The Hindu Business Line : Parking funds in new slots

PUBLIC SECTOR BANKS provide an excellent example of how consistent policy changes can affect institutions in fundamental ways, across the spectrum. Consider, for instance, the manner in which scheduled commercial banks (SCBs) are deploying their funds. Not too long ago, banks considered it routine to play safe and park their funds in government securities, far above the levels required under the Statutory Liquidity Ratio (SLR) norms. As a result, investments as a proportion of net time and demand liabilities — the investment-deposit ratio — climbed to a high of 42.7 per cent by April 2004, before declining a year later to 38.4 per cent. The news that the ratio has now dipped below 35 per cent reflects the paradigm shift in the investment decisions of bank managements. The goal appears to be to bring down SLR investments to the stipulated level of 25 per cent and, by that, attempt to boost earnings well above those from investments in g-secs.

The current of competition within the banking sector has generated the impulse to exploit market forces and spike earnings, a trend reflected in the adjustment in non-SLR investments. Broadly, SCBs appear to be shifting in favour of equity, and private sector equity at that. Bonds and debentures of public sector undertakings are still dominant but the trend will pick up for equity as the RBI begins to further ease up on non-SLR investment norms.

The movement away from government securities has been prompted by the fact that the yield on them is around 7.5 per cent, whereas lending to the commercial sector brings in 10 per cent or more. The systemic shift in investments is captured in the data that the RBI has provided for the investment-deposit ratio and the credit-deposit ratio, which reflect a sharp increase in the latter for the second half of 2005, a time when the demand for credit revved up. Clearly, banks are responding to market signals rather than playing safe with g-secs, as was their wont a few years ago. Just how market-savvy SCBs have become is also evident from the alacrity with which they are willing to lend to large commercial clients at sub-PLR rates and their recognition of the need to tap small and medium enterprises, many of which have been setting the equity market on fire. Credit to the sector, as a whole, has grown around 26 per cent, year-on-year for the past two years — undoubtedly, a reflection of the economic growth, but also of the positive approach of banks to cash in on the buoyancy in economic activity.

The decline in g-sec investments by SCBs follows a robust credit expansion and an attitudinal shift but there is a flip-side. Staying in tune with demands for credit from various segments, for instance the retail sector, requires familiarity with different ways of assessing the safety of investments. Laudable as the new mood of risk-taking is, putting in place strategies to deal with different market segments and, therefore, varying risk scenarios is quite another. Having entered the choppy waters of open markets and expanding horizons, public sector banks will need to learn how to chart their new course.