Banking sector set for massive transformation, says Rajan

“Will anyone in the audience lend money at an interest rate of 4 per cent to this gentleman?” Reserve Bank Governor Raghuram Rajan asked his audience here on Saturday, when a businessman wanted to know why the RBI kept the bank interest rate high while in many countries loans were as cheap as 4 per cent.

“No, nobody will,” the Governor answered himself. “Because, those depositing money in the banks expect a high interest rate.” Without the expectation of a high interest rate, people will not save and without savings there will be no investment and there will be inflation too, Rajan explained.

“As a regulatory body, we (RBI) have to be conservative; we put up bumps in the road in order to check those who are speeding fast.” Such bumps keep the financial system from heading into trouble. Like in the Chinese fable, the RBI is moving forward in the murky river stepping from one stone to another feeling each stone cautiously, Rajan said at the KP Hormis Commemorative Lecture, organised by Federal Bank. He also underscored the importance of keeping inflation under leash.

He said the banking sector was in need of more competition. This will happen soon with new institutions and new products coming. The small-finance banks and payment banks will offer competition to large banks which will be forced to adapt and cut operating costs. Competition would increase small businesses’ access to credit.

Rajan said three new structures will come into play in the market: trade receivables exchange which will tremendously help small businesses; an ‘e-mail-like’ address that will facilitate immediate transfer of funds and alliance of Internet market places and financial service firms. The new players in the market will cause a massive transformation in the existing banks which will need a new skill-set, new talent bank to stand up to the competition. All these developments will bring in massive transformation as well as huge opportunities for the banking system.

The Governor highlighted the importance of co-opting ‘Aadhar’ into the financial services sector. The Aadhar had immense possibility of being used as a collateral, particularly for student loans. “Your good name is your collateral; if you default once, you will never get a bank loan again.”

He called for professionalising public-sector bank managements and infusing the boards with new capabilities and skills. But, to attract new capabilities, the banks will have to offer decent compensation. On financial inclusion, Rajan said people should be hand-held about managing credit. Providing credit should be the last stage in the cash-savings-insurance-credit stages of financial inclusion. “First savings, then credit should be the approach,” he said.

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