Tamal Bandyopadhyay: Friday blues for banks

takes a close look at the banking system's obsession with balance sheet growth, which leads to "evergreening" in the last fortnight of every financial year.

What do commercial banks in India and the film industry have in common? Fridays are crucial for both industries. All Indian films are released on Fridays, just ahead of the weekend. Commercial banks, too, release the data on banking businesses "" growth in credit, deposits, investments and so on "" on Fridays. However, this is not done on a weekly basis. Banks are required to furnish the data on every alternate Friday, called reporting Fridays.

The system is as old as the Reserve Bank of India (RBI), which was born in April 1935. The RBI Act stipulates that banks must furnish these data every fortnight and Friday is an ideal day for this since the global financial markets take Saturdays and Sundays off. Under Section 42 of the RBI Act, banks are required to present the picture of their net demand and time liabilities (NDTL) to the banking regulator. They also need to keep a certain percentage of their NDTL as cash balance with the RBI in the form of cash reserve ratio (CRR).

At present the CRR is pegged at 5 per cent of banks NDTL. With the recent amendment to the RBI Act, the 3 per cent floor for CRR has been abolished. This means, the RBI can push it down to zero and take it up to any level it wants, depending on the stance of the monetary policy. With the amendment to the Act, the regulator has also stopped paying interest on the CRR. Going by the Act, on any given day, banks are required to keep CRR with the RBI on at least 70 per cent of their NDTL and on the reporting fortnight, there is no choice but to keep CRR on their entire NDTL. However, there have been instances of banks fudging the NDTL figures to lower their cash reserve requirement. Once they are caught by the RBI inspectors, they get penalised.

A Mumbai-based large public sector bank has recently been penalised for not keeping CRR on its foreign liabilities within the NDTL. Only inter-bank liabilities "" money raised from the overnight call money market "" have been excluded from the NDTL. This means banks need to show all other liabilities, including deposits raised by their foreign offices and NDTL, and keep CRR on them.

While the RBI periodically catches banks for depressing NDTL and keeping lesser amount of cash balance with the regulator, it does not do anything when banks swell their deposit mobilisation and credit disbursements to unrealistic levels on the last reporting Friday of any financial year (see chart). This distorts the entire growth story of the banking system.

Take a look at the RBI's weekly statistics supplement (WSS). Since the beginning of the 2006-06 fiscal year until the week ending May 26, the deposit mobilisation of the Indian banking system was Rs 27,214 crore, the lowest ever seen in the first two months of a financial year. However, this does not give the correct picture as the last reporting Friday of the last year was on March 31, while on other years the last reporting Fridays fell anywhere between March 18 and March 22 or so. This means, the annual deposit and credit figures of the banking system do not always catch the real story. If the reporting Friday falls on the last day of March, the figures get inflated, and if they fall in the third week of March, the last few days' credit and deposit growth get credited to the next financial year's account.

This is precisely what has happened this year, which had 27 reporting fortnights instead of the usual 26 reporting fortnights. With the last reporting Friday falling on March 31, last year's credit and deposit numbers got inflated and the growth since the beginning of this year looked thin. These numbers compare poorly with previous years as on those years, part of deposit and credit growth came from the past few days of the previous year with the reporting Friday falling much ahead of the year end.

In the last fortnight of 2005-06, the banking system mopped up Rs 1,02,500 crore deposits "" more than one-fourth of the total deposit mobilisation of the entire year! In the previous year, the system's deposit mop-up in the last fortnight (which ended on April 1) was Rs 84,937 crore.

The root of this practice of the Indian banking system for raising deposits and disbursing credit in the past few days of any financial year is the bankers' obsession for the balance sheet growth. Over 66,000 branches of scheduled commercial banks are given yearly business targets and as the year-end approaches, the branch managers step up their aggressiveness to fulfil these targets. They even disburse loans to their corporate customers in the last fortnight which come back in the form of deposits to the banks' kitty immediately. This way, both credit and deposits book swell up. In banking parlance, this is "evergreening". Instead of focussing on the balance sheet growth, banks must develop on obsession for healthy return on assets and return on equity. This will help the system immensely.