The Hindu Business Line : Banking system has entered the woods

`In the next three years, some of the banks will find it hard to land business which then could cut into profits. I do not want to sound scary but a few private and public sector banks will drop out by 2008 if the Government and the RBI do not act now.'

THE Centre's diktat to hold its stake in nationalised banks at 51 per cent could hurt the viability of the banking system as banking entities have been disabled from raising public funds.

Some banks have equity space allowing for a re-entry into equity markets while others such as Dena Bank do not have any. Bankers are aware that an in-house working group in Reserve Bank of India is studying the impasse, which could stall the process of falling in line with Basel II norms. Banks can raise preference share capital but under Basel II this money cannot be accounted for as Tier- I capital, comprising equity and free reserves.

Banks today indulge in cross-holding to raise Tier-II capital through bonds and other instruments, with fresh funds from the markets left untapped. There is some talk of allowing banks to float two-year papers for Tier-III capital though these monies can only be used to cover market risks under Basel II, say bankers.

Tier-II and Tier-III capital put together should not exceed Tier-I or base capital and some believe the solution may not really help. The RBI is aware of the problem as at one stage the former RBI Governor, Dr Bimal Jalan, had estimated fresh capital requirements of government banks at over Rs 10,000 crore. This estimate could only be higher today as there are a few old private banks, which are on the edge. The government's decision comes at a time when at least some parts of the banking system are turning sick again.

Punjab and Sind Bank needs fresh capital of Rs 600 crore while everyone seems to have forgotten the case of IFCI. This institution deserves to die and the quicker it happens the better as any rescue effort will hurt the fortunes of the good Samaritan. Privately, no banker wants to be spotted discussing IFCI, which was run down by government nominees.

The Centre has promised budgetary support for Punjab and Sind Bank. A rights issue with government picking up its portion can help Dena Bank, but seemingly the government is in no mood to help. If that is so, Dena Bank will have to live on the profits it makes from loaning.

Some bankers wonder whether the bad days are back again with government bailing out banks with taxpayers' money? Their fear is not misplaced as many thought a tough RBI Governor and Government directors including those from the Finance Ministry will not allow a Punjab and Sind Bank to happen. Yet, it has come to pass.

"In another three years, at least half of the government banks will face problems with the government refusing to accept mergers or a second VRS to reduce staff," confided a banker. It is there for all to see and if one is not naming banks it is because no Chairman will accept the idea that his bank will fall out of the marathon. At least for half of them even primitive banking technology is alien and they nurse a labour force which cannot be taught any tricks. Publicly, Government officials have said the Indian banking system has turned strong.

In the coming years, the best of corporate accounts will migrate from the many to a few, with the weak banks left holding bad accounts to turn redder. It has started happening with accounts being snatched by competitive dropping of lending rates. Some bankers did gather to form a cartel to prevent a hara-kiri in lending rates, but that did not work.

"In the next three years, some of the banks will find it hard to land business which then could cut into profits. I do not want to sound scary, but a few private and public sector banks will drop out by 2008 if the Government and the RBI do not act now," another banker confided.

He added, "Having accepted the play of markets, there is no way the inefficient can survive." And one is not talking of the urban co-op and rural co-op banks, which are in the worst possible shape. There is none to help them except public funds appropriated from the budget.

Can the rural credit delivery system stand the backwash of a few strong banks qualifying for Basel II? The banking system seems to have just entered the woods.

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