The Hindu Business Line : Report on Trend and Progress in Banking 2002-2003 — Revitalising banking through radical reform

One significant feature of the financial performance of banks in India during the year 2002-03 was the contribution of "trading" profits. Normally, banks make money on the margin between their cost of raising resources and the interest income received on their loans.

But in 2002-03, the treasury income — arising from trading in securities - became a prime source of profits because of the decline in interest rates and consequent rise in bond prices. The banks turned some of their gilt-edged assets to profits.

Profits from the sale of securities for scheduled commercial banks went up by 39 per cent in the year 2002-03 compared to the preceding year. And 51 banks recorded increases in trading profits during the year.

Trading profits accounted for about 7.7 per cent of the total income of banks and about 33 per cent of their operating profits during the year. During the previous two years, the ratio of trading profits to operating profits was lower, varying between 3.5 per cent and 16 per cent, rising to 32 per cent in 2001-02.

The share of trading profits varied across bank groups. Old private sector banks depended heavily on trading profits at over 50 per cent of operating profits both in 2001-02 and 2002-03.

Foreign banks, surprisingly, registered a decline in such profits, contributing only 13.5 per cent of operating profits. SBI group was, however, noted for its lower share of such profits in the total stream.

But many banks, for various reasons, did not do so well from trading, with 16 banks not recording any trading profit. The banking system, as a whole, however, gained from trading profits.

The proportion of non-performing assets (NPAs) went down in 2002-03. As a percentage of the total assets, NPAs declined in 2002-03 reflecting the salutary impact of earlier measures taken for reduction of NPAs as well as the introduction of the SARFAESI Act. (It is another matter that the Supreme Court is currently hearing petitions on the legality of this Act).

Non-performing loans, as a percentage of total assets, declined for public sector banks from 14 per cent in 1999-2000 to 9.4 per cent in 2002-03. The distribution of NPAs (gross as well as net) across various groups has shown the following pattern of change.

It is also significant that NPA recoveries in 2002-03 have additions, implying that incremental NPAs, both in gross and net terms, have turned negative. The largest decline has been in the State Bank group.

The robustness of the Indian banking system has definitely been enhanced, thanks to the careful stewardship of the RBI.

While the overall health of banks is improving, a few salient points need reiteration. The RBI and the Government should come to an agreement on the question of a unified regulator and auditor for cooperatives.

Divided suzerainty, like diarchy, cannot work. Cooperatives use the loopholes provided by such division of authority for escaping the scrutiny of regulators.

Second, it is time to give a decent burial to the tokenism of schemes like the Differential Interest Rate (DRI), under which a small sum of Rs 300 crore in 4 lakh accounts countrywide is being distributed at 4 per cent. Far more important is it to ensure that what is given at normal rates of interest goes to the borrower in quick time and without any non-official costs.

Third, the question of lending for small and medium enterprises requires careful attention.

In this context, the case of State Finance Corporations (SFCs) has to be reviewed. SFCs have tended to be ignored in the passion for reform and concentration on core banking.

State governments should be persuaded to clear the Augean stables of their SFCs and, if necessary, convert them into banks on the lines of ICICI. At the moment, they are looked after by Sidbi and managed, or mismanaged, by various State governments. Their working needs to be overhauled.

The fiction of the Rural Infrastructure Development Fund (RIDF), which enabled "defaulters" in priority lending — those who had under-performed — to salve their conscience by contributing funds to Nabard has to be changed.

If banks do not perform the obligation in respect of priority sector, they should be mandated to do their job. The easy option of RIDF has meant large funds being placed at the disposal of Nabard, which has not been able to disburse the amounts for suitable schemes to State governments. The scheme deserves a review.

The capital adequacy ratio — the holy grail of modern bank reform — has also improved in respect of all the bank groups, with 26 banks having a CRAR level in excess of 10 per cent.

For PSBs as a whole, the CRAR as at the end of March 2003 stood higher than 12.64 per cent compared to 11.76 per cent as at the end of March 2002. This is a significant achievement. The report concentrates attention on the need to continue improvement in risk management, adoption of technology and supervision. While it forms a comprehensive review of actions taken by the RBI on these aspects during the year, it is still a bit reticent about grading individual banks on its scale of performance measurement.

If the report could incorporate a benchmarking effort, banks will be motivated to improve their performance on various dimensions.

On the question of further reforms, the report touches on the setting up of the Asset Reconstruction Company (ARC). It is not clear when and how the ARC will become active.

Similarly, a number of legal reforms are still on the anvil and, hopefully, Parliament will find it possible to devote time to these Bills in the midst of its poll fever.

The weak spots in our financial system are in rural finance. The report refers to a number of initiatives taken in this regard. But it has still to address the grave weaknesses in the cooperative system — particularly the rural cooperative structure.

The institution of Nabard was expected to play a role in activating the rural cooperatives. It has not worked out exactly in the way it was visualised. A Committee under the Chairmanship of Minister of State, Mr Geela has looked into various related issues.

One hopes that Governor Reddy will devote special attention to strengthening the rural banking sector — including cooperative RRBs and micro-finance.

The solution lies in a multi-dimensional approach, particularly the depoliticisation of the cooperative sector. The long-forgotten recommendations of the Rural Credit Enquiry Committee report may need to be revisited. So too, the Khusro Committee of the 1980s.

The report has a detailed technical discussion on the new Basel norms regarding the measurement of operational risk. There has been considerable discussion in the international banking community as to the desirability of accepting the new norms recommended by the Basel II Committee.

When the accord is finally implemented, it should not prove counter-productive. Reduction of risk is alright, but reform should not lead to imposition of standards which our banking system will find difficult to implement.

It is worth the while subjecting the new Basel norms to a stress test — in simulated conditions of actual local bank operations.

Working bankers must get a chance to examine the various implications of the new Procrustean bed being introduced by the Basel II reformers.

The report covers the operations of non-banking finance companies (NBFCs) in greater detail than usual. Obviously, it reflects the realisation that NBFCs do perform an important role in the Indian financial system.

There is a revealing comparison of the regulatory scheme for NBFCs and banks. The RBI needs to come to terms with the fact that NBFCs do perform an important role in increasing the spread of financial intermediation. Globally, companies such as GE (Capital) and GMFC are instances of successful NBFCs which play an important role, even in developed economies.

The RBI should look at the problems faced by NBFCs sympathetically, especially in regard to tax treatment and access to the Financial Securitisation and Asset Reconstruction Act. Easier credit recoveries by NBFCs will help tone up the health of the whole financial system.

On the whole, the report narrates a good story of progress achieved and an agenda of reform. Much of the action has to be taken by individual banks. They need to be motivated by reward and punishment.

Hopefully, the RBI's latest report will form an important step in the process of revitalisation of Indian banking, which is now poised to shed its negative image as a loser and become a consumer-friendly institution. Here is hoping that the agenda of radical reform gets a real push with the new leadership of the central bank.

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