Local Area Bank and Regional Rural Bank

Local Area Banks
Local Area Banks were set up as per a Government of India Scheme announced in August 1996.
The intention of the government was to set up new private local banks with jurisdiction over two or
three contiguous districts. The objective of establishing the local area banks was to enable to
mobilization of the rural savings by local institutions and make them available for investments in
local areas. Thus, the overall idea was to bridge the gaps in the credit availability in the rural and
semi-urban areas, thereby strengthening the institutional credit mechanism in such areas.
Pursuant to announcement of this scheme, RBI received some 227 applications, but most of them
were rejected. RBI approved established of only 10 Local Area Banks but out of them only 4 are
into existence as of 2015.
Key Features of the Local Area Banks
Each local Area bank is registered as a public limited company under the Companies Act,
1956. However, they are licensed under the Banking Regulation Act, 1949.
The Local Area Banks are the only type of Non-scheduled Banks of India. However, they are
eligible to be included in the Second Schedule of the RBI Act 1934 subject to eligibility
criteria of RBI.
Local Area Banks have jurisdiction over a maximum of three contiguous districts, and their
basic function is to mobilise funds in rural and semi-urban areas.
The minimum start-up capital of a LAB was fixed at Rs.5 crore and the promoters were asked
to bring entire minimum share capital up-front. The promoters could be individuals, firms or
societies. The family of the individual promoters was not allowed to keep more than 40% of
the equity capital of the banks. The NRI promoters could not exceed more than 20% of total
number of promoters.
The Local Area banks are subject to prudential norms, accounting policies and other policies
as stipulated by the RBI. Such a bank has to maintain capital adequacy at 8% of risk
weighted assets and comply with the norms of income recognition, asset classification and
provisioning since inception.
Each Local Area Bank is allowed to open branch in only one urban centre per District and rest
of the branches were allowed to be opened in the rural and semi urban centers subject to
requisite clearance in respect of rural branches from the District Consultative Committee.
Functions of Local Area Banks
The Local Area Banks can do all normal banking business but their major function was to
finance agriculture and allied activities, small scale industries, agro-industries and trading /
non-farm activities in the rural and semi-urban areas.
These banks had to give out 40% of total credit to priority sector, of which 10% is to be
given to weaker sections of the society.
Current Functioning Local Area Banks in India. There are only four Local Area Banks (LAB) in India, which exist in the form of Non-scheduled
banks. They are as follows:
Coastal Local Area Bank Ltd
This bank was established on 27th December 1999. Its area of operation includes three contiguous
districts viz. Krishna, Guntur and West Godavari. Its head office is located at Vijayawada in Andhra
Pradesh.
Capital Local Area Bank Ltd
This bank was established on 14th January 2000. Its area of operation includes three districts viz.
Jalandhar, Kapurthala and Hoshiarpur in Punjab. The head office is at Phagwara (Punjab).
Krishna Bhima Samruddhi Local Area Bank Ltd
This bank was established on 28th February 2001 with an area of operation comprising three
contiguous districts of Mahbubnagar in Andhra Pradesh and Raichur and Gulbarga in the state of
Karnataka with its head office at Mahbubnagar(Andhra Pradesh).
Subhadra Local Area Bank Ltd., Kolhapur
This is smallest Local Area Bank with only 8 branches. Its head office is in Kolhapur.
Dysfunctional Local Area Banks
Further, a South Gujarat Local Area Bank Ltd was established in 2000 with headquarters at Navsari
in Gujarat. This bank failed to maintain CRR and SLR and suffered net losses in consecutive years.
Its promoters were found to be involved in scams. Consequently, this bank was merged with Bank
of Baroda in 2004. Further, one more local area bank namely Vinayak Local Area Bank Ltd., Sikar in
Rajasthan was established on 21st
October 2000. But RBI cancelled its license in 2002 due to
major irregularities.   
               Regional Rural Banks
The nationalization of the banks in 1969 boosted the confidence of the public in the Banking
system of the country. However, in the early 1970s, there was a feeling that even after
nationalization, there were cultural issues which made it difficult for commercial banks, even under
government ownership, to lend to farmers. This issue was taken up by the government and it set
up Narasimham Working Group in 1975. On the basis of this committee's recommendations, a
Regional Rural Banks Ordinance was promulgated in September 1975, which was replaced by the
Regional Rural Banks Act 1976.
Genesis of Regional Rural Banks
Regional Rural Banks came into existence on Gandhi Jayanti in 1975 with the formation of a
Prathama Grameen Bank. The rural banks had the legislative backing of the Regional Rural
Banks Act 1976 . This act allowed the government to set up banks from time to time wherever it
considered necessary.
