The Hindu Business Line : Time for ‘financial social contract’

As Rousseau said, ordinary voters and democratic politicians have a social contract by which politicians are given political power in return for providing good governance. Likewise, I suggest bankers honour a financial social contract with their depositors, says P.V. INDIRESAN.

Open letter to the Governor, Reserve Bank of India

With this letter I would like to interest you in an extension of the idea of social contract. As propounded by the French philosopher Rousseau, ordinary voters and democratic politicians have a social contract by which politicians are given political power in return for providing good governance. Likewise, I suggest bankers honour a financial Social Contract with their depositors.

Strictly speaking, in the economic form of social contract, capitalists acquire the savings of depositors in return for a promise to maximise their income. Banks function only as intermediaries by lending to capitalists in such a way the welfare of depositors gets maximised. I suggest, for your consideration, that you will maximise the interest of your depositors only when you maximise not total income, but the disposable income after deducting the cost of housing and travel-to-work. This is important because these costs vary widely from place to place. In other words, you diminish the welfare of depositors when your lending policy forces them to reside where dwelling and commuting costs are high.

Focus on disparity

I urge you also to consider another extension to your Corporate Social Responsibility as a banker. Along with most economists, you probably accept the idea that some increase in disparity must be accepted as collateral damage for rapid growth. Conceding there is truth in that surmise, I want you to ponder whether the disparity we are witnessing in our country is within manageable limits and whether the extent of disparity we have currently is prudent from a banking perspective.

For instance, suicides among farmers has once again become painful news. It is no secret that in nearly a third of our districts, a parallel government operates to which all businesses (including banks) have to pay protection money. In the long run, are not these instabilities a danger to the entire banking system that has been entrusted to you? Should you not take adequate steps to minimise these disparities and, thereby, place our banking system on a sounder footing? You can argue with considerable force that checking disparities is not a banker’s problem. Even then, I urge you to pause a little and ponder how far financial prudence can be separated from social unrest. Please consider how safe your banks will be if social and political unrest spreads the way it is doing. Please consider what costs have been added by the unrest (fortunately contained) in Singur.

Does Nandigram have a lesson or not for prudent bankers? Can you build an island of banks excluding all restless areas? Curiously, investment is resisted most where there has been little of it before. Have banks a responsibility to educate poorer areas, make them receptive to corporate investment?

I put it to you that as matters stand, mitigating the growing disparity cannot be left entirely to the government; others too should pitch in. For instance, it is the government’s responsibility to protect bank premises. Yet, every bank branch, without exception, engages private guards for the purpose. Likewise, even though it is primarily the government’s responsibility to mitigate disparities, considering the way unrest is spreading, should you not, in this case too, take your own steps to mitigate the problem? Has not that become necessary to protect your banking system?

Towards under-banked areas

When you start thinking of disparity, you will naturally notice that social and political unrest is linked to economic disparity and that economic disparity is highly correlated with disparity in credit per capita. There are already a number of government-sponsored schemes for providing specialised credit in backward areas. Unfortunately, those programmes are inadequate for the simple reason social and political unrest is increasing, not decreasing.

I am not asking you to re-allocate credit to less creditworthy people (the way Government forces banks to do) merely because they reside in distressed areas. I merely urge that even as you continue to patronise established and well-reputed creditors, you nudge them a little towards under-banked areas and a little distance away from over-banked ones. At the start, selected under-banked areas need not necessarily be infested ones.

As a matter of prudence, you may start with less banked areas on the periphery of disturbed areas rather than right in the middle of them. You may not go even that far; you may simply nudge investors a little distance away from over-banked areas. Even such a small step will be a move in the right direction.

You can argue with some truth that you will be doing precisely the same by supporting special economic zones (SEZs) You are right but only partially: SEZs are gated communities; they are not designed for inclusive growth. It is for you to ponder which will be better: to be forced to accept schemes devised later on by the government for inclusive development or to anticipate such a demand and make your own plans.

In this respect, my suggestion is this: Why don’t you charge higher interest in areas where house rents are higher than the national average? If you were to do so, your investors will be forced to move to areas (invariably outside large over-banked cities) to under-banked smaller towns and rural areas. It is true that such a shift is happening already but not fast enough. If you stick to reputed creditors, and yet spread credit geographically, the desired shift will happen faster and safely too.

Incidentally, real-estate speculators make super profits in high-rent areas. By raising interest rates in such places, banks will merely be claiming their due share. That is undoubtedly fair; it is also a penalty that real-estate speculators deserve.

Impose ‘polluter pays’ principle

You may complain that this proposal will hurt the economy by slowing down growth. In nominal terms of money that will appear so; in real terms, you will almost definitely profit more. The reason is simple: Wherever rents are high, the purchasing power of the rupee is low. Hence, when you lend money in high-rent areas, you are lending in places where purchasing power is low and is decreasing. When you move away, your money will go where purchasing power is higher.

You may argue that investors know best where to invest. That is true but only partially. Investors are concentrating on high-rent areas because they are not charged for the negative externalities they generate, for the social/economic/environmental costs of urban congestion and of the daily commute to work. Bankers have it in their power to impose the principle “polluter pays”. Is it not their duty to exercise that power? By failing to do so, are not your bankers failing in their obligations to society?

Sir, you need not accept any of my suggestions but please give some thought to the question whether or not you are inviting trouble by condoning disparity in credit dispersal (which is already worse than 25:1 between urban and rural areas). Consider too whether it is not your Corporate Social Responsibility or an essential part of your Social Contract to reform banking practices in such a manner that credit dispersal is fairer and less distorting and incidentally improves the bottom line too?

Here is an issue nobody wants to discuss. That is why I am writing an open letter in the hope that it will start a public debate.

(The author is a former Director, IIT Madras. Response may be sent to Indiresan@gmail.com)

This is 214th in the Vision 2020 series. The previous article was published on November 12.

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