A V Rajwade: Banks in India

WORLD MONEY

The pre-Budget, Budget and post-Budget announcements comprise a spate of initiatives encompassing the entire spectrum of banks in India "" from foreign banks to micro funding institutions (MFIs). This is as good a time as any to articulate a few perspectives.

First the positive. While the banking system has required recapitalisation of Rs 20,000 crore from the exchequer, the level of the net non-performing assets (NPAs) at the end of fiscal 2003-04, was a modest 2.9 per cent of advances.

In fact, the NPA record of the Indian banking system is perhaps the best in Asia "" banks in countries ranging from Japan to China to Korea to south-east Asia have suffered far larger losses. And this despite a history of political interference in lending policies and even micro-level decisions of the public sector banks at least in the 1970s and 1980s.

The negative number is that bank loans and advances as a percentage of nominal GDP are lower in India than in much of Asia. Result of comparatively tighter monetary policy and high reserve requirements? Whatever the underlying causes, the low proportion has implications for economic growth "" as does the high intermediation costs reflected in the gap between deposit and lending rates.

As far as public sector banks are concerned, there is considerable media debate about bank mergers and so on. Not much has happened on the ground so far. (More concrete steps towards consolidation seem to be emerging from the urban co-operative banks. Some old private banks may also be driven to consolidate by the new minimum capital norms.) One would also question whether mega banks are the most efficient intermediaries between the saver and the borrower.

On general principles, the complexity of administration grows exponentially with size. And as a people, we are not perhaps the best designers of systems and procedures, something which is all too evident in the framing of our laws, rules and regulations. (The complexity of the taxation of fringe benefits in the last Budget seems to guarantee fruitful employment to hundreds of tax practitioners and advisers).

But consolidation in terms of mergers apart, to my mind, there is a strong case for consolidation in terms of the business segments a bank caters to. The general pattern for public sector banks has been to cater to all segments "" from agriculture to international banking "" at least in theory.

Perhaps a time has come where each bank should think about and decide where its core competency lies and cater only to selected segments. (The public sector banks' low presence in newer areas like derivatives, consumer banking, foreign institutional investor business is a telling commentary on their business strategies.) Again, if intermediation costs are to come down, there is a strong case for closure of unviable branches.

One interesting corollary of the existing position is that funds transfer pricing in banks, instead of being designed to properly assess the economic output and value added by each profit centre/ branch, is driven by the need to reduce the number of loss making branches!

The formula often starts with the number of branches that can be "allowed" to report losses and what kind of seemingly plausible rationale leads to an FTP formula to get the desired result. In many ways, this defeats the very purpose of transfer pricing.

On both exiting business lines and closing unviable branches, the pre-Budget autonomy package for public sector banks gives freedom to bank boards. It remains to be seem how many will restructure their businesses, using the freedom given.

Foreign banks are unlikely to be enthused by the package of measures announced by the RBI last week. And takeover of sick banks by foreigners has always involved huge dollops of public funds, and not just tax concessions. Ask the Japanese.

The position of the co-operative banking sector is much worse. Has not a time come to consider whether the urban co-operative banks have a role to play in the current state of Indian banking? At one time, personal or small business loans were the forte of the urban co-operative banks, many of which were catering to specific communities.

In recent years, commercial banks have taken to such loans in a big way and have the volumes to justify standardisation of loan norms. The major weakness of the urban co-operative banks is that they often have to pay high interest rates to attract deposits "" and the inevitable corollary is riskier, higher interest bearing assets.

They also suffer from an inability to attract professionals, undue interference on the part of the board and so on. No wonder so many urban co-operative banks have faced serious problems in recent years.

While Madhavpura was the single largest example of an urban bank in deep trouble, there are any number of other cases in Maharashtra, Gujarat and Andhra. Perhaps its time to review the raison d'etre of the urban co-operative banking system, which has a deposit base of Rs 110,000 crores and NPAs in excess of 20 per cent.

Let me now turn to micro-finance institutions (MFIs). At least two private sector banks (ICICI and HDFC) have been making use of MFIs and NGOs as agents to penetrate the market for small loans quite successfully.

Micro finance has a lot to commend itself, and one does hope that the finance minister's initiative helps the growth of the sector. But external commercial borrowings to augment resources of MFIs? Surely not!

Email: avrco@vsnl.com