The Hindu Business Line : Banking on the future

In an overview of banking operations since Independence, especially the reform period, makes the point that past achievements pale in the face of the challenges ahead. An ombudsman, a slew of products, competitive rates and the best of technology cannot be substitutes for excellent service, innovative products and problem-solving, he says.

As independent India turns 60, banks are poised for a leap in to the future. Significantly, the international rating agency Moody’s have given the banking system a ‘stable’ rating. Commercial banking in India has a 200-year history. Three presidency banks were born in early19th century to aid and support commerce and industry. At the turn of the century some princely states and individual visionaries set up banks with local flavour, some of them joining t he international league. The Reserve Bank of India was established in1935 in the private sector but was nationalised in 1949.

With just Rs 1,019 crore of deposits and Rs 424 crore of credit, 96 banks were doing business in 1947. In the six eventful decades banks played a commendable role in promoting savings and investments, helping the nation in its march towards economic Independence. With present deposits at Rs 26,68,187 crore and credit Rs 18,95,801 crore, the growth has been highly impressive. The savings grew from 10 per cent in 1947 to 32.5 per cent now.

Social banking

By nationalising the Imperial Bank of India in 1955, the Government laid the foundation for social banking. State Bank of India began reaching out to smaller towns and nationalisation of 14 major banks in 1969 gave a boost to branch expansion. The per branch population came down from 64,000 in 1969 to 16,000 in 2007, despite a population explosion.

Launching of the lead bank scheme in 1972 heralded a planned and coordinated effort for the development of backward and rural areas. Agriculture and small industries and trade received an impetus during the 1970s and 1980s. Based on experience, the government shifted emphasis from area development to beneficiary specific schemes for employment generation and elimination of poverty. ‘Class banking’ transformed itself into ‘mass banking’.

Farm credit recorded a steady growth despite distortions such as the loan melas and periodical write-offs. Rs 500 crore of credit spread over 14 lakh accounts in 1972 improved to Rs 25,000 crore and 248 lakh accounts, in 1995. The Last decade saw the levels soar to Rs 1,72,684 crore and 290 lakh accounts.

At the other end of the spectrum, the banks have acquitted themselves admirably in handling foreign trade, investments and remittances, the burgeoning trade, capital inflows and the $215 billion strong reserves being a testimony.

Strong system

Directed lending, quantitative ceilings and regulated interest rate regime took a toll, eroding the banks’ profitability. The Narasimham committee I (‘91) and II (‘98) paved the way for deregulation of interest rates, introduction of income recognition norms, the concept of NPAs and prescription of capital adequacy, strengthening the financial system. Thanks to the reforms, the country escaped from the fallout of the South-East Asian currency crisis.

Recapitalising and reviving the sick banks cost the exchequer thousands of crore of rupees. That the current market value of the capital is much more than the cost is a matter of satisfaction. Accepting market realities and the need to raise further capital, the Government allowed dilution of stake in PSBs.

Wilful defaulters were looking to litigation as a way out to avoid repayment of loans. The prolonged and ineffective court proceedings and failure of the Board for Industrial and Financial Rehabilitation in reviving sick industries saw the creation of debt recovery tribunals, whose functioning was plagued by shortage of resources and manpower.

Enactment of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, floating of asset recovery and management companies, based on the concept of discounted sale of distressed assets and the creation of the corporate debt restructuring mechanism came to the rescue of the beleaguered banks. The recovery climate has improved. The capital adequacy ratio is at a healthy 12.4 per cent. The ROA had improved from 0.16 in 1995-96 to 0.9 in 2005-06. Gross NPAs had been reined in to a level of 3.3 from a high of 15.7 per cent, some banks even declaring net NPAs as ‘nil’.

The RBI, known for caution and conservatism, took to reforms swiftly. To avoid conflict of interest and to focus on its regulatory functions, it created the Board for Financial Supervision in 1994 and introduced the off-site monitoring and surveillance system in 1995. Responding to the rising concerns about money laundering, it tightened the ‘know your customer’ norms in 2002. Most banks are expected to be Basel-II compliant by March 2008, the foreign banks and the Indian banks with overseas presence being the first to fall in line.

