RBI’s Directive Powers Over Co-operative Banks: Ensuring Compliance and Stability

India has over 1,500 urban co-operative banks and dozens of multi-state co-operative banks serving millions of depositors – many of them belonging to low-income and middle-income groups. When Punjab and Maharashtra Co-operative (PMC) Bank collapsed in 2019 under the weight of financial fraud and misreported exposures, it exposed a glaring regulatory gap: the Reserve Bank of India (RBI) lacked the teeth it needed to step in early and decisively. That gap was largely addressed by the Banking Regulation (Amendment) Act, 2020, which brought co-operative banks firmly under RBI’s supervisory umbrella. At the heart of this oversight framework is the RBI’s power to issue binding directions – a power that determines how these banks operate, how they are managed, and how depositor interests are protected.

The legal foundation: where does RBI’s directive power come from? 🔗

The Banking Regulation Act, 1949 is the primary statute governing banking in India. Originally enacted to regulate commercial banking companies, it was extended to co-operative banks through Section 56, which was inserted by the Banking Laws (Application to Co-operative Societies) Act, 1965. This section makes most provisions of the Act applicable to co-operative societies engaged in banking, with necessary modifications.

The directive powers of the RBI flow primarily from two key provisions:

Section 35A – This is the central provision. It empowers the RBI to issue directions to any banking company (including co-operative banks) if it is satisfied that such directions are necessary in the public interest, in the interest of banking policy, to prevent the affairs of a bank from being conducted in a manner detrimental to depositors, or to secure the proper management of banking operations. Directions issued under this section are binding and must be followed by the bank without exception.

Section 36 – This provision gives the RBI additional supervisory powers. Under it, the RBI can prohibit a banking company from entering into specific transactions, advise it on its operations, call for meetings of directors to discuss the bank’s affairs, and appoint observers to watch how the bank’s business is being conducted. Taken together, Sections 21, 35, and 35A vest the RBI with authority to inspect banks, issue directions, and take corrective action as necessary.

What kinds of directions can RBI issue to co-operative banks? 🔗

The scope of RBI’s directive powers is deliberately broad. This breadth is intentional – banking crises rarely follow a predictable pattern, and a regulator needs flexibility to respond to diverse situations. Here is how these directions typically operate in practice.

Operational and business restrictions 🔗

The RBI can direct a co-operative bank to stop certain transactions entirely. This includes restricting lending above a certain limit, freezing fresh deposit acceptance, placing caps on customer withdrawals, or preventing the bank from opening new accounts. When the PMC Bank fraud came to light in 2019, RBI placed the bank under “All-Inclusive Directions” under Section 35A read with Section 56 of the Banking Regulation Act, initially limiting withdrawals to ₹1,000 per depositor. This was a direct exercise of the power to restrict operations to prevent further harm to depositors.

Management and governance directions 🔗

One of the most significant expansions brought in by the Banking Regulation (Amendment) Act, 2020 relates to the RBI’s power over a co-operative bank’s management and board. Previously, RBI had limited control over who ran co-operative banks. Post-2020, the position changed significantly:

The RBI can prescribe qualifications and conditions for the appointment of a Chairman of a co-operative bank. If the Chairman does not meet the “fit and proper” criteria – for example, if they are insolvent or have been convicted of a crime involving moral turpitude – the RBI can direct the bank to remove the person and appoint a suitable replacement. Similarly, the RBI can issue directions to reconstitute the Board of Directors if it does not have at least 51% of members with professional expertise in areas like accountancy, banking, economics, or law. If the bank fails to comply, the RBI may step in and remove individual directors, replacing them with qualified persons.

Supersession of the board of directors 🔗

This is the most drastic form of direction the RBI can issue. Under the amended law, RBI’s power to supersede a Board of Directors has been extended to all co-operative banks – not just multi-state co-operative banks as was the case earlier. When the RBI supersedes a board, it appoints an Administrator to manage the bank’s affairs. This can last for up to five years. For co-operative banks registered under state law, the RBI issues this order in consultation with the concerned state government. This is a significant safeguard given the dual regulatory structure – co-operative societies are historically a state subject under the Constitution.

In the PMC Bank case, the Board was superseded under Section 36AAA read with Section 56, and an Administrator was appointed to manage the bank – a real-world demonstration of how these powers work in a crisis scenario.

Directions on audit and financial reporting 🔗

The RBI can order a special audit of a co-operative bank at any time for specified periods or transactions. Prior approval from the RBI is now required before a co-operative bank can appoint, re-appoint, or remove its auditor. The governance and management-related provisions of the BR Act, including Section 35B and Section 36AB, became applicable to co-operative banks from 26 June 2020, aligning their audit standards with those applicable to scheduled commercial banks.

