That demand and supply drive pricing and supply shifts to better paying markets is conventional wisdom. But this is not how it has played out for banking services.

Travelling through rural Bihar, I come across a bright young man who wants to set up a rice mill. He is a graduate, has earmarked land for the mill, uses a laptop and has a ready business plan and prospective buyers. There is no bank in his village, but there are two in the Block, commercial and co operative.

Both branch managers expect a bribe, which our young entrepreneur considers to be an inevitable cost. His choice is not based on service quality or product offering, but simply on the quantum and manner of the bribe.

What makes the story truly sad is that there is nothing new about it. But juxtapose this with complaints of urban bankers on decreasing NIMs (net interest margins) and rate wars and you are scratching the surface of the problem. That demand and supply drive pricing and supply shifts to better paying markets is conventional wisdom. But this is not how it has played out for banking services. The policy response is to increase supply through licensing of more banks.

It is obvious from the speech of the Finance Minister, the Discussion Paper and the Draft Guidelines and it is laudable intent. It is worth deliberating a bit on the nature of economic growth in India and the challenges for banks while realising this grand vision.

There is no denying the growth — whether captured through GDP numbers or latent in the potential of young, aspiring Indians. Unfortunately, unequal growth has given us a small billionaires’ club, a handful of urban centres and a sea of humanity living on the tattered edges of subsistence.

The new wealth is, more often than not, the result of crony capitalism, deriving from proximity to power and crass exploitation of resources. Most financial institutions, bound by strict regulations, accountable to demanding shareholders, weary of reputational risk and often riding high on the jingoism of environmental and social responsibility, find it hard to negotiate this space and are left with a narrow choice of clients.

It is true that the high growth of the last few years, driven by services sector growth and expanding salaried class, has afforded banks the opportunity to grow profitably through simple intermediation. But the nature of that growth may be changing in the decades ahead and expansion of banking services to a more ‘entrepreneurial’ population may be a different challenge. Indeed, it is very likely that the real population dividend will not play out as much in the BPOs (already facing competition from other low-cost economies and protectionist West) as in the vast hinterland markets that are in the shadow zone of regulation and taxation — providing basic food, clothes, private education, private healthcare (abortions and organ transplants for a price), construction material (to feed perennial construction of shabby houses), transportation (the ubiquitous overcrowded minivans), and the like. Add to this the ecosystem around state-sponsored roads, bridges, new capital cities and mines.

The problem about bank finance is that it brings the entire revenue model from the shadow zone into the broad daylight. Unfortunately, banks cannot ignore these issues and dealing with them imposes additional cost and distorts the risk-reward trade-off.

In an ironic twist, policymakers glory in the idea of clean financial institutions, but resist the idea of institutionalising and opening up the economy to global capital and systems that might improve governance quality and transparency. It is not being suggested that global companies are more ethical, but it is in their own interest to have formal and transparent governance.

To disassociate the two issues is to forget the crucial fact that finance can grease the economic machine; but if the engine is dysfunctional and parts not connected to each other, the grease alone cannot make it work.

(The author is Director, PricewaterhouseCoopers. The views expressed are personal.)

(This article was published on November 23, 2012)
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