Tamal Bandyopadhyay: Banking on the Budget agenda

puts across some of the key issues facing the banking sector.

Dear Mr Chidambaram,
You are one finance minister who always makes efforts to appreciate the needs of the banking sector. Every time bank chiefs meet you, they get excited by your assurance that the momentum of financial sector reforms would be kept and consolidation would take place through mergers. However, you have not been able to make a headway in the face of relentless opposition from the Left. Will you walk the talk this time when you present the Union Budget next week?

Six years ago, your predecessor Yashwant Sinha made a big-bang announcement of bringing down the government holding in public sector banks to 33 per cent. It was, at the same time, made clear that the government would retain management control over public sector banks, implying that the reduction of its stake would not lead to privatisation. However, nothing has happened on this front.

You did address two other long-pending issues "" the removal of the cap on voting rights (pegged at 10 per cent now) and foreign ownership of domestic banks "" in last year's Budget. While the necessary amendment to the Banking Regulation Act, 1949, for the removal of voting rights cap is still awaited, the Reserve Bank of India (RBI) has laid down the roadmap for foreign ownership in local banks. To that extent, you have made a beginning. One hopes that you will carry it forward this year.

While the banking sector is by and large robust with 10 listed banks having less than one per cent net non-performing assets, there are pockets of gloom. For instance, IFCI has been on a slow road to death and the government has not taken any initiative either to revive it or wind it up. Similarly, two public sector banks "" Punjab & Sind Bank in Delhi and Dena Bank in Mumbai "" are not in the pink of health and you need to decide their fate. Ditto for the IIBI in Kolkata.

I believe that the blue-print for consolidation in the banking sector has already been drafted by your ministry. You have informally had an audit of the sector carried out by a reputed consultancy firm, identified the potential candidates, and gauged the impact of such a move to the last detail. However, you are not willing to reveal anything on this apprehending opposition from certain political quarters.

You will possibly need to take a close look at certain other intermediaries in the financial sector too such as National Bank for Agriculture and Rural Development (Nabard), Small Industries Development Bank of India (Sidbi) and Exim Bank. ICICI and IDBI had to convert themselves into commercial banks as their old avatar of a financial institution was an anachronism in today's banking world. Perhaps it is also time to reposition some of these intermediaries so that they do not lose their relevance.

Finally, a word on your stance on interest rates. Over the past five years, the RBI and the finance ministry have been working in tandem to bring down interest rates. In 2001, the administered rates were cut by Yashwant Sinha by 100 to 150 basis points. In 2002, Sinha cut them again by 50 basis points. His successor Jaswant Singh followed it up in 2003 with another 100 basis points cut. Each time, the finance minister's gesture was reciprocated by the RBI governor. The rate cuts helped corporate India reduce its cost of borrowings and banks' higher treasury income.

However, things are different now. The RBI has raised the rates and yet you seem to have reservations about banks hiking their lending rates. This is because you feel that any hike in interest rates will derail the economy from its high growth path. Please take a close look at the numbers. In fiscal year 2005-06 (up to February 3), bank credit has grown by Rs 3,28,675 crore or 31.2 per cent against deposit growth of Rs 2,94,813 crore or 17.6 per cent. On an incremental basis, the credit-deposit ratio of Indian banking industry is over 100 per cent. Even on an outstanding basis, the credit-deposit ratio is now over 70 per cent.

Banks are required to allot 25 per cent of their liabilities to government bonds and another 5 per cent is kept with the RBI in the form of cash reserve ratio (CRR). This means, they have already reached the optimum level of lending from their deposit kitty and have started using their capital and reserves. Soon, they will be left with no money to lend. In fact, the next battle will be fought by the banks to garner deposits and not disburse loans. How will you take the growth story forward then? One way of tackling this problem could be making corporations pay a premium for money and at the same time finding ways to increase liquidity in the system.

The purpose of writing this letter is to flag certain issues. I am sure you'll find ways to address them.
Wishing you all the very best,
Yours sincerely,
Tamal Bandyopadhyay