Tamal Bandyopadhyay: Reinventing Nabard

For the past eight months now, over 5,000 employees of the National Bank of Agriculture and Rural Development (Nabard) are observing work-to-rule, demanding pay parity with the Reserve Bank of India (RBI) employees.

This means that all Nabard employees, including its senior executives, stop work when the clock strikes five in the evening "" signally the end of office hours.

Nabard's net profit or "operational surplus", as it is technically known, is likely to be sharply down in 2004-05 from 2003-04. All this can well indicate that all is not well with the over-two-decade old institution that was carved out of the RBI in 1982, right?

Wrong. Possibly for the first time in its history, the sleepy apex agency for rural lending in the country is waking up to reality and getting its act together.

Nabard was set up to provide refinance for agriculture credit, inspect cooperative and regional rural banks (RRBs) and assist rural development. But supervisory powers without regulatory authority are meaningless.

So, its inspection of cooperative banks has not been able to stem the rot in the sector which is largely controlled by politicians.

To add to its woes, with the advent of a low-interest-rate regime, commercial banks have stopped taking refinance from Nabard. So, Nabard has done what it should have much earlier.

It has cut the refinance rate as well as short-term loan rates and allowed banks to reset interest rates. The net result: Nabard has taken a hit of Rs 314 crore on its profitability. The main beneficiaries of these decisions are the cooperative banks and RRBs.

Nabard has cut refinance rates drastically by over 50 per cent. From 12.5 to 13 per cent, the refinance rate has been reduced to 5 to 5.5 per cent. Banks have been encouraged to pre-pay their high-cost refinance from Nabard and replace it with new loans "" which is half as expensive.

The total amount of high cost loan pre-paid by cooperative banks and RRBs to Nabard last year was Rs 3,693 crore. Following this, Nabard's annual interest income has dropped by Rs 185 crore. It will continue to impact its income in the coming years.

Then, it also reset the loan rates for those banks that could not pay the high interest rates. The new rate for loans, in this case, is 8 per cent "" down from over 12 per cent. In this case, too, cooperative banks are the main beneficiaries.

At least 13 banks availed of the new rate for loans worth Rs 3,375 crore. The impact on Nabard's interest income? Nabard took a hit of Rs 67 crore.

These are all long-term investment credit. Nabard also disburses short-term crop loans. Here too, the apex body has cut the loan rates.

These loans are granted to banks from its general line of credit from the RBI which costs Nabard 6 per cent. It has on-lent the money at 5.25 per cent, earning a negative spread of 75 basis points (one basis point is one hundredth of a percentage point). In this case, the hit was Rs 62.25 crore.

Thus, the total loss on earnings for Nabard in 2004-05 was Rs 314 crore. No wonder, its balance-sheet has been affected. But this is a small price to pay to gain control over the cooperative sector.

How has that happened? While resetting the loan rates, Nabard has forced the cooperative banks to sign a memorandum of understanding (MoU) with it on their performance.

In other words, if these banks fail to achieve the targets outlined in the MoU on various parameters, Nabard can pull them up. This is significant considering the sad state of affairs in the cooperative banking sector. For the first time, Nabard has got a handle to tackle this sector known for its inefficiency and political interference.

The cooperative credit structure in the country consists of primary agriculture credit societies (PACS), district central cooperative banks (DCCBs) and state cooperative banks (SCBs).

Collectively, these banks account for 67 per cent of the rural credit outlets. Despite a meagre 6 per cent share in the deposits of the banking system, they account for 44 per cent of the total rural credit flow.

They contribute a lion's share to the flow and stock of rural credit, particularly in crop loans, investment (term) loans for agriculture and allied activities, loans for the handloom and non-farm sector.

The precondition for the refinance facility is the cooperative sector's commitment to continue to play a qualitative and quantitative role in the flow of agriculture credit. In the recent years, however, the share of cooperative banks in credit flow has been on the decline.

The total erosion in the value of assets of six SCBs and 141 DCCBs aggregated Rs 8,649.77 crore as on September 30, 2004, including erosion in deposits to the tune of Rs 3,241.37 crore.

Nine DCCBs have ended up eroding their total deposit base, while for 17 DCCBs, the level of erosion for deposits has been between 50 and 100 per cent.

Look at some more facts about the state of affairs of cooperative banks. One SCB and as many as 19 DCCBs have not been complying with the minimum capital requirement stipulated in Section 11(1) of the Banking Regulation Act for over 10 years; four SCBs and 85 DCCBs between five and 10 years and two SCBs and 18 DCCBs for three to five years.

On account of these reasons and poor recycling of funds, the share of cooperatives in the issue of rural credit is dropping.

The gross non-performing assets (NPAs) of SCBs have increased from 12.73 per cent as on March 31, 2001 to 18.08 per cent as on March 31, 2003. During this period, NPAs of DCCBs have increased from 18.26 to 21.64 per cent.

Even though commercial banks "" led by ICICI Bank and a few others "" have aggressively been making forays into rural lendings, the cooperative banking sector is the mainstay of the agricultural loan superstructure.

Caught in the crossfire of dual control (the state governments and the RBI) and run by inefficient boards, this sector of the banking industry is a time bomb waiting to be explode.

At this juncture, Nabard's carrot and stick approach ("take cheap money but sign an MoU on performance") could play a crucial role in turning around cooperative banks. The RBI had played a similar role in the mid-1990s when it forced commercial banks to clean up their balance sheets.

The government did infuse dollops of recapitalisation funds to protect the balance sheets of commercial banks but as a pre-condition to the fund infusion, the banking sector regulator brought all these banks to the discussion table and signed a series of MoU with their CEOs setting up performance parameters.

The annual exercise of performance evaluation process continued for a few years, until commercial banks cleaned up their balance sheets.

With the United Progressive Alliance-led government's emphasis on "timely and adequate agriculture credit", Nabard chairperson Ranjana Kumar must seize the opportunity to clean up the cooperative banking sector. Cheaper refinance is not the only carrot that Kumar is offering to the cooperative banking sector. She has also started giving them freedom on agriculture loan sanctions.

For instance, cooperative banks as well as RRBs normally follow the "scales of finance" approach "" historically prescribed without using any discretion and ignoring the ground realities, such as the quality of land or method of cultivation or even the status of the labour (hired or family labour).

Kumar replaced this system by introducing a "range" offering discretion to the branch managers sanctioning these loans. She has also made it clear that these managers should not be hounded by the investigative agencies and using discretion will not be construed as an "audit irregularity".

This is fine. At the same time, Nabard should hold the stick firmly if the government is serious about reforming the cooperative sector.

Cheaper refinance and recapitalisation funds (which the government is planning to pump in) alone will not revive the cooperative banking sector. The repositioning of Nabard and revival of cooperative banks are inseparable.