The Hindu Business Line : `Banking sector stronger than ever before'

Thirteen years after reforms were introduced, the banking sector is stronger than ever before, said Professor T.T. Ram Mohan, IIM-Ahmedabad. He was delivering the first Tarakeswar Chakraborti endowment lecture, "Bank Reforms in India - Charting a unique course", sponsored by the All India Bank Employees Association and the University of Madras at Chennai this evening.

Professor Ram Mohan pointed out that within five to seven years after deregulation elsewhere in the world, the banking system experiences a crisis and there is a widespread failure of banks. Banks that had been privatised would have had to be re-nationalised or sold to foreigners. The cost of cleaning up the banking system ranged from 5 per cent to 35 per cent of GDP with setbacks to economic growth.

Deregulation normally caused spreads to narrow and brought banks profitability under pressure. Attempts to shore up profits led banks to risky lending and ultimate collapse. Drawing attention to the fact that this had not happened here, Professor Ram Mohan listed the factors that he said ensured that Indian banks didn't go through the same sequence.

First and most importantly, he said, pre-emptive recapitalisation in India helped bolster bank balance sheets before reforms were set in motion.

Second, public confidence in government-owned banks relative to capital markets meant that deposits did not exit the banking system and therefore spreads were not under any pressure.

Third, the risk averseness of government-owned enterprises, while a shortcoming in other business, was not such a bad thing in banking.

Fourth, stringent regulations on two assets that commonly lead to downfall - namely stocks and real estate ensured that there were no mishaps.

Fifth, the measured approach to capital account convertibility, helped. A hasty approach had proved the undoing of many a banking system.

Sixth, the investment in retail branches in an earlier era turned out to be a big source of strength for public sector banks providing them access to low-cost deposits, a key source of competitive advantage.

The combination of these factors was what made the Indian experience unique and kept the recapitalisation cost in India at just about 1 per cent of GDP, the lowest that any country had incurred on this issue.

Urging labour unions to face new challenges, Professor Ram Mohan asked them to take responsibility for superior customer service. Mentioning the need for improvement in compensation levels, he asked them to move away from industry-wide wage settlements and help individual banks set higher levels depending on their capacity to pay.