The RRBs were owned by three entities with their respective shares as follows:
Central Government → 50%
State government → 15%
Sponsor bank → 35%
Regional Rural Banks were conceived as low cost institutions having a rural ethos, local feel and
pro poor focus. Every bank was to be sponsored by a "Public Sector Bank", however, they were
planned as the self sustaining credit institution which were able to refinance their internal
resources in themselves and were excepted from the statutory pre-emptions.
Problems with Regional Rural Banks
But the original assumptions were belied as within a very short time, most banks were making
losses. The RRB concept was based upon the policy that they would lend only to the weaker
sections of rural society, charging lower interest rates, opening branches in remote and rural areas
and keep a low cost profile. But the commercial motivation was absent.
Initially the banks expanded and by the end of year 1985 RRBS had opened 12606 branches.
During this period their credit deposit Ratio (C.D.R) expanded very fast. In 1976 it was 165% and
gradually declined to 104 % in December 1986. The Credit Deposit Ratio continuously declined
thereafter.
Later, the questions started being raised about the viability of these banks. The Khusrau
Committee of 1989, noted that the weaknesses of RRBs are endemic to the system and non-
viability is built into it, and the only option was to merge the RRBs with the sponsor banks. The
objective of serving the weaker sections effectively could be achieved only by self-sustaining credit
institutions. RRBs were finding themselves unable to sustain because of the mounting losses due to
imprudent commercial policy. Thus, Khusrau Committee (aka Agricultural Credit. Review Committee) said that the RRBs have no justifiable cause for continuance and
recommended their mergers with sponsor banks.
But by that time, the branch network had expanded so large that it would be political unwise for
the government to merge the RRBs with sponsor Banks.
Recommendations of Narsimham Committee on RRBs
The Narsimham Committee in 1990s also reiterated that the RRBs should be merged with the
sponsor banks. By 1993, 172 of the 196 RRBs were recorded unprofitable. The paid up capital
which was ` 25 Lakh at that time was not able to absorb the loan losses of most of the RRBs. The
loan recovery was around 40%. The First Narasimham Committee recommended that the RRBs
should also be permitted to engage in all types of banking business and should not be forced to
restrict their operations to the target groups. The Narasimham committee also recommended
that there should be mergers of the RRBs with their sponsor bank, BUT the "sponsor banks might
decide whether to retain the identities of sponsored RRBs or to merge them with rural subsidiaries
of commercial banks to be set up on the recommendation of the committee". The first
recommendation of letting the RRBs do all businesses was accepted by the government.
Some measures were taken by the Reserve Bank of India also. It allowed the RRBs to relocate
their branches if they were making losses at one location for more than 3 years. They were also
allowed to finance the non-target groups to the extent not exceeding 40 percent of their
incremental lending. This limit was subsequently enhanced to 60 percent in 1994. As a result, the
RRBs diversified into a range of non-priority sector (NPS) advances, including jewel and deposit-
linked loans, consumer loans and home loans
Some efforts were done by NABARD with funding support of the Swiss Development Corporation
(SDC). It took a number of HR and Organizational Development in these banks.
Turnaround of RRBs
The above discussion makes it clear that most RRB were making loss and had deviated from the
original idea that had created them. But there were some profit making RRBs also. Some reforms
led the rise in the number of the profit making RRBs but most of them were having a low credit
deposit ratio. This was coupled with the decreasing percentage of loans to small and marginal
farmers out of the total loans disbursed by the RRBs. The RRBs NPA level was high. In the early
2000s there was no prescribed CRAR (capital to risk weighted asset ratio) for the RRBs. In 2005,
based upon the recommendation of an internal working group the RRBs were asked to maintain a
capital to risk weighted asset ratio at 5% and over the period of time they were expected to align
themselves to Basel I standards. However, the major reform was to merge the RRBs with the
sponsor banks.There were 196 RRBs sponsored by 27 SCBs and one State Cooperative Bank were operating in
the country with a network of 14,484 branches spread over 523 districts as on March 31, 2005.
The government started the process of consolidation and amalgamation in 2005, bringing the
number down to 82 in 2010.
As of March-end, 2011, the total number of RRBs stood at 82. This number fell to 64 in March
2013. As of March 2014, the number of RRBs has been reduced to 57. After the 2014 elections, the
new NDA government has put hold on further amalgamation of the Regional Rural Banks. The
focus of the new government is to improve their performance and exploring new avenues of
investments in the same. Currently, there is a bill pending to amend the RRB Act which aims at
increasing the pool of investors to tap capital for RRBs.
Regulation of RRBs
Regional Rural Banks are regulated by National Bank for Agriculture and Rural Development
(NABARD). Please note that currently seven states viz. Tripura, Nagaland, Manipur, Mizoram,
Arunachal Pradesh Meghalaya and Puducherry, have state-level RRBs. Gujarat and Karnataka too
have demanded formation of state level RRB. In case of West Bengal, the state Assembly took
unanimous resolution in favour of State level RRB in the year 2004

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