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“Role of banks has drifted away from core objectives”

Special Correspondent

There has been reduction in advances to working capital: former RBI Governor

ENLIGHTENING: Y. V. Reddy, former RBI Governor, answering a question from audience after delivering the S. Guhan Memorial Lecture in Chennai on Thursday. N. L. Raja and Tara Murali, trustees, Citizen Consumer and Civic Action Group, are in the picture.— Photo : R. Ravindran

CHENNAI: A banking system that serves India’s needs is imperative at this stage of the country’s development in a scenario where advances from banks towards working capital, agriculture and small businesses are shrinking, former RBI Governor Y. V. Reddy said on Thursday.

Delivering the fourth S. Guhan memorial lecture hosted by the Citizen Consumer and Civic Action Group (CAG), Mr. Reddy pointed out that the role of banks had drifted away from the core objectives of conducting traditional retail banking that facilitate economic growth.

Even with over a quarter of their asset base earmarked for government securities, banks were encouraged to participate in bond markets, establish private equity and also invest in mutual funds. As a result, there is a reduction in advances to working capital and other funding to sectors such as agriculture and SMEs, he said.

“There is broad agreement about the strength and resilience of banks in India…. However, in my view, we have to assess whether there is a hollowness in the provision of banking services in our country,” he said.

Mr. Reddy proposed a policy that would put back the emphasis on lending directly to real sector activities and would curb the “financialisation” of funds that depositors placed in the banks.

According to Mr. Reddy, the global financial crisis had raised uncertainty over what the ideal model for the financial sector was. Pointing to the various contentions – that India was saved only because of conservative policy, of proceeding with measures in place or carrying forward reforms with certain amendments – he called for understanding on the fact that the “lessons we are in the process of learning are of a fundamental nature and not merely incremental.’

The financial system had to be assessed with reference to some of the fundamental factors that had been flagged in global debates as being critical to the efficiency and stability of the financial sectors, Mr. Reddy said.

He pointed out that India had a reasonably balanced macro management system with no excessive current account surplus or deficit or dependence on exports or external demand though on the flip side the economy was vulnerable to shocks on the fuel, food, fiscal and external finance fronts.

India’s monetary policy was by and large sound as it had addressed the objectives of growth, price stability and financial stability and the regime of multiplicity in indicators, objectives and instruments had gained global acceptance, he said.

Mr. Reddy suggested a detailed study on the inter-linkages between some mutual funds and Non-Banking Finance Companies with corporates or banks, the actual operations in concert with each other and in the equity and corporate bond markets. This, he felt, would bring in reassurance that serious conflicts of interests with systemic consequences were not pervasive. While ruling out evidence on excessive financialisation in the absence of large scale derivatives or structured products, Mr. Reddy advocated eternal vigilance, which was the price to be paid for stability. He also saw merit in a detailed analysis of commercial banks lending to profit-seeking micro-finance institutions, which “were growing too rapidly and making too much profits for comfort.”

CAG Trustees N. L. Raja and Tara Murali also spoke.

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