The Hindu Business Line : No logic in shackling NBFCs

So long as the performance of Non-Banking Finance Companies is within the guidelines laid down by the RBI and their capital adequacy and lending operations are in order, no purpose is served by a ceiling on lending by banks to NBFCs. Indeed, this would amount to subverting priority lending, says S.VENKITARAMANAN.

Trend and Progress of Banking in India 2006-07

The annual publication on "Trend and Progress of Banking in India for the year 2006-07" has appeared. It is on expected lines and contains, as usual, a wealth of information. Most of the information included in it has already been dealt with, albeit in a summarised fashion in the Macroeconomic Review that accompanied Governor Y.V. Reddy's monetary policy statement issued on October 31.

As a matter of comparison, the latest report differs when read side by side with the predecessor report for 2004-05. I refer, in particular, to the comparative statement between various countries, especially in relation to the ratio of credit to GDP, figures for which were released in the previous year's publication.

It would help if the trend towards such transparency in international comparisons is continued. I searched in vain for similar figures in the latest report. Maybe the latest figures reflect a worsening place in the global league tables and, hence, have not been presented!

The disbursement of credit to various sectors of the economy has already been discussed in the monetary policy statement and the accompanying documents. There is little to add to the debate on this. The latest report stresses the progress made in respect of regulatory requirements and other aspects.

In respect of non-performing assets, the trend of improvement has been maintained. As at the end of March 2006, the net NPAs as percentage of total assets of all scheduled commercial banks stood at 0.7 per cent, compared to 1.8 per cent in 2003. In terms of gross NPAs, the percentage was 1.9 per cent, compared to 4.1 per cent in 2003, the difference being the amounts provided for. The relative distribution of NPAs in respect of public sector banks, private sector banks and foreign banks is shown in the Table.

Considering that the foreign banks are concentrating their activities in relatively well-developed metros and technologically advanced centres, their lower ratio of NPA can be very well explained.

Public sector banks have a high ratio of gross NPAs to assets, but old private sector banks fared no better It is only the new private sector banks that have performed best in regard to the lowering of NPAs with respect to assets. Their relatively better human resources and high IT capabilities may explain part of the difference.

Profit Numbers

The RBI Report on Trend and Progress of Banking 2005-06 gives comparative data on net profits as a percentage of assets. This information shows that for scheduled commercial banks as a whole, the ratio of net profits to assets declined from 1.13 per cent in 2003-04 to 0.88 per cent in 2005-06, although operating expenses decreased from 2.21 per cent to 2.11 per cent. Wage bill decreased from 1.34 per cent of assets to 1.20 per cent. The change in net profits is explained mainly by the changes in provisions and contingencies and interest margins.

So far as different groups of banks are concerned, the public sector banks, profits of which stood at 1.12 per cent in 2003-04 and 0.82 per cent in 2005-06, were more or less of the same pattern as scheduled commercial banks in general. The wages as a proportion of total assets in respect of public sector banks declined from 1.54 per cent to 1.36 per cent in the same period.

Old private sector banks had a poor showing in respect of net profits as a percentage of assets decreasing from 1.2 per cent to 0.59 per cent in the same period.

New private sector banks, however, showed an increase in the same period from 0.83 per cent to 0.97 per cent. The wage bill for the last category ranged around 0.5 per cent — due mainly to computerisation.

The ambivalent attitude of the RBI to credit growth was commented on in the last article in this column "Blowing Hot and Cold" (November 27). Nothing describes this better than the attitude towards NBFCs disclosed in the latest report as well as the recent instructions issued contemporaneously on exposure of banks to NBFCs.

The central bank needs to change its love-hate relationship with the NBFCs. While it recognises NBFCs as useful adjuncts to the regular banking system in view of their efficiency, spread and cost advantages, it seeks, at the same time, to restrict their access to banking finance. A strange stance indeed!

Arbitrary Limits

The latest instructions dated November 3, 2006, are worth examining in this regard. They prescribe that the total exposure of banks to NBFCs be restricted to 40 per cent of the bank's net worth.

A detailed reading of the task force report leading to the issue of these extremely arbitrary limits does not disclose any special logic for the imposition of a drastic overall limit of 40 per cent of net worth.

After all, the lending by NBFCs is mainly for creation of assets, especially employment-generating assets such as trucks and buses. While these are part of priority sector advances and on-lending by banks to NBFCs for such purposes is recognised as part of the priority sector — requiring adequate capital on the part of NBFCs — it does not seem reasonable to impose a restriction of 40 per cent of banks' net-worth on lending for NBFCs for the priority sector.

Either the RBI wants to encourage priority sector lending through NBFCs or it does not. The apex bank's attitude in imposing such specific caps on lending by banks to NBFCs, which it supervises in detail, is indeed arbitrary.

It should instead declare its positive attitude towards encouraging NBFCs, which are, after all, performing an admittedly useful role in disbursing priority sector loans.

NBFCs, which lend moneys for hire-purchase transactions, are recognised as an efficient part of our financial structure. The RBI should facilitate their functioning, rather than discourage them. By all means, put restrictions on their capital market exposures except when the exposure is a legitimate activity in the sense that it is investment in the NBFCs' own subsidiaries.

The RBI has to recognise that even micro-finance institutions, which it encourages, are also a type of NBFCs — they are only more dispersed and less supervised than formal NBFCs.

There cannot be, on the one hand, an exhortation to banks to increase lending to priority sector and, at the same time, a severe restriction on banks' exposure to on-lending to NBFCs.

As long as NBFCs are supervised by RBI in respect of their capital adequacy and their lending operations, there does not seem to be any logic for creating obstacles in the sense of an overall limit on lending by banks to NBFCs.

That would amount to RBI effectively subverting priority lending through NBFCs. Surely, that is not the intention of RBI.

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