By M. N. Minocha
In the first flush of enthusiasm of introducing banking sector reforms in the1990s, our policy- makers were obsessed with implementing Basel norms and internalizing international best practices.
This mindless implementation of Basel norms and practices led to several distortions in policy which later proved to be harmful to the economy. Against this background, it is refreshing to find that Reserve Bank of India (RBI) is now making a plea for focusing on India- specific issues, notwithstanding global considerations. The Report on Trend and Progress of Banking in India, 2010- 11 (TPBR), released in December 2011 puts it successfully: The surmise, therefore, is that Indian banks should increase their global presence. In the rapidly changing global financial landscape, it is imperative for the Indian banks to think global but act local! This change in the stance of banking policy was long overdue and welcome.
Among the more conspicuous distortions that resulted from the mindless adoption of Basel norms, two may be highlighted here: Inequitable interest rate structure and disenfranchisement of small borrowers. The interest rate structure which emerged from the implementation of Basel norms was designed to pamper the private corporate sector, and which was biased against agricultural and small borrowers generally. For instance, a small farmer was made to pay an interest rate of 12 per cent at a time when a highly rated corporate entity could raise money from banks at 6 per cent. The RBI realized this later and admitted openly that in this interest rate structure there was cross subsidization of economically well- off borrowers by the economically poor borrowers. RBI appointed a Working Group in April 2008 to look into this issue. As a result of the recommendations of this Working Group, banks switched over to the Base Rate System with effect from July 1, 2010. Thus it took two decades for the RBI to correct the distortion. Meanwhile, the small borrowers, particularly small farmers, were “exploited” by the interest rate regime. Perhaps the unkindest cut of the Basel bank culture induced by- product was the disenfranchisement of small farmers.
“Lean operations” required that banks should shed borrowal accounts. There was a dramatic decline in the number of small borrowal accounts with credit limits of Rs. 25,000; their number which had risen to 62.55 million in March 1992 dipped to only 36.87 million by March 2003. The credit outstanding of this category of accounts which formed nearly 22 per cent of total outstanding credit in 1992 plunged to only 5.2 per cent in 2003. Public sector banks (PSBs) were trying to boost their profits by economies of exclusion. Contrast this with the obsessive concern of today’s policy- makers – both the Government and RBI – with financial inclusion. It is against this background that the change in the banking policy stance, as articulated in the RBI’s TPB Report needs to be appreciated. First, about the strength of the Indian banking system. The banking system emerged largely unscathed from the global financial crisis of 2007- 08. Despite the challenging headwinds from international developments, the performance of Indian banks remained robust in 2010- 11. The resilience of the banking system was marketed by improvement in the capital base, asset quality and profitability. Indian banks are adequately prepared for migration to Basel III regime. Quick assessments show that at the aggregate level Indian banks will not have any difficulty to adjusting to the new capital rules both in terms of quantum and quality. Thus Indian banks are comfortably placed in terms of compliance with the higher capital requirements. In regard to asset quality, both gross and net NPA (Non- Performing Asset) ratios declined in 2010- 11, from the previous year’s level. Gross NPAs have been steadily declining from 15.7 per cent in 1997 to 2.25 per cent in 2011, but this does not reveal the underlying realities. Gross NPA ratio rose from 1.81 per cent in 2008 to 2.21 per cent in 2010. The Report exhorts banks to step up their efforts to resolve the existing NPAs.
The profitability of banks improved both in terms of return on assets (RoA) and return on equity (RoE). Further, the banking system has registered an impressive improvement in productivity over the last 15 years and many of the productivity/ efficiency indicators have moved closer to the global levels. The change in the banking policy stance is clearly reflected in the following statements: “The banking sector is a key driver of inclusive growth”. The most significant task of the Indian banking sector is to ensure that banking products and services are made available to every individual in the country efficiently to achieve total financial inclusion. In the next decade the major challenge before banks is financing of the millions in the unorganized sector, self- employed in the micro and small business sector, the small and marginal farmers as also rural sharecroppers in the agricultural sector. Other challenges include financing affordable housing and education needs of low income households. It is good that RBI has spelt out in clear terms the future agenda for public sector banks. Even now there are some PSBs who grumble that “no- frills accounts” are acting as a drag on their profits and that the government should subsidise them. Such bankers should now get ready to obey the mandate of RBI. In the medium term, expected positive economic performance, strong savings growth spurred by the favourable demographic dividend, emphasis on expansion of physical infrastructure and the extent of financial exclusion to be bridged – all these factors will pave the way for healthy growth of the banking system. In the Basel bank culture inspired euphoria some Indian policy- makers had delusions of grandeur. Indian banks should grow to a size “too big to fail”. The global financial crisis of 2008 exploded this myth about the size. RBI now takes a balanced view it is unlikely that any of the Indian banks will come in the top ten of the global league even after reasonable consolidation. Indian banks should look inwards rather than outwards, focusing their efforts on deeper financial penetration. The latest Financial Stability Report (issue No. 4) released by the RBI in December 2011 endorses this assessment of the strength of the Indian banking system.
“Indian banks remain robust, notwithstanding a decline in CRAR and spurt in a NPA levels in the recent past. Increased capital needs and liquidity requirements under Basel III will need to be carefully phased in”. The tragedy of banking sector reforms in the post – 1990s phase has been that policy- markers tried to mimic western banking, particularly, American banking models. This led to the kind of distortions discussed above. A redeeming feature of the reform scenario is RBI’s introspection and transparency. INAV
It has admitted openly the mistakes committed and set out to correct distortions. The interest rate structure is a case in point. RBI’s call for total financial inclusion articulated forcefully in this Report, one hopes, will spur all PSBS to achieve the goal.