Leverage, Scale of Operations and Financial Performance of Primary (Urban) Cooperative Banks in India

Primary (Urban) Cooperative Banks (UCBs) in India operate under the provisions of the Banking Regulation Act of 1949 – As Applicable to Cooperative Societies (AACS). Considering the large heterogeneity in asset sizes of UCBs and the absence of any regulatory cap on their leverages, the principal objective of this paper is to understand the interrelationship of UCBs’ leverage and scale of operations with financial performance. The analysis, based on a three-year pooled data sample of 140 well-distributed UCBs, shows a significant difference across the capital adequacy, leverage and net interest margin, based on the scale of operations, but due to heterogeneous and skewed distribution of UCBs in terms of asset size, the impact of the scale of operations on the financial performance does not manifest very clearly. It, however, shows that the scale of operations is unrelated to the incidence of non-performing advances. Further, UCBs with higher leverages do not show superior financial performance in terms of key financial variables, namely, gross and net non-performing assets, capital adequacy ratio, net interest margin, and return on assets, and their cost-income ratio remain unaffected by the financial leverage. However, banks with higher leverage do gain in terms of their return on equity. These findings provide nuanced guidance to the UCBs and are also useful for regulatory policy making on the subject