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Since 1st March, 1999
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- In India, the financial sector calls most for reform today

I do not give much thought these days to the problems of the nation. There are wiser men at its helm to do it, and I am busy enough with my journalistic commitments. But I recently gave a talk to the Bangalore chapter of Confederation of Indian Industry. The audience was a surprisingly sophisticated group of industrialists; they asked probing and challenging questions, one of which was, what I would do in the present circumstances if I were in the government. It is a question the prime minister has been asking himself. He left economic policy to his esteemed colleagues for eight years with dire results, so he is polishing up the lessons he learnt during his baptism of fire in 1991. He will no doubt do his own thinking, helped by his esteemed confreres. But he tends to accept rather readily the constraints imposed on him by his political associates; so he is unlikely to go as far as he can or should. It is a generally pointless exercise for powerless men to think about what they would do in power. But since the confederationists made me think about it anyway, I might as well share my thoughts — at least, as many as would fit into a column.

The sector that calls most for reform today is the financial sector. It underwent considerable reform in the 1990s. When I joined the finance ministry, the most sought-after man in it was not the finance minister or his right-hand man, but a joint secretary with a rather unimpressive office in the central quadrangle of the ministry. From early in the morning, the biggest industrialists used to queue up outside his office in their best suits. He was the controller of capital issues. He gave permission to make public issues. More important, he priced those public issues — or rather, underpriced them. Underpricing was the difference between the issue price and the likely market price after issue. The more he underpriced them, the less the money the company would raise. But the greater the underpricing, the greater the profit the lucky allottees of shares would make on issue. He insisted on a proportion of the shares being issued to “small” shareholders, who made obscene profits on issue. So he was extremely popular. We abolished his post, transferred the ministry’s power to Securities and Exchange Board of India, and abolished the power to price issues. This reform contributed to the burst of competition in Indian industry and its accelerated growth. But it has exhausted itself. SEBI today is far more bureaucratic than the finance ministry ever was, has made far more rules, and employs far more people. Thanks to it, the capital market raises little capital, and little of it goes into risk-taking and enterprise.

But even worse than the state of capital market is the state of banking. It is a largely government oligopoly. The BJP government issued a few licences, some of them to private banks; but that increased competition little. Reserve Bank had announced many years ago that it would license more foreign banks in 2009; it is still sleeping on that promise, three years later. It also issued a discussion paper on bank licences, and forgot it. The UPA government showed some desire to reform the industry in its early years; it appointed committees. But after they reported, it buried the reports. It was dissatisfied with its banks’ unwillingness to lend to farmers. P. Chidambaram, when he became finance minister in 2004, ordered banks to triple their loans to farmers in three years. They did; they lost a good deal of money in bad debts, and did not do more than they were made to. The banks’ unwillingness to lend to villagers led to the emergence of micro-finance organizations in the south. But Andhra politicians killed them by making it impossible for them to collect debts, and the Reserve Bank completed the task by imposing interest rate controls. The government gave jobs to unskilled villagers under the Mahatma Gandhi National Rural Employment Guarantee Scheme, and made them open accounts with government banks, but most of those accounts have remained moribund. Thus banking has seen much energetic but stupid action under the UPA, and consequently, little change.

I think our obsession with banks is so 19th-century. Banks are antiquated institutions. They are perfect institutions to finance governments; it is no wonder that Indian banks are so fond of government bonds. They are the wrong institutions to finance enterprise, which needs risk capital. They promise to pay fixed interest to depositors, and hence must earn fixed interest on their loans. But business is risky; returns on it vary. So banks tend to lend to less risky businesses — big companies with stable business.

However, all our financial concepts and institutions are antiquated. First, we have two forms of money — currency and bank deposits — which can be interchanged only by banks. To protect their interests, the Reserve Bank has sabotaged the emergence of a third form, electronic money. All money should be as costless to hold as currency. The government should make sure everyone in the economy has a mobile phone; it should give one free to those who do not have one. Everyone should be able to get his phone loaded by going to any bank branch or post office and paying cash, and conversely, to get them to unload cash out of his phone, without any charge. He should be able to hold cash in a bank without interest, and without any bank charges. Any pair of mobile phone owners should be able to transact cash between themselves; it should be possible to walk into a shop and buy anything with just the cash in the phone.

If anyone can keep cash in a bank without cost, banks will lose access to deposits. If they want money, they must get it by selling some financial instrument to cash holders. They must become pure investment intermediaries, like the present mutual funds. They may offer to invest the money in loans. They may classify the loans by term and by risk level, and offer interest varying with either: a cash holder should be able to walk into a bank and buy instruments varying from three-month bills giving very safe returns of 4 per cent to five-year bonds giving very unsafe returns of 40 per cent; money collected against the instruments would be lent out to the corresponding group of borrowers, and investors would bear the risk of lenders’ default. The instruments may also be like the present shares, offering a return at the money receiver’s will, or they may entitle the investor to a certain proportion of the receiver’s profits. Risk today is taken entirely by banks in the case of loans and by investors in the case of shares. Instead, cash in all forms — currency, deposits and electronic money — should become cost-free and risk-free, and if it is invested, the risk should always be taken by the investors. Financial intermediaries’ role should be to assess the risk involved, classify it, and make up bundles of uniform risk in which the investors can put their money.