The Hindu Business Line : Trend and Progress of Banking in India 2005-05

The RBI's latest Report on Trend and Progress of Banking in India describes, with greater clarity than its previous editions, the achievements and weaknesses in the banking system. Ranging from non-food credit and parameters such as the credit-GDP ratio, and agricultural lending, to the policy on NBFCs, the Report testifies to the significant advances made by the financial system in its twin objectives of stability and growth, says S. Venkitaramanan.

THE Reserve Bank of India's Report on Trend and Progress of Banking in India 2004-05, released recently, represents a considerable improvement over its predecessors in terms of clarity and comparability of figures with international experience. It is a tribute to the skill-set of those involved in its preparation that it has become established as a standard of reference in banking circles. It deals with various issues professionally, on both the achievements and weaknesses in the system.

The report discloses what is already well known — that credit has been registering a robust growth. Non-food credit expanded during the year by nearly 27.5 per cent. Priority sector credit increased almost 31 per cent. Industrial credit (medium and large) went up 17 per cent, while housing loans grew 44 per cent. The most significant jump was in real estate loans, which rose by 90 per cent.

The deployment of credit needs more particular attention inasmuch as export credit, an important segment, grew only 17 per cent. Agriculture itself accounts for a credit flow of Rs 1,22,870 crore, an increase of 35 per cent over the previous year, a sharp step-up with reference to an increase of only 23 per cent in 2003-04.

Small-scale industries, however, accounted for a credit flow of only Rs 76,000 crore, up 15 per cent over 2003-04, compared to 9 per cent the previous year. The flow of credit to small-scale industries has increased, but is still not adequate.

While the report is, in general, self-congratulatory on the progress in meeting credit targets to most sectors, it has a revealing chart, which shows the distance it has still to travel.

The chart, showing the credit-GDP ratio in different countries, shows that the ratio is as high as 250 per cent in the US and 150 per cent in the UK. In China, it is also high, nearly 150 per cent. Even in Thailand, it is nearer 75 per cent. In India, it is around 40 per cent.

Only Philippines and Brazil are lower than India. India has a lot of catching up to do, if it is to use credit as a tool of economic growth, as have the US, the UK, China and even Thailand.

While the RBI is right to stress the stability and safety aspects of its management of the banking system, it has also to focus on reasons why the credit-GDP ratio is significantly low in India, as compared to developed countries, such as the US, and even developing countries, such as Thailand and China. The structural bottlenecks in credit expansion seem to be sticky and deserve to be analysed and tackled holistically.

Subject to this general caveat, the observations in the Report on Trend and Progress of Banking deserve to be studied carefully. The report indicates that the RBI has commissioned a number of Task Forces on improvement of credit flows. The reports of the Task Forces have been received. We eagerly look forward to action taken on them.

Of particular significance is the action taken on the Task Force to improve credit flows to small industries, especially in the light of the package announced by the Finance Minister. The need for a sharper thrust on credit to small and medium industries is obvious. How far the RBI is successful in implementing the various recommendations made in this regard will determine the rate of growth of this vital sector.

Turning to credit flows to agriculture, the report points out that the banking system has been able to reach the ambitious targets laid down by Government in 2004 to double credit to agriculture over the years. The expansion of credit to agriculture has been on track to reach this target. The report mentions actions taken on the report of Prof S. Vyas on agriculture credit.

This includes the preparation of Special Agricultural Credit Plans (SACPs) by banks in the public and the private sectors. The implementation of these plans is being monitored. Action taken in this regard includes waiver of margins/security requirements for loans up to Rs 50,000 and in the case of agri-business and agri-clinics up to Rs.5 lakhs.

It was also decided to continue the National Agricultural Insurance Scheme in its present form for 2005-06. Proactive steps taken in this regard need to be supplemented by monitoring of tendencies to weak lending practices.

In spite of the rapid expansion of credit flows, there has been a steady improvement in the soundness indicators of the banking system. The level of NPAs, both in gross and net terms, has declined. The capital adequacy ratio has improved steadily.

One significant statistic cited by the report is that the non-performing loans-to-capital ratio, which stood at 71 per cent in March 1999, has fallen to 22.8 per cent in March 2004, and further to 15.5 per cent in March 2005. These are significant successes.

The report gives comparative data to judge the performance of the Indian banking system against global peers.

The report refers to what is called the funding-volatility ratio, which determines the soundness of the banking system from the perspective of its balance sheet. The lower the ratio, the better the banks' liquidity.

Globally, the funding volatility has varied in the range of (-) 0.71 and 0.11. India's ratio has been in the range of (-) 0.11 to (-) 0.23. This compares favourably with the global indicators.

Another interesting comparative static, which the report presents, is regarding return on assets. The return on assets for Indian banks was 1.1 per cent in 2004. It declined to 0.9 per cent in March 2005. In other emerging markets, the figure ranges between 0.9 in Korea to 1.8 per cent in Brazil. Developed countries, like the US, however, showed a return of 1.4 per cent, and the UK 0.6 per cent. China's figures are not given.

The NPA-to-assets ratio also shows India in a good light (see Table 1). We have to strive hard to reach the levels attained in developed countries.

The variation of NPA ratios between different bank groups shows the possibility of improvement. While for scheduled commercial banks as a whole the gross NPA/gross advance was 5.2 per cent, it was 5.8 per cent for nationalised banks, 6 per cent for old private sector banks and 2.8 per cent for foreign banks. The scope for improvement in public sector banks is clear, although they have their own special characteristics.

The capital adequacy ratios of the banking system compare well with those of emerging market economies (see Table 2).

The figures for Canada seem to need some explanation. The report does not make any reference to China. The Basel II norms will be more restrictive. Already, American lawmakers are up in arms against the restrictive implications of Basel lI, which may need more capital for the same amount of assets. We have still to have any such reaction — possibly for want of information about the likely impact of the Basel II regime.

The report offers a ray of hope to NBFCs in terms of its comments that the Reserve Bank of India is examining the issues involved in financing of NBFCs by banks so that the bankers are able to use the core competencies of NBFCs to extend their reach.

The revised policy relating to access of external commercial borrowing by NBFCs with approval of the RBI to finance infrastructure projects is expected to invite increased participation of NBFCs in infrastructure financing by easing the resource enrolment. One hopes for a more liberal approach to NBFCs being financed by banks in general even in regard to domestic lending.

The fact is that India has advanced substantially in respect of banking in the last decade or so. However, when we compare ourselves with China, we find ourselves lacking in some respects. We need to expand the depth and penetration of our banks, albeit with an eye on safety and prudential norms.

Overall, the report is a well-crafted document indicating directions for further improvement in the financial structure. It is a credible progress report testifying to the significant advances made by India's financial system in its twin objectives of financial stability and growth.

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