A rogue stock broker, with a Midas touch, had once walked away with 70% of the money of a cooperative bank called Madhavpura. All hell broke loose when the man defaulted and the scam surfaced. Some of the smaller banks, daisy-chained to Madhavpura, shut shop. That was 2001.Eighteen years later, an upstart builder with fabulous political connections in Maharashtra, the country’s largest real estate market, is in the news for borrowing half the deposit of Punjab & Maharashtra Cooperative Bank (PMCB) — another large multi-state urban cooperative bank (UCB) like Madhavpura. Wheels within wheels, the chairman of PMCB happens to be the founder of the realty group.Why has so little changed in so many years? The auditors were fooled, the Reserve Bank of India (RBI) was blindsided, and the government was oblivious to the flagrant violation of rules by directors who focused on cutting sweetheart deals and getting themselves re-elected. It’s a bank that gave guarantees, issued letters of credit (LCs) and holds deposits of credit societies and smaller banks.Banks of all kinds have been hit by frauds — tony high-street banks, stodgy State-owned monoliths, old community lenders as well as UCBs. But the UCBs are the odd man out. They are nobody’s child. In eight out of 10 cases, households and shopkeepers — attracted by higher returns and friendly staff — lose money when a UCB fails.Depositors of private sector banks, which have been as dodgy as PMCBs, were hurt when these banks faced sudden death. As the high priest in shotgun weddings, RBI force-merged insolvent private banks with PSU banks. Shareholders of such private banks lost out, but depositors were protected.It’s a different story for UCBs. Hopes of depositors slowly die in the course of a tardy liquidation process; even extracting a lakh guaranteed under deposit insurance is difficult. As the story fades, RBI and the State leave depositors to their fate. After all, the UCB deposit base is just 4% of the deposits of scheduled commercial banks.Heart-rending WhatsApp videos of depositors waiting outside PMCB branches is a grim reminder of the regulatory twilight zone in which these banks operate. Though RBI regulates the banking functions, a system of ‘dual regulation’ requires RBI to approach the State to sack the CEO or chairman of a troubled UCB.But a homemaker who salts away her savings into a UCB is clueless about the pitfalls of dual regulation. It may never cross her mind that the State and the regulator can distance themselves if the bank fails. For her, a bank is a bank is a bank. She is driven by higher returns on her deposits.Similarly, a swindler snoops around for a weak link in the financial system. Sadly, they may both step into a shoddy UCB. And while fraudsters will laugh their way to another bank, many depositors may never recover from the shock after their trust is shattered.As higher rates attract more deposits, UCBs comes under pressure to lend to high-risk borrowers. Unless a UCB has a strong board, a skilled CEO and a credible credit committee, it will either face business failure or land in the hands of scamsters. The regulator and the government must sense it.The PMCB fiasco throws up basic questions: shouldn’t the same rules apply to all entities accepting deposit and functioning as a bank? Should some banks go down because they are too small, and pose no systemic risk? Should the State turn a blind eye because the number of people hurt is not large enough to make a difference in the next election?Can RBI get away with a ‘tick box’-style annual inspection where aspects like concentration of loans to a high-risk sector like real estate, and multiple loans to thinly capitalised outfits escape its radar? If RBI lacks the manpower to inspect 1,500 UCBs, it should hire more hands.Countless autorickshaws and taxis in Mumbai still carry a sticker that says ‘Hypothecated to ABC cooperative bank’. While it’s a testimony how UCBs touch the lives of those ignored by big banks, many UCBs have drifted from the principles of ‘cooperative’ movement. The PMCB debacle will further question their role and motive.It’s time for them to transform or merge. One of the cable news videos last week showed a lady, with all her savings sunk in PMCB, asking the reporter, “If the government is after black money, why did it block ours?” A question to which the State, RBI and cooperative banks, along with all their political patrons, will have no answer.Views expressed by the author are his own.