Future shape of banking
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Three reports view emerging trends in India with different priorities
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The most urgent need is to increase credit provision to the rural areas for both agricultural and non-agricultural areas, states the Independent Commission.
A WORRIED LOT: Bank officers in Madurai demonstrating against the Government policies on the financial sector. — Photo: K. Ganesan
INDIAN BANKING stands at the threshold of a mega change in the next five years. Many new situations as compared to the present scenario are predicted to emerge. However, participants and analysts in the industry too see the opportunities and failures in distinctively different ways. While the core area of discussion in the recent reports published on the industry relates to consolidation and foreign direct investment, "Social Banking,'' an area of concern, has got short shrift.
Three substantial reports on the banking industry have been released in the last few weeks: `India Top 20 Banks' by Standard & Poor's, a leading international rating agency, along with Crisil, the Indian arm of Standard & Poor's; `India Banking 2010: Towards a High-performing Sector' by McKinsey & Company, a leading international consulting agency; and the Interim Report of the Independent Commission on Banking and Financial Policy set up by the All-India Bank Officers' Confederation.
A thrust area
Standard & Poor's, which compares Indian and Chinese banking, prescribes risk management as a thrust area for the former. McKinsey, however, suggests different goals (and ways of achieving them) to different sets of bankers — public sector, old private, new private and foreign — while visualising different scenarios of Indian banking five years from now. The Independent Commission of Bank Officers analyses, in detail, the issues that had hampered the Indian banking system in the past and argues how the Government's recent proposals — foreign direct investment (FDI) and consolidation of public sector banks — will not ensure systemic transparency and efficiency as projected.
One has to see these reports in the light of the United Progressive Alliance (UPA) Government's priorities in the rural and agrarian sector, and the future growth of the economy as well as employment generation. These reports also focus on the emerging scenario in April 2009, when the second phase of the "Road Map for Foreign Banks' Presence in India" begins. In the second phase, the removal of limitations on the operations of the wholly owned subsidiaries and the treating of foreign banks on a par with domestic banks to the extent appropriate will be implemented after reviewing the experience with phase one (March 2005 to March 2009), and after due consultations with all stakeholders in the banking sector. While rating the country's top 20 banks (most of them are public sector banks), Standard & Poor's narrates the key challenges in the system, with priority given to "the need for banking sector consolidation.'' It expects that "rationalisation will ultimately occur among the Indian public sector banks, albeit at a moderate pace.'' At the same time, consolidation could occur between foreign banks and private sector banks, "although any sharp increase in such activity is only expected after March 2009,'' as per the guidelines for the Road Map for the presence of foreign banks.
Potential scenarios
In an interesting futuristic study, McKinsey uncovers "three potential scenarios'' that could emerge in the banking sector by 2010 (after the entry of a large number of foreign players), based on the interplay between policy and regulatory interventions and management strategies. The first is a "high performing'' scenario, where policy makers intervene only to the extent required to ensure system stability and protection of consumers' interest, and bank managements step up the drive for far-reaching change.
In the second, "evolving'' scenario, policy makers adopt a pro-market stance but are cautious on pushing reform. The share of the banking sector value added would be 4.7 per cent of GDP. And in the third scenario — stagnating — policy makers intervene to set restrictive conditions and management is unable to execute changes to deliver value to shareholders or customers. Here, the share of the banking sector value added would be only 3.3 per cent of GDP.
The evidence from many emerging market economies, particularly Latin America, shows that a greater reliance on banking FDI has given rise to conditions of: stalled overall growth in credit with domestic banks also reducing loan exposure; far greater financial instability during episodes of shock to the domestic economy; and uncertainty and slow economic growth due to foreign banks acting as conduits for transmission of contagion and strategic decisions from parent banks onto developing markets. "It is to be noted that these consequences are but an expression of the loss of economic sovereignty. We can choose to ignore these lessons only at our own peril,'' states the Independent Commission of Bank Officers.
Consolidation of banks
On consolidation of banks, especially public sector banks, the Commission says that "while the gains from consolidation are expected along greater economies of scale and scope available to bigger banks, the evidence does not support an automatic association between large size and profitability.
On the other hand, bigger banks tend to rely much more on arm's length transactions and standardised balance sheets and loan accounts, on fee based income that seek to avert credit and interest risk, and on trading risk at the securities market. These tendencies give rise to the phenomenon of financial exclusion (whereby a large segment of the population remains unbanked) at the same time that it engenders financial fragility via a greater exposure to financial markets.''
Social development aspect
While stressing the need to create a market-driven banking sector with adequate focus on social development, McKinsey proposes a strong focus on "social development by moving away from universal directed norms to an explicit incentive-driven framework by introducing credit guarantees and market subsidies to encourage leading public sector, private and foreign players to leverage technology to innovate and profitably provide banking services to lower income and rural markets.'' Standard & Poor's also makes a reference to the rural banking of public sector banks: "Although they are significant in terms of deposit gathering, the bulk of rural branches (of public sector banks) tend to be unprofitable, counter-balanced by the profitable urban and metropolitan branches.''
"The most urgent and immediate need is to increase credit provision to the rural areas for both agricultural and non-agricultural purposes,'' states the Independent Commission. "Given the option, the scheduled commercial banks would not like to operate in rural areas. This has been proved clearly since March 1995 after the disbanding of the branch licensing policy and the granting of freedom to bank boards to decide on their branch expansion programme. Since then, there has been a reduction of roughly 840 rural branches instead of an addition of at least 8,000 bank branches in rural areas under the erstwhile policy thrust. This approach has thus spawned a serious institutional vacuum in the rural credit structure,'' it added.
It is necessary to modify the nature of expectations of profitability of rural branches. It is wrong to consider, according to the Commission, even as a business proposition, that every rural branch should reach a break-even point and attain positive profits in three years or so.
Today, the overall level of non-performing loans (NPLs) in the entire financial system is around Rs. 1,20,000 crore. Of this, around Rs. 50,000 crore are NPLs on account of the corporate sector, the rest accounted for by the rural and cooperative sector. The cooperative sector is not ruined by the rural poor, but by politicians and other manipulators. What India needs is a proper banking structure to ensure that these funds reach the end user.
OOMMEN A. NINAN
in Mumbai
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