The Hindu Business Line : Not enough focus on farm front

The Report on Trend and Progress of Banking is a highly competent document. Greater attention should, however, be devoted to problems faced by banks in reaching out to poorer farmers and the conflicts arising from the crisis on the agriculture front.

S. Venkitaramanan

The RBI’s Report on the Trend and Progress of Banking in India for 2006-07 shows an impressive record of growth of lending and improvement in financial indicators of the banking system, in spite of continuing pressure on banks to increase lending to specific sectors.

This trend is partly a carry over from the days of directed lending when banks were obliged to lend certain proportion of disbursements to specific sectors and borrowers. A market-based economy cannot obviously continue with such practices. But, habits die hard.

At the outset, we must compliment the RBI and the banking system for managing to escape the impact of the US sub-prime crisis, which had hit banks in countries as varied as Singapore, France, Germany and Switzerland. The measured stance of India’s regulator has stayed away from encouraging innovation for innovation’s sake. The Indian banking system has, by and large, escaped the adverse effects of the US’ sudden infatuation with sub-prime borrowers.

Central bank independence

Turning to Government’s intervention in banking matters, of late, this pressure has increased, especially with the Finance Minister nudging banks to reduce interest rates. This is contrary to the recognised practice, which leaves interest rates to the central bank’s guidance. But, by and large, one must be thankful that the direction of the Government policy has been on central bank independence accompanied by increased emphasis on improving governance, prudential regulation and technical progress in respect of computerisation in banks.

The Report on Trend and Progress of Banking has incorporated a volume of data on various aspects of banks’ performance. Important financial indicators of the performance of Scheduled Commercial Banks have been brought out clearly in the report.

A tell-tale Table shows that the cost of deposits rose from 4.1 per cent in 2005-06 to 4.5 per cent in 2006-07, reflecting higher interest rate regime.

Similarly, the cost of overall borrowing rose from 3 per cent to 3.5 per cent. As a result, the cost of funds, in general, rose, albeit marginally, from 4 per cent to 4.4 per cent. The return on funds, including advances and investments, rose from 7.4 per cent to 7.7 per cent. The overall result has been that the spread was at 3.3 per cent. The banks have had great difficulty in managing their operations profitably.

Movement in NPAs

One of the measures on the efficiency of performance of banks is movement in non-performing assets. NPAs, as at the end of March 2006, for SCBs, as a whole, as a percentage of gross advances, came to 2.5 per cent.

Public sector banks have a slightly higher figure of 2.7 per cent and private sector banks a still higher 3.1 per cent, while the new private sector banks, however, had a figure of 1.9 per cent. Table 1 compares the non-performing experience across various countries.

It shows that the Asian financial crisis years of 1997-98 had generally led to an increase in non-performing loans in developing countries. Similar crises led to increase of NPLs in developed countries such as Japan. It is creditable that India has been able to reduce this NPL substantially compared to the experience of other countries in the region.

Table 2 describes the distribution of non-performing loans among different groups of banks.

Reduction in NPLs

The figures show a gradual reduction in the percentage of NPL for all categories of banks. Public sector banks have also performed well, as expected, given their social priority. Old private sector banks have not been markedly more efficient than public sector banks.

New private sector banks, however, concentrating as they do on corporate account and higher net-worth individuals, have shown a better performance in regard to this ratio.

Foreign banks are mostly in the metropolitan areas and have basically refrained from stretching out to small borrowers and rural lending. This is reflected correspondingly in their lower NPL ratio.

The Report discusses various methods of managing a financial crisis arising from increase in non-performing loans. It discusses the solutions of setting up Asset Management or Reconstruction Companies, which help banks offload their non-performing loans. Korea has been a pioneer in this regard. India has also acquired rich experience by setting up Asset Reconstruction Company of India Ltd (ARCL).

The Report rightly points out that the rise of NPLs ultimately leads to a pressure on the fisc of the concerned countries since the burden of NPAs is borne by the Government in cases where banks fail.

This was the experience in the exemplar of asset reconstruction companies, the Resolution Trust Corporation of America, set up to solve the problem of loan losses arising from the failure of Savings and Loans Associations. The losses were in the region of hundreds of billions of dollars.

Capital adequacy ratio

The capital adequacy ratio of various banks, which represents risks at the adjusted capital ratio to the risk-weighted adjusted assets, has improved considerably in the post-reform years (Table 3).

Further improvement depends on the progress of ratios in the private sector market and the Government’s decision to enable private sector participation in PSBs. It goes without saying that when profitability increases, banks can add to their capital out of their own resources.

Generally, the Report points to the need for improvement in human relations and better training of bank personnel. This is unexceptional.

But, so long as the PSBs continue to be governed by different rules and procedures, they cannot be expected to match the flexibility of private sector banks. Whether the RBI will follow policies that enable foreign entities to increase their share in PSBs is not discussed in the Report.

As usual, the latest Report on Trend and Progress of Banking is a highly competent document.

One, however, notes that there greater attention should be devoted to problems faced by banks in reaching out to poorer farmers and the conflicts arising from the crisis on the farming front. The measures so far taken have not addressed the issue adequately.