The Hindu : Business : Message from the RBI report

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Monday, Dec 13, 2004

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Message from the RBI report

Banks will have to go back to their basic business of lending to boost their profits. That unassailable conclusion of the recent RBI report on banking was one of the core items discussed at a recent seminar arranged by the RBI.

THE RESERVE Bank of India Report on Trends and Progress of Banking in India, 2003-04, places the major issues of contemporary Indian banking in proper perspective. The report was released on November 29. The RBI conducted a two day seminar for its top officials in Chennai on December 4 and 5 essentially to familiarise them with the report. Speakers from outside, including the Chairman and Managing Director of Indian Bank, M. B. N. Rao, the CEO of the Citigroup in India, Sanjay Nayar, and the Banking Ombudsman for Tamil Nadu, S. Gopalakrishnan, participated in a round table at the concluding session.

The RBI's Executive Director in charge of banking, Usha Thorat, outlined the main topics on which subsequent discussions were based: first, regulatory and other inputs that would be needed by the banking system to sustain, if not enhance, the GDP growth rate, projected at between 6 and 6.5 per cent for the current year; second, how far globalisation has impacted Indian commercial banks; third, are consumers better off today compared to the early 1990s, the start of reform; fourth, how can one ensure financial integrity in the changed circumstances; fifth, corporate governance issues in the liberalisation era.

Of special significance this year is the fact that commercial banks, especially public sector banks, can no longer reap windfall incomes from treasury operations. As interest rates declined to historic lows, their valuation of securities (considerably in excess of statutory requirements) went up. Now that interest rates are on the rise, banks may even have to take a hit on their securities holdings. It is in this context that the RBI report makes the point that an increasing proportion of banks' income will have to emanate from the traditional business of lending. Though hardly a novel suggestion, this is still profound in today's context.

The reform era has unleashed the forces of disintermediation. In proportionate terms (though not in an absolute sense) banks were expected to earn less from their basic activity of deposit taking and lending. Fee income (from non-fund based activities) was expected to increase even as interest income (the spread between cost of deposits and lending rates) decreased. The reform period naturally saw banks enter areas hitherto forbidden or unfamiliar. The period has also seen the advent of universal banking under which banks, spearheaded by ICICI Bank, aim to become financial super markets, undertaking varied functions such as insurance and investment banking besides the more traditional ones under one roof.

Focus returns to lending

The fact that lending is emphasised today as a means of boosting profitability has its own story to tell. While non-traditional activities have become important have not been able to displace the more traditional functions in boosting banks' balance sheets. More to the point, the opportunity to earn large treasury incomes arose in a falling interest rate regime. Banks were holding securities far in excess of what was required. While that resulted in a bonanza, the excess holding of securities by itself is not a welcome development as it indicates that banks continue to be risk averse. In the end, it is a question of credit delivery and not just credit availability.

The RBI report has laid great stress on credit delivery especially to the SME (small and medium enterprise) segment and agriculture. All the bankers who spoke at the seminar felt that lending to SMEs is already a high growth business and holds great potential. Yet from the public sector standpoint there are nagging questions as to how they can overcome their "credit shyness'' and "fear psychosis'' and lend vigorously to this sector and agriculture.

These are, however, issues that concern the public sector as a whole not just the banks. For consumers, the picture, nearly a decade and a half into reforms, is on the whole bright .The reform process has moved forward. The banking system is vibrant. Consumers have a choice.

In fact competition is the most significant outcome of the reform process. Since the mid-1990s a new class of banks — the new generation private banks — was licensed. Occupying a middle slot between foreign banks and PSBs, these banks have provided the much-needed competition to the more established categories. The above points and many others were discussed at length in the workshop.

No doubt the organisers would have achieved their objectives of familiarising their top executives with an important RBI annual publication that is also relied upon extensively by many outside.

C. R. L. Narasimhan

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