M. Y. Khan
THE Annual Credit and Monetary Policy statement for 2005-06 of the Governor of the Reserve Bank of India is innovative in many directions. For the first time the Policy, under `Prudential Measures', focuses on protection of depositor interest. The Policy statement states that "it is inappropriate to ignore the mandate relating to depositors interest.
Further in our country the socio-economic profile for a typical depositor who seeks safe avenues for savings deserve special attention relative to other stakeholders in the bank".
By this, banks can nominate to their their governing boards representatives of depositors, who will be fully accountable for looking after the interests of customers.
Another important step to improve the quality of banking services, particularly for small depositors and to provide full protection to other customers, is the elimination of the oftentimes unreasonably high service/user charges. Banks will have to explain the rationale of enhancement of user charges and should take the RBI's nod before enhancing or levying new charges.
In a free banking environment, surveillance of banking services vis-à-vis customer needs is to be strengthened. The intention of the RBI appears to be to strengthen the quality of purposive supervision. As such the supervision should be organised around the two purposes of systematic stability (prudential supervision), on the one hand, and customer protection (function of supervision of business) on the other.
The supervision department or the competition commission can take care of the business ethics of banks. The supervisor must ensure that banks do not take the adverse selection or the moral hazard approach and expose their deposits to high risk.
The RBI must set up a banking competition commission, similar to the US' anti-trust law, to ensure fair banking practices. The commission should monitor the structure of the service or any other charge levied by the banks on customers. New domestic and foreign banks are said to be collecting stiff service charges without explaining their rationale. This is supported by the fact that the share of `other income' has been rising, reflecting in the main the service charges.
The share of `other income' rose from 24.0 per cent in 2002-03 to 24.3 per cent in case of new private banks, and from 25.6 per cent to 31 per cent for foreign banks. In contrast, for the nationalised banks, the share of `other income' to the total is lower (Table).
The Credit Policy wants banks to raise their capital adequacy ratio to a minimum of 15 per cent especially with the slashing of the cash reserve ratio (CRR) and the statutory liquidity ratio (SLR0. A high capital ratio is the simplest and cheapest way of reducing the incidence of bank failure but its efficiency will depend on accurate valuation of bank assets and on digging out the disguised problematic loans. The RBI Credit Policy focus on mergers and amalgamation of banks, supervision of financial conglomerates, governance of private banks, setting up the board for regulations and supervision, and settlement systems are new initiatives that will go a long way to enhance the efficiency of the banking system.
However, the RBI is going to face a tough task in implementing a new policy direction, as recommended by the Twelfth Finance Commission. Now on States will have to mobilise funds directly from the market by issuing their own papers to meet the loan portion of their Plan outlay.
The central bank will have to bring co-ordination in the borrowing programmes of the States, so that the interest rate structure and liquidity of the financial system are not dislocated.
Besides, many States may have negative net worth, and such States will have to be assisted in market borrowing with much caution. However, no State should be allowed to come to the market unless it has been rated and has observed disclosure norms as applicable to listed companies. The disclosure norms can be set by the RBI.
Any entity that wants to mobilise funds from the market would have to comply with corporate governance norms, and similarly the States too must; they must also submit the proof of the same to the RBI or the Union Government.
Banks, as per the Credit Policy statement, have to go to an RBI-approved agency for credit rating. They have been advised to start internal Capital Adequacy Assessment and an Internal Rating. This should generate consciousness among banks to internalise the prudential norms and to set their systems in order. They should also monitor their systematic risks to depositors.
The restructuring of urban co-operative banks is overdue. The RBI Governor has rightly paid attention to deteriorating financial condition of these banks. Though some urban co-operative banks did put through a restructuring process, it was limited to reducing the working force, cutting wages and other benefits of employees and sale of properties. This restructuring resulted in nominal profits but has not vouchsafed healthy growth of banking activities.
Many urban co-operative banks have cut down on their banking activities also. The urban co-operative banks should be headed by expert bankers, appointed by the RBI.
The last but not the least is the declaration of RBI to bring out quarterly policy announcements.
This is a new and bold step of Governor. The Governor has exposed the RBI to assessment of its performance for four times in a year.
Every department of Union and State government should follow this RBI lead. That would surely help them in revising and re-crafting their policies and targets.
(The author is a Former Economic Advisor to SEBI.)