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Wednesday, Feb 18, 2004

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Banking sector reform: Skewed dividends

Pinaki Chakraborty

THE last RBI report on `Trend and Progress of Banking in India' (2002-03) indicated that the return on assets of all scheduled commercial banks (SCBs) — the ratio of net profit to total assets — showed a marked improvement to 1 per cent in 2002-03, the highest in the last six years.

The positive effect of reforms seems to have been felt not only in the increase in profit but also in the reduction in non-performing assets (NPAs) and increase in the capital adequacy ratio of banks.

The decline in the ratio of NPAs to advances was attributed to the improved risk management practices and greater recovery efforts, driven by the recently-enacted Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.

The turnaround in the macroeconomic environment has contributed to the sustained increase in the credit flow to the commercial sector as well as investment in government securities this fiscal.

As mentioned, the capital level of the banking sector also improved significantly, with the capital adequacy of SCBs rising from 10.4 per cent to 12.6 per cent between 1997 and 2003.

In absolute terms, the overall NPAs of the banking sector declined by over Rs 2003 crore at end March 2003.

The net NPAs to net advances of public sector banks (PSBs) declined from 5.8 per cent to 4.5 per cent between 2001-02 and 2002-03 — a reduction of 1.3 percentage points, which is much higher than that of private and foreign banks (Table 1).

However, there are still wide disparities in the performance across bank groups. In other words, all the banks groups have not been benefited equally by the reform.

The Statistical Tables Relating to Banks in India, which provides detailed earnings and expenditure profile of banks, categorises SCBs into five major groups — State Bank of India and associates, nationalised banks, regional rural banks, foreign banks and other scheduled commercial banks.

If we compare the bank groups' specific earnings to expenditure ratios (EE ratio), except for the regional rural banks, this ratio increased across groups between 2002 and 2003 (Table 2).

However, the increase in this ratio differs across bank groups, reflecting their differential performances.

Though the increase in the group EE ratio was highest for the foreign banks, from 1.37 to 1.45, for the nationalised banks, the increase was from 1.22 to 1.30 — an 0.08 percentage point jump, similar to that of the increase of foreign banks.

The most spectacular number was the profit growth for nationalised banks, at 60.33 per cent, while the same was as low as 21.15 per cent for foreign banks (Table 2).

However, the NPAs of rural banks continued to be high, with the asset quality of the lower tier being relatively worse than the higher tier. Their growth of profit also remained as low as 0.82 per cent during this period.

Another noteworthy change in the expenditure profile of the nationalised banks is the decline in the share of salary expenditure in total operating expenses from 72.43 to 70.44 per cent between 2002 and 2003.

In foreign banks, the salary expenditure is significantly lower than that of other bank groups, which naturally gives them leeway for other expenditures related to maintenance for better banking services. This is reflected in high maintenance expenditure at more than 5 per cent of the operating expenses for foreign banks.

The share of this category of expenditure is significantly lower in the other groups. Salary continues to be more than 85 per cent of the operating expenses in the regional rural banks.

Despite the PSBs' staff rationalisation programmes, their salary expenditure continues to be high and will remain so in the medium term because of expenses that need to be incurred on VRS and other benefit schemes associated with staff rationalisation.

However, it would be unjust to attribute a lower EE ratio to nationalised banks compared to foreign banks due to the high operating expenses arising out of their wage bills.

There are several reasons for the differences in the EE ratios of both nationalised and foreign banks, both on the expenditure and receipts side.

The major expenditure-side edge foreign banks have over wages and salaries is the technology-intensive banking operations and lower NPAs.

On the receipts side, the advantage stems from their higher forex income, principally due to forward exchange contracts and better asset quality vis--vis pubic sector banks.

But there has been a recent turnaround in all these indicators where nationalised banks are doing exceedingly well, as has been reported in the improvement in the EE ratio and the profit growth of nationalised banks.

Forex income has been quite buoyant for the foreign bank groups, primarily due to the forward exchange contract, while PSBs also have shown substantial increase in forex income in the last two years.

For PSBs, the net interest income as a percentage of total assets increased from 2.73 per cent to 2.91 per cent between 2001-02 and 2002-03.

Also, the operating expenses as a percentage of total assets declined from 2.29 per cent to 2.25 per cent when the same had increased both for private and foreign banks (Table 1).

However, within a regulated environment, the nature of the banking business in India since bank nationalisation was not guided only by the criteria of profit-making. It had larger social commitments through directed credit programmes and SLR-based investment in government securities at below market rates of interest to finance much needed public sector expenditure in various social and economic services.

Financial liberalisation, however, relaxed some of these norms. And the recent improvement in the financial performance of public sector banks indicates that their financial viability will improve with better monitoring and management.

The scope for further improvement in the banking sector appears to be bright if the macroeconomic environment remains favourable. However, the divergence in financial performance across bank groups and within groups remains a source of concern. There is need to examine these differences and their rectification is important for the improvement of services across all banking groups, which cater to the needs of clients from various socio-economic strata.

In this context, the financial viability of regional rural banks assumes critical importance.

The benchmarking of norms and guidelines for further reform in the banking sector must focus on the most vulnerable banking groups ranked in terms of performance differentials.

While outlining norms for PSBs, their performance needs to be judged keeping in mind the larger objective of banking, apart from profit-making by the banks.

(The author is Senior Economist, National Institute of Public Finance and Policy, New Delhi. E-mail:

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