Directions on capital and reconstruction 🔗

The RBI can direct co-operative banks on matters relating to capital adequacy and can initiate schemes for reconstruction or amalgamation. Importantly, after the 2020 amendment, the RBI can undertake reconstruction or amalgamation of a co-operative bank without first imposing a moratorium, ensuring that depositors can access their funds more quickly during a resolution process.

Why does this matter for depositor protection? 🔗

Co-operative banks occupy a unique space in Indian banking. They serve low-income urban workers, small traders, and members of specific communities. A large proportion of their depositors are individuals who may not have alternative banking options or the financial literacy to monitor the health of their bank. This makes depositor protection an acute concern.

Before 2020, the dual regulatory structure – where the RBI controlled banking operations but the Registrar of Co-operative Societies (RCS) controlled management and governance – created dangerous blind spots. The RBI could see problems developing but had limited power to fix them without state government cooperation. The PMC Bank crisis underscored this: financial irregularities had been building for years, but the absence of RBI authority over the bank’s management meant early intervention was structurally difficult.

The directive powers under Section 35A serve as an early intervention tool. By restricting withdrawals, freezing bad lending, or replacing dysfunctional boards, the RBI can contain a crisis before it escalates into a full-scale collapse. The RBI has enforced similar restrictions on multiple co-operative banks – including Vasantdada Nagari Sahakari Bank, Vithalrao Vikhe Patil Co-operative Bank, and the Madgaum Urban Co-operative Bank – demonstrating that Section 35A is not an extraordinary measure, but a regularly-used supervisory tool.

The constitutional dimension: banking vs. co-operative societies 🔗

There is an important constitutional dimension to this regulatory framework that law students must be aware of. Banking is a Union List subject (Entry 45), meaning Parliament has exclusive authority to legislate on it. Co-operative societies, on the other hand, fall in the State List (Entry 32), meaning states regulate their incorporation, management, and winding up.

This creates an inherent tension. When Parliament, through the 2020 amendment, extended RBI’s powers over the management and governance of co-operative banks, it was effectively legislating on matters that states have traditionally controlled. The PRS Legislative Brief on the Banking Regulation (Amendment) Bill, 2020 specifically noted this constitutional question: whether regulation of management, audit, capital, and winding up of co-operative banks falls within Parliament’s legislative competence as being essential to regulating the activity of banking. The legislative position taken is that since the principal activity of these entities is banking, Parliament’s power over banking extends to these matters. This debate is legally significant and continues to shape how the directive framework is interpreted and applied.

Penalties for non-compliance with RBI directions 🔗

RBI directions are not merely advisory. Non-compliance attracts serious consequences. Under Section 46 of the Banking Regulation Act, intentional misrepresentation or failure to comply with RBI inspection requirements can result in imprisonment up to three years, fines up to ₹1 crore, and additional daily penalties for continuing violations. Beyond criminal penalties, the RBI can intensify its supervisory intervention – moving from issuing directions to superseding the board and eventually initiating winding up proceedings if a bank’s condition deteriorates further.

The bigger picture: aligning co-operative banks with commercial bank standards 🔗

The trajectory of RBI’s directive powers over co-operative banks reflects a clear policy direction: these banks must be regulated on par with commercial banks. The 2020 amendment ensured uniform governance standards and auditing practices across co-operative banks, reducing the regulatory arbitrage that had previously allowed governance failures to persist. The RBI’s power to issue directions is the mechanism through which this alignment is enforced day-to-day – through regular inspections, off-site surveillance, and binding instructions that shape how every co-operative bank conducts its business.

For students of business law, understanding this framework is essential not just for examinations but for appreciating how law functions as a tool of economic governance. The power to issue directions is not about bureaucratic control – it is about maintaining public trust in institutions that millions of ordinary Indians depend upon for their savings.

What do you think? Given the dual regulatory structure where both the RBI and state Registrars of Co-operative Societies have overlapping jurisdiction, do you think the 2020 amendments have effectively resolved the governance gaps in co-operative banking, or do structural conflicts between Union and State authority remain a challenge? And if you were a depositor in a co-operative bank placed under RBI’s All-Inclusive Directions, how do you think the law currently balances your right to access funds against the need to stabilise a failing bank?

References

1. https://www.pib.gov.in/PressReleasePage.aspx?PRID=2117408
2. https://indiankanoon.org/doc/1129081/
3. https://agrudpartners.com/overview-of-banking-regulation-act-1949/
4. https://www.rbi.org.in/commonman/english/scripts/PressReleases.aspx?Id=3077
5. https://prsindia.org/billtrack/prs-products/prs-legislative-brief-3515
6. https://www.businesstoday.in/industry/banks/story/rbi-clamp-down-on-pmc-bank-punjab-and-maharashtra-cooperative-bank-section-35a-of-banking-regulation-act-230706-2019-09-24
7. https://lawbhoomi.com/banking-regulation-act-1949/
8. https://vajiramandravi.com/current-affairs/banking-regulation-act-1949/