RBI Revises Prudential Norms For Urban Co-operative Banks

The Reserve Bank of India (RBI) has introduced new prudential norms for Urban Co-operative Banks (UCBs), with the objective of enhancing their financial health along with providing them greater freedom in lending.

The new norms, which are effective from February 25, modify regulations relating to small-value loans, exposure to real estate, and provisioning for Security Receipts (SRs).

In the circular published on February 24, 2025, RBI stated, "With a view to rationalising these norms, and thereby allowing greater operational flexibility to UCBs without diluting the regulatory objectives, the above prudential norms have been reviewed". 

Amended Definition of Small Value Loans

The RBI has increased the maximum cap on small-value loans for Urban Co-operative Banks (UCBs). The limit was previously fixed at Rs 25 lakh or 0.2 per cent of a UCB's Tier I capital, whichever was higher. Under the new system, the limit has been raised to 0.4 per cent of Tier I capital, capped at Rs 3 crore per borrower.

This change is expected to provide UCBs more autonomy to lend to small and medium enterprise borrowers and individual lenders while maintaining financial prudence. RBI, even though it has allowed a higher loan limit, also requires banks to monitor the quality of loans disbursed and directs the banks to reduce limits if they see any signs of risk. The change is in line with the central bank's attempt to encourage a responsible credit boom while reducing risks associated with high-ticket loans.

Increased Limits for Housing Finance

Urban Co-operative Banks have also been given more flexibility in housing and the real estate sector. The overall exposure of a UCB to housing, real estate, and commercial real estate advances had a limit of 10 per cent of total assets, while an additional relaxation of 5 per cent on housing advances, which were priority sector advances was also allowed.

As per the new instructions, UCBs are permitted to finance a maximum of 25 per cent of their aggregate advances and loans for residential mortgages in the non-priority sector. The exposure to the real estate industry, excluding housing loans, has been restricted to 5 per cent of aggregate advances and loans.

The RBI has also increased the housing loan cap a borrower can avail. Tier 1 UCBs are now permitted to give home loans of Rs 60 lakh and Tier 4 UCBs can advance up to Rs 3 crore to a borrower. The new caps are expected to boost access to housing finance without letting UCBs become overly exposed to realty risks.

Extended Timeline for Provisioning on Security Receipts

To ease the financial load on UCBs, the RBI has extended the timeline of compliance for provisioning on Security Receipts (SRs). The previous glide path, where complete compliance was to be attained by FY 2025-26, has now been stretched by two more years up to FY 2027-28.

Security Receipts are issued by Asset Reconstruction Companies (ARCs) when banks offload their non-performing assets (NPAs). The extension of the compliance period helps UCBs have an extended breathing period to restructure their balance sheets without facing financial constraints at once. The RBI has, however, clarified that any provisions already made would still have to be maintained.

Implications for UCBs and Borrowers

The new guidelines are an attempt by RBI to balance the regulatory requirements with the operational independence of UCBs. By relaxing loan ceilings and extending provisions, the central bank is seeking to increase the financial solidity of these banks, and at the same time, enable them to enrich small enterprises, individual borrowers, and the housing sector.

For the borrowers, these changes would mean greater access to small business loans and housing finance of larger amounts. However, UCBs will need to exercise caution and maintain good risk assessment procedures so that their balance sheets are not put under undue strain.

According to Vivek Iyer, partner and financial services risk leader, Grant Thornton Bharat, "This will significantly benefit the MSME space, as an uptick in small value loans with a larger risk appetite in terms of increased exposure limits will enable the UCBs to significantly push credit growth in the MSME space which is the stated key driver of Indian GDP growth. The increased borrower limit also reflects the adjustment of the loan value limits in terms of today’s purchasing power parity terms".

With these reforms, the RBI further strengthens the regulatory framework of UCBs so that they are competitive and financially stable and can help propel economic growth.