Kerala will bear the biggest brunt of demonetisation: Cooperative banks gasping for breath

If there is a single state that is falling into a real financial crisis because of the current drive of demoneitsation, it's Kerala.

The rest of India, despite the injuries, massive damages and impaired lives of millions of poor people, might limp back to normal later than sooner, but Kerala has a deeper problem: the cooperative banking system that holds more than RS 60,000 crore in deposits and has disbursed more than Rs 30,000 crore in loans has been paralysed because both the Reserve Bank of India (RBI) and the Finance Ministry are suspicious of its dealings.

The cooperative banks, with different categories (state, district, primary etc) and hundreds of branches (at least 1,500) have been the lifeline of people in rural areas for decades, but with demonetisation, there is a literal freeze on their functioning because they are neither allowed to receive invalidated Rs 500 and Rs 1,000 rupee notes from their customers nor receive fresh cash from the RBI in exchange of its own reserve to continue daily operations. Unlike in the case of nationalised and private banks, it’s not a question of long queues or hassles, but a total collapse: weddings, funerals, education and even daily survival are affected. Reportedly, some banks are left with only a few thousand rupees in valid currency.

The RBI had initially allowed the cooperative banks to take deposits in old currency after the announcement of demonetisation, but no exchange of old notes. However, after four days, the RBI withdrew the permission because of the suspected risk of counterfeit currency and black money being laundered. The justification for this move was that these banks could create pre-dated fixed deposits and their staff are not trained in detecting counterfeit notes.

Representational image. PTI

Both the fears, which incidentally are also raised by some of the BJP leaders in the state, are genuine because unconfirmed reports showed that immediately after the announcement of demonetisation, many of these banks took large sums of old cash and registered them as pre-dated fixed deposits. Since most of these banks are not computerised, this is indeed a possibility. A senior economist in the state said that at least Rs 2,500 crore could have been laundered in this way. Actual figures notwithstanding, obviously that’s why the RBI asked them to stop. Although both the Chief Minister Pinarayi Vijayan and Finance Minister Dr Thomas Issac personally travelled to Delhi and asked Arun Jaitely for help, the freeze wasn’t lifted. And it's unlikely to happen.

The quantum of deposits in the cooperative banks has always been baffling because the 2012 credit survey showed a high level of indebtedness by people in rural areas. If the people in rural areas are in such debt, how can the banks, which serve the same areas, have so much in cash? Obviously, the inference is that the deposits are not by poor people, but by those with a lot of cash. Nobody, other than the banks, know the details of these deposits. No source of income is asked, no TDS filed, no PAN required and hence no reporting to the Income Tax Department. The interest that accrues from these accounts are also tax-free. Some, therefore call this the Swiss Banks of Kerala. There is certainly some merit in the argument that it’s a great mechanism for the rural moneybags to evade tax unless they come under the lens of the RBI.

Although the crisis is new, the suspicions are not. As early as 2008, there was a move to bring the cooperative banks under the purview of income tax. In 2013, an RBI money laundering probe found that cooperative banks, not just in Kerala, but across India, were involved in shady deals while in 2015, about 480 urban cooperative banks were under the RBI scanner for money laundering. In fact, in 2013, the then Finance Minister P Chidambaram himself had admitted that urban cooperative banks (UCB) were regularly used for money laundering. If the UCBs, which are governed by stricter RBI rules, can indulge in alleged illegality, the cooperative banks at lower levels can do much worse.

Instead of clearing the suspicions and allegations, the behaviour of the cooperative banks in Kerala has made them more suspicious. In 2009, a group of primary cooperative banks went to the Supreme Court when the the Income Tax Department asked them questions. Later, they, represented by political leaders met the then Finance Minister Pranab Kumar Mukherjee when
I-T Department issued notices asking them to file to returns.

What’s also unmissable in the impasse that both the cooperative banks and their customers face is politics. The cooperative bank system in most parts of Kerala is the lifeline of the CPM, especially in its strongholds such as Kannur. A lot of CPM family members are employed by these banks, hence the loudest protest is from the them. In fact, its leaders are livid and they accuse that this is a “neoliberal” ploy to destroy the age-old system and hand it over to the corporates.

As early as 2008, Sitaram Yechury, the present general secretary of CPM, was unequivocal that his party wouldn’t allow any I-T imposition on cooperative banks. In 2011, President of the State Co-operative Bank in Kerala M Mehaboob, a CPM leader, was more frontal, when he said: "We cannot allow the I-T department to examine the accounts in co-operative banks. The I-T department has been targeting state co-operative sector with a malicious intent.” He also said that the I-T move would “upset” its depositors and that more than 60 percent of deposits are from pensioners.

The Congress and its partner-parties are also minor beneficiaries and hence they also lend support to the CPM on the issue. They also have appealed to the Centre that the present crisis needs to be addressed immediately.

The party that’s trying to cash in during this unfortunate situation is the BJP because of two reasons - one, it has no foothold on the sector and two, it’s a potent proxy attack on the CPM. Their demands, if met, will simply destroy the system and break some of the financial muscle of the party. Unfortunately, in its eagerness to score political points, it’s insensitive to the visible anxiety of about 1.5 crore customers.

The apprehensions of the RBI and the Finance Ministry cannot be glossed over either. It’s indeed true that the cooperative banking system has been an integral life-partner for millions of people in rural Kerala and they were the pioneers of inclusive financing, decades ahead of the Prime Minister Narendra Modi’s Jan Dhan scheme, with the first such bank being set up a 100 years ago. It’s indeed the common man’s friendly neighbourhood bank for their small savings, chit-funds, agricultural loans, microcredit etc. Their growth in the state is certainly an indicator of the failure of the scheduled banks in early years.

However, if the same system is misused for laundering money and tax-evasion, it has to be stopped. By blocking any legal scrutiny, the CPM is helping money launderers to use poor people as human-shield. It has to proactively join hands with the RBI in locating the bad money and protecting the poor, instead of fielding the poor in the frontline to protect the rich. Ultimately, rule of law is applicable to everyone. Under Indian law, cooperative banks cannot be run as “party villages”, particularly when the state government had mooted the grand idea of merging them all into a unique Kerala Bank.