlier rate cuts of 25 basis points each in February and April, which had reduced the rate to 6 per cent. The move has forced public and private sector banks to slash their interest rates.

Meanwhile, Urban Cooperative Banks, which also operate under RBI regulations like Kerala Bank, continue to offer higher interest rates on deposits. As per the revised rates effective from July 1, Urban Coop banks are offering 7.70 per cent on fixed deposits, higher than the rate offered by Kerala Bank. However, service and rural cooperative banks are not permitted to park their surplus funds in Urban Coop Banks, as per government guidelines, limiting their options for better returns.

"This is double standards. Both Kerala Bank and Urban Coop banks operate under the same RBI guidelines, yet service coop banks are not allowed to deposit their funds where higher returns are available," said another official from the cooperative bank secretaries forum, who also requested anonymity. "We are forced to depend on Kerala Bank, which offers lower interest on investments, while we continue to provide higher rates to our customers," the official added.

The official also pointed out that there is a 0.9 per cent to 1.4 per cent gap between the interest rates they offer depositors and what they receive for their deposits, further squeezing their margins. "We request the government to address the issue and allow us to deposit where we get more returns," the official, who is also a secretary at a bank, said.

Moreover, the Cooperative Department has introduced a new mandate under its Deposit Guarantee Scheme, requiring cooperative banks to contribute 20 paise per ₹100 of total deposits annually. This rate is set to double to 40 paise per ₹100 next year, according to the first official.

For instance, a bank with total deposits of ₹50 crore would now need to contribute ₹1 crore annually under the scheme. "Earlier, we only had to contribute 10 paise per ₹100 annually on the increase in total deposits. So, if deposits rose from ₹50 crore to ₹55 crore, the contribution applied only on the ₹5 crore increase," the official explained. "Now, not only has the rate doubled, but it also applies to the entire deposit base. This has a serious impact on the profits earned by cooperative banks."

This comes as a double blow to Kerala’s cooperative banking sector, which has already been reeling from a series of financial frauds. The Enforcement Directorate had earlier uncovered a ₹300 crore scam at the Karuvannur Cooperative Bank in Thrissur. In addition to this, the anti-money laundering agency has flagged 13 other cooperative banks in the state for alleged financial irregularities and fraud.

These developments are steadily eroding public trust and driving investors away from cooperative banks. A significant portion of the deposits in these banks come from elderly citizens who invest their pensions and life savings. Meanwhile, the younger generation is increasingly reluctant to invest in cooperative banks, preferring more secure and transparent financial institutions.

"A bulk of our deposits, around 90 per cent, come from senior citizens, and we’re required to offer them an additional 0.50 per cent interest. With Kerala Bank offering lower returns, our profit margins are getting uncomfortably tight," the official said.

The official also noted that the entire cooperative banking sector comes under scrutiny whenever fraud is reported at any one institution. "This seriously affects our day-to-day functioning. Many cooperative banks operate strictly within the legal framework," the official said. "Yet, these isolated incidents are driving away customers, and the government remains silent on the issue."

Adding to their troubles, the RBI has objected to cooperative societies using the word ‘bank’ in their names and cautioned the public against depositing money with such institutions. It also clarified that deposits in these entities are not covered by the DICGC, leaving investors at risk of losing their savings in case of liquidation. The state government has strongly opposed the RBI’s regulations on cooperative institutions, arguing that the central bank ignored Supreme Court rulings that classify the cooperative sector as a state subject.