Socio-economic concerns

Growing volumes saw banks flounder in the accounting, fraud prevention and customer service areas. The securities scam of 1992 was a turning point. To expose the system to healthy competition, new private banks were allowed to open shop in the 1990s, with Rs 100-crore capital and 100 per cent computerisation upfront. This had the desired effect of stirring the PSBs and their unions in to action. A little prodding from the RBI made banks introduce computerisation, albeit at snail’s pace.

As subsidised funding dried up following the reforms and commercial banks encroached into their niche space of term-lending, ICICI and IDBI scented the winds of change and opted to become universal banks, through backward mergers. Looking for new growth avenues, banks took to retail banking aggressively. Loans for housing, cars, personal needs and loans for the SME sector had grown fast. A common man’s dream to own a dwelling could become a reality. The move helped generate jobs too in the construction, automobile and services sector.

At the turn of the millennium, the Government turned its attention to the socio-economic concerns and realised that the benefits of development were not reaching the weak and poor. ‘Micro-credit’, for credit delivery through self-help groups, became the new mantra. Though four crore families have been brought under its umbrella with the help of 26 lakh SHGs, the qualitative aspects left much to be desired.

The average credit, just enough to meet the consumption needs, hardly enables a sustainable income-generating investment. Drinking water, health-care, education, storage, roads, transport and marketing do not find a place in the plan. Access to credit is important but not at a usurious rate of 24-36 per cent. There is a clear case for restructuring and better regulation of ‘micro-finance’. The proposed new legislation on money lending is expected to address this issue.

Excluded segments

Of the 8.9 crore farm households in India, 59 per cent have bank accounts. Only 51 per cent have access to formal credit, another 21 per cent managing credit from other sources. World over, governments are concerned at the progress of economic reforms at he cost of the ‘exclusion’ of large segments of vulnerable people. Aiming at 100 per cent coverage and unmindful of the pitfalls of such a statistics-oriented approach, lately, India too has embarked on ‘inclusive banking’.

A no-frills SB account is not an end but only a step in that direction. Provision of credit and other inputs is far more important. The real test also lies accomplishing the gigantic task, leveraging technology.

With the advent of core banking solutions, a customer deals with a bank and not just the branch. Anywhere-anytime banking (thro ATMs), instant money transfers (using ‘real-time gross settlement’), electronic clearing and funds transfer at point of sale have radically transformed banking, minimising paper work, frauds, delays and transit losses, and helping better cash management in business. Truncation of cheques is under implementation. Paperless and cashless society is no more a pipe dream.

Availability of hedging instruments and derivatives has made the life of market players easier. Credit derivatives are the latest to get the nod of RBI. Financial engineering is the key to ‘customer delight’.

Challenges ahead

Past achievements pale in the face of the challenges ahead. Customer orientation continues to be supreme. An ombudsman, a slew of products, competitive rates and the best of technology cannot be substitutes for excellent service, innovative products and problem-solving. It is the ‘attitude’ and not the ‘aids’ that can deliver. Competition knows only one way — to grow.

Sophisticated asset-liability and risk management will limit business losses. Market developments such as door-step banking may throw up new operational risks. Adopting best international practices in compliance and corporate governance, prudent accounting and sound legal standards would be hallmarks of efficiency and excellence in management.

A vital issue to be addressed jointly by the banks and unions is consolidation. Indian banks will be vulnerable in the treacherous international markets, where size and strength do matter.

The varying sizes and government ownership neither constitute a free market nor a level playing field. Wastage, inefficiencies and unhealthy competition are not in the best interests of a strong system.

In a service industry human resources are crucial. The Indian Banks Association and the Indian Institute of Banking and Finance should focus on empowering bank employees with knowledge, skills and the right attitude to meet the challenges of the ever-changing contours of banking.

(The author is a former Managing Director of State Bank of Mysore and is accessible at murthy@mandavilli.com)