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RISK AND PARANOIA

- The Reserve Bank’s distaste for competition

It may not always be evident from what I say about it, but I have enormous respect for the Reserve Bank. It is a part of the government, and yet it is entirely clean: there is not a whiff of corruption about it. It makes rules, and publishes them: everyone knows, or can know, what it is imposing on him. And as long as he lives by the rules, he has to fear nothing. There is no arbitrariness, no show of power. In all these respects, the Reserve Bank is an ideal official institution. If the rest of India’s government were to work like the Reserve Bank, India would be a paradise. Well, that is an exaggeration, in view of what I am about to say; but despite my reservations, the Reserve Bank is an institution that must be preserved — although a bit of reform would do it no harm.

Where the Reserve Bank does not suit my taste is in its distaste for competition. It loves its daughters, the government banks, and does not like the idea of new competitors making their lives difficult. It would not quite put it that way. It would deny that it loves its daughters; it just hates the private sector. It would never be so undiplomatic to say that; but the conditions it placed on new private banks say it all. Basically, private citizens who aspired to set up a bank had to be enormously rich: they had to plank down a hundred or five hundred crore as equity even before the Reserve Bank would look at them. They had to find a number of equally wealthy friends, for they were not allowed to bring in more than 10 per cent of the equity. They had to make a success of the bank within five years, against the combined might of established public sector banks. And after having won the battle, they had to turn tails and run away: they had to sell their stake in a dozen years, and hand the banks over to someone else. The Reserve Bank did not place any conditions on that second generation of owners because it knew it had plenty of time to make their lives miserable.

Having set these impossible conditions, the Reserve Bank invited applications. India has a private sector of more than a million enterprises and a financial sector of more than 10,000 firms — ones identified in the Reserve Bank’s view by a negative characteristic, and christened non-bank financial companies. Many of them would like to start banks, but they took one look at the Reserve Bank’s conditions, read its intentions and gave up the idea. But a couple of dozen hardy souls applied. The Reserve Bank was surprised, but it had an answer for their audacity. It appointed a committee — predictably chaired by a former governor of the Reserve Bank — to examine the applications. It did such a leisurely review that I have forgotten what conclusion it came to. But after all that ritual, the Reserve Bank gave TWO licences.

Meanwhile, the Reserve Bank tried to persuade its daughters, the public sector banks, to swamp the market by expanding into villages. They were not interested; their well paid managers loved the properties in cities they had bought with bank loans, their children went to well-chosen schools, and their wives gathered in the best restaurants in their radiant jewellery for their weekly kitty clubs. None of this would be possible in villages, so branches in villages could not be manned. The Reserve Bank offered the banks an alternative: instead of employees, they could appoint agents in villages, whom it chose to call business correspondents. These guys would carry a lot of cash, and a notebook with an account for every villager. They would act as walking banks, keeping, receiving and transferring money for the villagers. Brilliant idea, worthy of the Reserve Bank. Unfortunately, it did not work: local worthies who had the money and reputation to become bank correspondents were already in the moneylending business, and could see no advantage in doing the business on behalf of banks. And banks were not keen on supervising “agents” sitting in remote villages on whom they had no influence.

That is the story of the past eight years. Now, however, there is a new government. It, too, wants villagers to get banking services; so said the finance minister in his budget speech. In the old days of the Congress, the governor could expect a timid query from the prime minister on the rims of a meeting, and would fob him off by saying that the Reserve Bank was seriously considering the applications. But the new prime minister is different. He went to Bombay, hauled the governor out of his eyrie, took him in his helicopter to Vikramaditya, India’s latest aircraft career, and showed him the acrobatics of the seaplanes. Somewhere on the way back, he made it clear that the governor could not sit forever on new bank licences.

So, now the Reserve Bank has acted on the finance minister’s budget announcement. It has put out papers on small banks, and on payment banks. On small banks, it proposes to repeat its failed experiment of 1996, when it allowed “local area banks”; just four of them survived. The new small banks will also be given a licence for a few contiguous districts; whether they can break out of this prison will depend on the Reserve Bank’s pleasure. And it has repeated the conditions it imposed on ordinary, unqualified, private sector aspirants on whose applications it is sitting at the end of three years: that those who start these banks must make sure they lose control of the banks within 12 years, bringing down their equity to 26 per cent.

Payment banks are just a new name for business correspondents. They will take deposits, just like normal banks, and handle clients’ payments. But they will have to park all the money they receive in government bonds and treasury bills. With this single restriction, the Reserve Bank aims to eliminate the lender’s risk — and more important, the risk that it abhors, namely the risk that the lender and the borrower will conspire together to rob the depositor.

I think that as usual, the Reserve Bank is paranoid, and that its paranoia has prevented our banking system from playing its part in the growth of enterprise and innovation. That is a pity, but I do not think that even the new government will have the courage to force the Reserve Bank to be more entrepreneurial in its thinking. What it can do, however, is to insist that the new payment banks should have national licences, not subject to any geographical restrictions, and that they should be allowed to offer their clients a range of investment choices of marketable securities, from the safest government securities to bills of exchange, hundis, shares and derivatives. Let the Reserve Bank mollycoddle government banks; let us citizens have the chance to climb out of its lap, decide for ourselves the degree of risk we want to take, and invest in any financial security we like.