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Banks asked to improve non-interest income

By Our Special Correspondent

MUMBAI NOV. 17. The Reserve Bank of India today stated that the recent increase in profits of scheduled commercial banks emanates from trading incomes and warned banks against lapsing into a state of complacency due to high profitability emerging from gilt (Government of India securities) trading.

"An analysis of the sources of profitability for the scheduled commercial banks in India shows that much of the recent increase in profits emanates from trading incomes, reflecting the sustained softening of interest rates,'' the RBI stated in its Report on Trend and Progress of Banking in India, 2002-03. Bank balance sheets are, thus, getting linked to the interest rate environment.

"To the extent bank stock valuations are being driven by the expectations of trading profits, a new linkage is being forged between debt and equity markets. It is in this context that the RBI has been emphasising that high profitability emerging from gilt trading should not lull banks into a state of complacency,'' the RBI added. It also noted that banks are holding gilts well above the statutory requirements.

A major structural rigidity in Indian context relates to the cost of credit, the RBI said. The cost of credit is gradually emerging as a key determinant in investment decisions. The RBI has followed a soft interest rate policy stance in recent years.

"While interest rates in the money markets and the yields in government securities markets have been coming down in response to the monetary policy initiatives, the pass through to the credit markets is still not strong,'' the RBI felt.

Emphasising that the primary business of banking is the creation of credit, the RBI stated, "While narrow banking (like trading in gilts) could be appropriate at times of easy liquidity, the macro-economic performance of the banking system in the long-term would hinge on their ability to fund industrial and other enterprises.''

The future profitability of public sector banks would depend on their ability to generate greater non-interest income and control operating expenses. Blue-chip clients continue to have the option to raise low-cost funds directly from domestic and international markets. The reforms-supported new environment is offering depositors and borrowers a wide range of opportunities to transact their business. "Since retail customers are fast becoming more demanding in the competitive environment, banks have to offer value-added services,'' the RBI added.

Harnessing technology to improve productivity so as to produce highly competitive types of banking and generating greater non-interest income by diversifying into non-fund based activities will be important features of the Indian banking of tomorrow.

However, the RBI admitted that, to the extent there is public ownership in banks, there are possibilities of multiple objectives of the Government as owner and the complex principal-agent relationship.

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