| A question of access The author is former governor, Reserve Bank of India
The Reserve Bank of India’s review of the trend and progress of banking 2002-03 is a credible progress report on the performance of the banks and financial institutions during 2002-03. It carries forward the tradition of incisive analysis and the policy focus of its predecessors.
Banks performed well in the year 2002-03, with a fair amount of progress in disbursement of credit as well as in working results. Disbursement of non-food credit registered a growth of 18.6 per cent over the previous year. More significant was the rise in net profits. Scheduled commercial banks as a whole made a net profit of Rs 17,000 crore (one per cent of assets) in 2002-03 compared to Rs 11,576 crore in 2001-02 and Rs 6,000 crore in 2000-01.
The increase in net profits over the years came after adequate provisions had been made for non-performing assets. The spread — the margin between interest paid and interest charged — has, however, remained more or less the same — 2.77 to 2.85 per cent. The robustness in profits is due not only to better management but also to the trading profits gained as a result of selling some of the abundant stock of government securities at a higher price. These profits were realized because of the declining interest rate environment leading to higher bond prices.
The RBI’s report discusses briefly the role played by such trading profits in the improved profit picture of the banks. Trading profits arising from sale of securities by SCBs rose by 39 per cent in the year 2002-03 with respect to the previous year. As many as 51 banks recorded increases in such profits. The share of trading profits was 7.7 per cent of the total income of banks and 33 per cent of operating profits. This is to be compared with the lower figure of 3.5 per cent two years earlier. It is noteworthy that old private sector banks’ performance depended heavily on such trading profits, which accounted for over 50 per cent of their operating profits. The State Bank of India group, however, had only a low share. On the whole, while declining interest rates did hit bottom-lines of banks, they also served to strengthen it through the trading route.
So far as credit performance was concerned, the banks managed a sharp decline in NPAs as a percentage of the total assets. This ratio declined from 5.5 per cent on a gross basis in 2000 to 4 per cent in 2003 (for the period ending March 31). The net NPA ratio declined from 2.7 per cent in the period ending March 31, 2000, to 1.9 per cent in the period ending March 31, 2003. Public sector banks had a particularly good record, their gross NPAs/assets’ ratio going down from six per cent in 2000 to 4.2 per cent in 2003. The net ratio for PSBs declined from 2.9 per cent to 1.9 per cent in the same period. Foreign banks fared well, because of their selective portfolio of credit, the ratio declining from a gross figure of 3.2 per cent and one per cent net in 2000 to 2.4 per cent and 0.8 per cent respectively in 2003. New private sector banks, however, had a rise in the gross ratio from 1.6 per cent in 2000 to 3.8 per cent in 2003. This must have been due to a larger share of difficult and risky assets, as their lending grew.
Taking SCBs as a whole, the additions to NPAs in 2002-03 were lower than the recoveries in the same period. This contributed to an improvement in the overall NPA status of the banks. This reflects the greater awareness of credit risk by banks and also the impact of bankers’ resorting to the provisions of the new act on securitization and asset reconstruction.
The overall improvement in the health of banks in India is also reflected by the performance of bank shares on the markets. Some of the public sector bank shares have become the favourites of investors, especially foreign institutional investors. This is an indication of the markets’ increasing confidence in dealing with banks’ stocks and provides a measure of the efficiency of bank management. The rising bank stock prices have also encouraged some banks to issue their shares at a premium.
The RBI report touches on the sensitive topic of the new Basel norms regarding the measurement of operational risk. Even as the world has just got accustomed to Basel I norms, the experts of the Basel-based committee have come forward with a new set of rules regarding risk management. There has been some discomfort in international banking circles about their acceptance. Whether our banks will be able to implement them in their current form is a difficult question. Apparently, China has registered its significant vote of protest. Hopefully, the RBI will hasten slowly before it puts our banks through the new rules of Basel II. While much consultation has taken place, it seems worthwhile to form a joint front with other developing countries and a few of the European dissident nations to mitigate the dangers of new Basel II.
While on the subject of financial sector reforms, it is fair to point out that the RBI has already put forward a number of proposals for legal reforms, which would improve banking sector performance. Many of them are still awaiting parliamentary approval. It is perhaps too much to hope that with ensuing elections, Parliament will find the time to devote attention to the important but “boring” affair of legal reforms. But our lawmakers must realize that a non-performing financial system can do grievous harm. Hopefully, the policy-makers in the ministry of finance and law will bestir themselves to keep the legal reform agenda on track, in spite of the temptation to postpone it till after the polls.
While on the issue of reforms, it is important to note that there are serious flaws in the performance of the finance sector so far as rural credit is concerned. Cooperatives are still languishing in the grip of political masters and poor governance. They “benefit” by the confusion in supervision and audit. The RBI should be able to put new life into the cooperatives, if it at least acts — and acts soon — on the recommendations of the Khusro committee of the Eighties, which are gathering dust in the pigeonholes of the RBI and the government of India.
Priority sector requirements, which involve the prescription that banks should distribute a specified percentage of credit to priority sectors, have played an important part in our rural credit structure. Over time, however, this requirement has been diluted through setting up the rural infrastructural development fund. Defaulters — banks which have not performed as per the requirement of priority sector lending for rural areas — are permitted to “buy” peace by contributing the difference to the National Bank for Agriculture and Rural Development, which administers the RIDF. We are, however, faced by a situation in which states are not fully utilizing the RIDF funds. The inability of NABARD to administer RIDF as designed also raises questions. The RBI needs to revisit the issue of RIDF and ensure that under the banks new systems have an incentive to perform their mandated priority disbursements rather than adopt the easy option of contribution to RIDF.
The report points out that banks have improved their capital adequacy ratios over the year. The risk weighted capital adequacy ratio has risen for PSBs as a whole to 12.64 per cent over the previous year. Among the SCBs, 26 banks had a CRAR level above 10 per cent. Capital adequacy is a well-acclaimed benchmark in financial circles. The Indian banking system has a creditable record in this regard as well.
The RBI report catalogues a number of steps taken by the central bank to improve bank management, apart from technological upgradation and innovation in supervision. It includes a comprehensive review of various measures taken. It would be good if the RBI evolves and publishes a measure of relative performance of banks on a consolidated scale of functioning on various dimensions of banks’ efficiency. The benchmarking of banks on this basis can act as a spur to genuine competition among banks and will motivate better performance.
The RBI’s latest report on the trends in banking and finance does not cover adequately the problem of limited access to credit by small-scale industries and medium-scale enterprises. This requires detailed study and restructuring. Among the major candidates for attention would be state finance corporations, at present left to the mercies of state governments and the Small Industries Development Bank of India. If there has to be significant progress in this vulnerable sector of small-scale and medium enterprises, the RBI needs to spearhead a dedicated effort to reorganize the SFCs. This is a difficult task, but cannot and should not be postponed merely because it is politically sensitive.
To sum up, the RBI’s latest report on the trend of banking in India puts forth a creditable report on achievements. It also sets out an agenda for further action and reform. This agenda needs to be expanded and pursued actively and comprehensively if the Indian banking system is to be enabled to fulfil its legitimate role in the transformation of India’s resurgent economy.