Pulls and pressures on banking system

ISSUE/ELECTION YEAR

Appraisal dilution no reform

N NAGARAJAN
Chief economic advisor,
Indian Banks' Association

The finance minister recently announced a slew of measures, mandating banks to lend at rates less than the cost of funds to an increasing array of activities.

In certain areas, the government has committed to compensate the difference between the mandated rate and the cost.

In others, banks are expected to bear the loss. Another set of measures aim to ease the credit delivery mechanism by facilitating wider reach as also by diluting appraisal norms.

A section of the media feels the main intention behind these measures was to garner votes from certain segments, particularly the farmers and upper middle class.

The important but neglected aspect is the likely impact of these measures on banks. Four aspects are worth examining. First, are they in conformity with the reform process? So far, all measures taken with respect to the sector has been in the interest of furthering reforms.

Even when conditions were not conducive, there were only a brief lull in pushing the process further, except in 1997 when the East-Asian crises demanded a short term rollback to avoid contagion effect.

The current instance, however, is in sharp contrast. An essential ingredient of reform is deregulation of interest rates.

Another ingredient is the freedom to banks to take decisions on business consideration. To dictate rates chargeable on their advances and urge them to dilute credit appraisal standards, is not in line with the reform process.

Secondly, what is the likely impact of the measures on banks? A rough and ready estimate reveals that the net interest income of banks could decline up to 50 basis points, depending on the distribution of their loan portfolio.

Moreover, lending at rates below the cost of banking services is akin to selling products below the cost of production. No commercial entity can survive in the long run.

The list of borrowers enjoying such concessional rates is ever increasing. Cross-subsidisation is possible but only up to a limit. Thereafter, overall non-viability of banks could not be avoided.

Thirdly, why should the government distribute such favours through banks? Banks command financial resources, which the politicians could distribute without any personal loss.

It is another matter that the money belongs to the public at large and, hence, the losers are also the public. Politicians may justify that the beneficiaries (though very small and selected in number) are also public.

In any democracy, lobbying plays an important role and condition in India is no exception. Politicians themselves lobby for some sectors. In contrast, banks have no god fathers. In fact, they are orphans at the corridors of power.

Lastly, is the minister justified in announcing these measures at this time? The situation in the US, though not strictly comparable, may justify the action.

Long ago, a Fed-bashing study found that, historically, the Fed had been consistently following a regime of easy money policy during the years of Presidential election irrespective of economic situation.

It attributed this accommodative action to the Fed's desire (may be under political duress) to help the parties to raise funds for the election process.

(The views expressed are personal)

Foggy on the road ahead

K KANNAN
Former chairman,
Bank of Baroda

A budget in an election year used to give various directions to financial sector. The signals could be to lend money at lower rates or postpone repayment of principle and waive interest or, even, write-off both.

In earlier days, the specifying of credit-deposit ratio, rural-semi urban lending as well as flow of credit for agriculture and allied activities were monitored at the state level with central and state ministers along with a few MPs attending the meetings.

Banks were asked to 'bleed' as lead bank and banks used to 'plead' with authorities to give time to correct the situation. Banks were ready to lend to state-owned corporation or subscribe to state bonds to fulfil the deficit in the CD ratio.

'Garibi hatao', 20-point economic programme lending at 4 per cent rate of interest, finance to self-employment (PMRY and IRDP) are experiments to cater to the rural and poor voters.

The cost of such loan melas and write-off was given to the bank by way of recapitalisation at the cost of the public "" provision in the budget.

With public sector banks hitting the market, the market capitalisation and the PE ratio has taken over priority sector lending ratio.

Hence, in the interim budget this year there is no direct direction to the financial sector. However, one can see the approach is coming through Nabard, Sidbi, GIC, and LIC to lend to rural areas.

The finance minister used the phrase "gross national contentment" so that the feel good factor goes to agriculturists. He has asked the Indian Banks Association for lowering the rate of interest for agriculture below PLR.

Issue of more kisan credit card to enable farmers to get automatic credit is another measure announced. Nabard and Sidbi will raise finance from banks at lower rate for their shortfall in priority sector.

Acknowledging that the credit delivery system is not functioning as expected, RBI has constituted two committees as directed by the ministry.

The Nabard has reduced refinance rate to banks to induce them to borrow more. It has also lent for rural roads and other infrastructure. Sidbi will follow suit to lend to state finance corporations which are bankrupt.

However, the feel good factor is not shared by large unemployed youths of the country and also by farmers. There is a young affluent society connected with technology-based employment, while others are unemployed.

Money is available for VRS and not for creation of jobs. So the growth has been termed as jobless growth. Hence, one expects that to sustain the growth, new measures from the finance minister will be announced in the regular budget.

According to the deputy prime minister, the feel-good factor has not touched farmers. Banks are lending to big corporates and they are directing their branches to lend to retail, to housing, benefiting housing developers and automobiles.

They are yet to go to rural-semi urban area, help agriculture, tiny and small units and self-employment as in the past.

The Reserve Bank of India and finance ministry should wake up banks and other financial institutions to take pride in developmental banking. Otherwise, recycling of social control and nationalisation will resurface once again.