Economic growth could suffer

There is enough empirical evidence to show that sustained economic growth is underpinned by a strong banking and financial system. In this context, to enable the economy to achieve 8-10 per cent GDP growth, the recent decline in domestic savings rate, particularly in financial assets, needs to be reversed.

In today’s integrated and globalised world of financial markets, savers are closely tracking returns and flock to those institutions offering competitive rates to savers. Therefore, the suggestion that banks must cut deposit and lending rates appears to be too simplistic (CRR’s relevance should not be overlooked, Business Line , September 8).

How can banks cut rates when competing instruments in the market are offering higher rates?

Let us not forget the 2004-05 experience when deposits grew by 13 per cent, credit growth was a robust 30 per cent and interest rates came under intense pressure.

The main reason interest rates have remained stable this time, even as deposits rose by 13.5 per cent in 2011-12, was because credit growth was very subdued at 17 per cent. Latest data show that all scheduled commercial banks’ (ASCB) deposits grew by 14.1 per cent year-on-year up to August 24, 2012, against 18 per cent a year ago and the RBI’s full year’s target of 16 per cent.

The persisting trend of lukewarm growth in bank deposits is a matter of concern, more so because bank deposits are getting pushed out and funds are flowing into the shadow banking system of liquid mutual funds, tax-free bonds by PSUs, etc.

TAX ADVANTAGES

In the present milieu, when banks have to compete for retail deposits with other players, it is difficult to see how they can offer rates that are out of sync with the market. Perhaps, companies offering tax-free bonds should not be allowed to unfairly crowd out the retail market.

We see no necessity of giving a tax advantage to these large infrastructure companies, as these entities have the financial strength and standing to raise funds directly from the market. Instead, banks, provident funds and pension funds could be allowed this benefit of garnering tax-free long-term funds for investing in infrastructure, which would help promote a vibrant corporate debt market and incentivise infrastructure development.

As we move into the busy season and credit demand picks up, slower deposit growth will not only add to tight liquidity but the resource crunch will also make it difficult for banks to support economic growth, going forward.

Inability to mop up adequate resources through deposits is not good for banks, and definitely not good for the economy. Banks will not be in a position to meet the credit needs of productive sectors of the economy. China, on the other hand, has been able to support its economic growth due to a robust growth in bank resources.

In our view, for GDP growth to return to the 8-9 per cent levels seen in the past, bank finance backed by robust deposit growth is necessary. Therefore, the tax advantages flowing to non-banks, which affects deposit mobilisation by banks, may be re-examined in the present context.

LEVEL PLAYING FIELD

Another issue is the need for a level playing field. Just as banks mobilise deposits from the public, other competing institutions such as insurance companies, NBFCs and mutual funds are also engaged in collecting funds at the retail level. So, it is only fair to ask that these institutions also be subject to CRR.

Interestingly, this was one of the issues considered by the Khan Committee, which then decided that domestic financial institutions such as IDBI and ICICI be allowed to become banks, and be subject to the same regulations.

By the same reasoning, institutions that perform functions similar to those of banks should also be subject to the same rules.

Today, insurance companies and large NBFCs operate regularly in the stock market and are commercial entities, so they should also share the burden of the costs imposed by pre-emptions such as CRR.

Perhaps, at least a 3 per cent CRR can be introduced for such companies, against a 4.75 per cent CRR for banks.

IMPOUNDED FUNDS

Besides the issue of level playing field, another aspect is the cost of CRR as the large sums kept idle on account of CRR earn no interest and hurt the financial health of banks.

Imposing CRR as a measure for mopping up liquidity should not be confused with payment of interest on these balances as a liquidity-infusing measure.

Banks are only asking for a fair return to be given on impounded funds to compensate them for the foregone lending opportunity. Besides, keeping funds idle affects overall production.

When capital adequacy was first proposed for NBFCs by the James Raj Study Group 1975 and the A C Shah Committee suggested prudential norms for NBFCs way back in 1992, these ideas also went against the thinking at that time.

The Narasimham Committee and the Tarapore Committee had also suggested a sharp reduction in pre-emptions such as CRR. Perhaps, it is now time to take the debate forward.

(The author is Head, Economic Research Department, State Bank of India)

COMMENT NOW