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CENTRAL BANK’S DILEMMA
- The economy will benefit if licences are given to rural banks

The Reserve Bank of India controls how many banks may compete for our business. It has not licensed any bank in ten years. Meanwhile, Indian banks’ margins continue to be amongst the highest in the world: they pay depositors a pittance, and charge borrowers through the nose. Not that they make unreasonable profits; they just incur extraordinarily high costs. To put it slightly differently, they are extremely inefficient. That they can remain so has much to do with the fact that the RBI has protected them from competition; it is reasonable to infer that the RBI has not given licences to fresh banks because it does not want banks to have to face competition. As I have put it before, the RBI is the mother of government banks; it protects them like a doting mother, and makes sure they fatten themselves.

That is good business from the government’s point of view; there is no reason for any government type to lose sleep over it. But then, the present government has another obsession, namely inclusive growth. The commonsense meaning of this piece of officialese would be that income distribution should improve, or at least not worsen. A commonsense government would therefore make taxation more progressive, or reduce tax evasion. But our government cannot or would not do that. It prefers to give handouts to the poor. If it collected more taxes, it would become unpopular. If it distributes handouts, those whom it favours will hopefully vote for the ruling party. That is the political arithmetic.

That is my interpretation. How does the government think? How would it justify perpetuation of oligopoly in banking? The finance minister does not bother to talk about such things; but recently, an explanation of sorts has emanated from the mother of banks. K.C. Chakrabarty, the deputy governor of RBI, gave a speech in Chennai in the first week of November, drafted by Dr Mridul Saggar. It had never struck me that the reason why the RBI protects government banks is that if they could not face competition and had to contract, they would not be able to afford so many employees. They employ a million workers. One would never imagine that; when one goes to the bank, one does not find them falling over each other to serve one. But they are why the RBI has protected banks from competition, and reneged on its promise to allow more foreign banks in.

But now it is preparing to change its tune, because the primary reason for its abhorrence of competition, namely too many employees, is about to disappear. A large proportion of the employees was taken soon after nationalization of 14 banks in 1969, and more after another seven were nationalized in 1980. Many of these workers are about to retire. So the fears of redundancy arising from competition have receded; the RBI does not mind if new workers are brought in by new banks. Old banks are still against it; they have been telling the RBI that the economy is slowing down, that it will raise their bad debts and reduce their profits. That is a bad time to have to face new competition. The RBI is hesitating, but trying to persuade the old banks.

Another reason for the RBI’s change of mind is the government’s fetish about financial inclusion. One would have thought that the way of making the poor less poor was to give them more money. But our government thinks differently; it thinks that they should be given more loans, so that they can renege on them. So the RBI has devised a “package” that would become a fundamental right of the poor; it would include four “products” to use officialese — a savings account with overdraft facility, a remittance “product”, a long-term deposit “product”, and a credit card.

But there is a problem in extending the package to all the poor: many live far away from bank branches. The RBI has been trying for decades to make banks open branches in villages; but they do not like it. There are no good schools or doctors in villages, and bank employees do not like to be stationed there. The RBI thought of another solution called bank correspondents: they would be agents instead of employees. But then banks would not have much control on them, and would not like to leave much cash with them, and without cash, the correspondents would not be able to service depositors’ accounts.

Something like this has been tried out in Kenya which I have just been to see. There, a company called Safaricom has opened windows in shops all over the country. Anyone can go to one of the branches, pay in money, and ask the girl to transfer the money to his wife in some village. He then rings up his wife on his cellphone and asks her to go and collect the money; the girl rings up her Safari colleague on her cellphone and asks her to pay the wife, and the transaction is made. Behind the village branch, there is a local rich man — a shopkeeper or transporter, for example — who puts up the money temporarily if there is a shortage. That is how M-Pesa started; now the system also takes deposits from clients and gives credit. So it started as a money transfer system, and has developed into a deposit bank.

One reason why M-Pesa worked in Kenya and bank correspondents have not in India is that Safaricom is virtually a monopoly. It is not so legally, but because it was the pioneer, it had the field to itself. In India, a problem would arise if there were only a couple of rich guys in a village and 20 banks competed for them. The other problem is in making the system profitable. M-Pesa makes good money on money transfers. In India, taking deposits would be a loss-making activity, and would have to be backed up by lending; banks may be prepared to let correspondents handle deposits, but would not like them to be giving out loans on their behalf.

The problem arises because banks have no knowledge of villagers and do not know whom to lend and whom not to. Local rich guys would; but they would already be local moneylenders, and there is no reason why they should give up their own moneylending business and do it on behalf of the banks. There is a deep prejudice against moneylenders amongst our rulers, going back 150 years; now they find they cannot extend banking to villages without turning to moneylenders. And the moneylenders would not serve banks; they are banks already.

The obvious solution would be to give rural bank licences. But the most eligible people for those licences would be moneylenders. The official types loathe the moneylender, and they cannot find anyone else who could run banks with any chance of success. So they will keep bumbling. And every once in a while, they will lose their cool and do something stupid like banning microfinance institutions, as they did in Andhra Pradesh. Competition can eliminate inefficient banks, but not mindless governments.

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