Column: More idealistic, less practical

Written by Madan Sabnavis | Updated: Jan 9 2014, 08:14am hrs
RBIs report on inclusive banking is visionary and idealistic, which has to be suitably calibrated with the existing system and structures in order to work. The creation of new kind of banks, review of priority sector lending and a revolutionary thought of dispensing with SLR are some issues that provoke discussion.

First, the definition of inclusive banking is laudable as the aspiration is to ensure that every adult has an account by January 2016 with Aadhaar being the facilitator. This goes along with access to credit, and certain norms have been laid down for credit as well as deposits and investment to GDP for every district. In fact, a distance factor has been brought in so that no one has to walk for more than 15 minutes to reach a point of contact. While this is a perfect picture of a perfect banking system, the question is one of incredible cost and financial illiteracy. Shouldnt the existing system be incentivised to do it rather than create new structures

Second, the report talks of creating payment banks which take small deposits and invest in short-term SLR securities with zero risk like a narrow bank. Given that operational costs are high and return on short-term paper lower than the cost of deposit (there will be products offered with CPI indexation), will such banks be viable

Third, there is a case for having new wholesale banks, which could be subsidiaries of existing outfits. These banks would deal only with wholesale deposits and could be wholesale investment banks or wholesale consumer banks based on the number of branches they have. By keeping a minimum threshold of R5 crore for a deposit, these banks could mimic what were the DFIs earlier, which were transformed to universal banks due to an unviable model. One is not sure if this model would work as banks gain from CASA deposits, which will not be available.

On priority sector lending there are some fairly aggressive suggestions. The first pertains to increasing the limit from 40% to 50%. This goes against the grain of an open financial system and antithetical to the One Hundred Small Steps report discussed some years ago and Narasimham before that. While banks would rarely openly oppose such lending, pre-empting 50% of the 73% of funds (rest 27% set aside for CRR and SLR requirements) available for a sector, which runs a higher risk of becoming an NPA, may not be palatable. In fact, the report shows how high the NPAs are in the regional banks which are heavily tilted in the priority space of farm and SME loans (urban cooperative banks). With RBI voicing concern over building NPAs, having more space for priority lending is unlikely.

The report further asks banks to charge commercial rates on farm loans with the 2% subvention rate being transferred to the Aadhaar account. The argument is that no loan should go at lower than the base rate and the 7% mark of course. If this rule is removed, then banks could charge a commercial rate which could come in the way of farm loans and vitiate the ethos of such inclusive lending.

Connected to farm lending, there are suggestions made that banks hedge their commodity price risk through put options. There are two issues here. The first is that we still do not have options in domestic commodity trading and the second is that banks are not allowed to trade in commodities anywhere. Therefore, while the idea is progressive, the Banking Regulation Act has to change to let banks deal with commodities. The Forward Contracts Regulation Act has to be amended to let options in, which has to go through Parliament. Therefore, this is still some distance away as it has not happened for the last decade when futures trading in commodities was revived.

Going one step further, the report is also asking for a great deal of sophistication in the operations of regional banks, which will be a tall order as they are spread all across the country and the staff has limited exposure to the world of derivatives. Therefore, expecting them to rebalance their portfolios and hedge commodity risk will be hard to implement.

Another interesting recommendation is to do away with the SLR and CRR (to a large extent) eventually. There are three issues here. The first is that having SLR actually provides resilience to the banking system, which has been a strength during the global financial crisis. In fact, as the system becomes more complex with derivatives flooding the market, such buffers are needed to ensure the integrity of the system. Second, SLR is actually not quite as regressive. Banks get around 32-33% as CASA deposits that is virtual free money as it comes at a very low cost, which can be matched quite profitably with the returns of around 7-8%. Third, even today when the stipulated SLR is 23%, banks voluntarily hold on to excess of 4-5% in SLR securities as it makes sense for them. CRR, on the other hand, is effective for monetary policy and removing it weakens the toolkit.

The report, though visionary, focuses more on creating new institutions rather than fine-tuning operations of existing banks to deliver similar results, which is possible. Increasing priority sector limits may not be considered to be progressive while removing SLR/CRR, though quite revolutionary, may not really get a buy-in.

The author is chief economist, CARE Ratings. Views are personal