Tamal Bandyopadhyay: The banking agenda

Our City Editor sets out some priorities for the finance minister

P Chidambaram

Dear Mr Chidambaram,
Public sector bankers are reticent by nature. But last month, after meeting you in Mumbai, they were unusually animated. In particular, they were excited by your assurances that the pace of financial sector reforms would not slacken. I am sure you will live up to their expectations today when you present the United Progressive Alliance's maiden Budget.

The objective of writing this open letter is not to tell you what to do in the Budget. I would not dare to do that since the memory of your dream Budget on February 28, 1997, is still fresh in public memory.

The BSE Sensex soared 262 points on that day on unprecedented tax cuts and the promise to rein in the fiscal deficit at 5 per cent of GDP. I would merely like to dwell on some key issues in the financial sector that urgently need your attention.

In 1996, banks prevailed on the government to insulate them from the additional burden of financing agriculture after much concern that it would be forced to double the flow of credit to agriculture and agro-based industries over the next five years as mentioned in the United Front's common economic programme.

While presenting the Budget then, you entrusted the responsibility of implementing the new measures for raising the credit level to agriculture on the Reserve Bank of India (RBI) and the National Bank for Agriculture and Rural Development. In fact, the Centre promised to fork out Rs 800 crore on a new scheme called the accelerated irrigation benefit programme.

This time, however, bankers are not so lucky. You want them to raise their lending to the farm sector by 30 per cent in 2004-05. Frankly, there is nothing wrong with this directive because this is one sector that has continuously been neglected by the banking industry.

When big corporations looked elsewhere for funds, the bankers took the easy way out by chasing zero-risk sovereign paper and the urban middle class for retail loans. You must, by all means, take steps to ensure credit flow to agriculture.

However, there is one caveat: let the banks decide the interest rate. After all, most of the public sector banks are listed entities today and they are answerable to their shareholders.

Please do not follow the footsteps of former Finance Minister Jaswant Singh who occasionally told banks at what rate they should extend loans to farmers.

Talking about the rates, over the past three years the RBI and the finance ministry have been working in tandem to reduce 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 Singh followed it up in 2003 with another 100 basis points cut. And each time, the finance minister's gesture was reciprocated by the RBI governor.

Last year, within hours of the Budget, the RBI cut the repurchase or repo rate as well as savings bank rate by 50 basis points each to 5 and 3.5 per cent respectively.

Corporate India lapped up these rate cuts because it helped them reduce their cost of borrowings. The banking sector also thrived on the rate cuts because they propped up their treasury income manifold as bond prices soared. The only loser in the entire rate cut game was possibly the common man.

With global rates firming up, the situation has changed. Perhaps it is time to take another look at the interest rate conundrum. In particular, the savings community should not be forced to bear the brunt of falling interest rates.

You played a major role in opening up the health insurance business ahead of the life and general insurance sectors. You were also instrumental in setting up the Infrastructure Development Finance Corporation (IDFC) and local area banks (LABs). Unfortunately, neither of these experiments worked well.

The IDFC has not done much for infrastructure financing. As far as the LABs are concerned, the objective was to mobilise rural savings and make them available for investment in the local areas.

It was hoped that these banks provided competition to the regional rural banks (RRBs), cooperative banks and even public sector banks. But even seven years later, only five LABs have been set up and they are too small to provide competition to any other bank.

It's also time to take a closer look at both the RRBs and the cooperative banks. The government, at the instance of the RBI, did try to bring the cooperative banks on par with the commercial banks by amending the Banking Regulation Act.

But the move was stalled in the face of stiff resistance from some political parties. It is true that the cooperative banks are a different kettle of fish and need to be treated differently.

But they should not be allowed to become a political cesspool. Cooperative banks can certainly play a stellar role in changing the face of rural India, provided they are run professionally and not as political fiefdoms.

You had opened up the health insurance sector in 1996. Now, you could consider a wider foreign participation in the life and general insurance businesses. Capping foreign investment at 26 per cent is out of sync with the rest of the financial sector.

While foreign entities can hold up to 74 per cent in a bank, shouldn't the foreign stake in the insurance sector be raised to at least 49 per cent?

The sector has grown remarkably and the private players who set up shop in December, 2000, have already acquired 15 per cent of the market share in life insurance.

Raising the foreign stake in the insurance sector will help the sector's growth because foreign entities can pump in the fresh capital that is needed to grow the business.

You could also take forward the government's stated intention of bringing down its stake in public sector banks. India is a unique market where the government has not privatised the state-run banking sector but made the banks raise money from the public and get themselves listed.

At the same time, it allowed private banks to set up shop to infuse competition and offer choices to consumers. The net result of this is a robust banking system that can withstand external shocks.

In 2001, Sinha had said that the government would cut its stake in state-run banks to 33 per cent. That has not been done yet. Ditto for the cap on voting rights.

First, Sinha had hinted at freeing the voting rights. Then, last year Singh said: "The voting rights of any person holding shares of a banking company are restricted to 10 per cent irrespective of his/her shareholding. The Banking Regulation Act, 1949, will be amended to remove this limitation."

With the RBI proposing to cap promoters' investment in banks at 10 per cent, the voting rights issue has possibly become irrelevant now. This is because if one is not allowed the hold more than 10 per cent stake in a bank, one's voting right cannot exceed the present limit of 10 per cent.

What is more, the RBI also wants to restrict private and foreign banks' stake in private banks at up to 5 per cent. The objective behind the move is to ensure stability of the financial sector on which the health of the real sector is dependent.

But the point to note is that a diverse and broad-based shareholding pattern does not necessarily guarantee corporate governance. Indeed, there have been instances where a broker has taken over a bank or an over-adventurous entrepreneur has mortgaged the bank to the market, though these are rare instances.

Finally, a few words about the managerial freedom of public sector banks. Former Finance Minister Sinha had dismantled the Banking Service Recruitment Board three years ago. But the change was a token one.

In reality, little has changed. Banks are allowed to recruit from the market only in select areas like infotech and marketing and so on. Ironically, the public sector bank CEOs who hire these professionals from the market get possibly one-third of the salary of these new recruits!

How can you expect a bank chief earning Rs 40,000 a month to handle assets over Rs 4 lakh crore? Please give the bank boards freedom to pay market-related packages to the CEOs.

Make the top executives' performance incentive linked. This will infuse a greater degree of professionalism in the Indian state-run banking industry.

Waiting for another dream Budget,
Yours sincerely,
Tamal Bandyopadhyay