Ease priority-sector lending norms

PV Maiya

PV Maiya, managing director, Central Depository Services (India) and former managing director of ICICI Bank, writes on what the April credit policy should contain.

The economy can no longer be characterised as being in a phase of slowdown or in transitional modulation with globalisation. The distress across several industries is a clear indicator of recession. Stagnating exports and widening trade deficit are worrisome, though foreign-exchange reserves are comfortable. We can draw some comfort from the resilience of agricultural sector, thanks to yet another good monsoon but we may run out of luck next time. Governmental policy initiatives announced on infrastructural areas, external trade and towards fiscal prudence need to be translated into action.For the second successive year, banking system's credit-deposit ratio hovers around 50 per cent; incrementally this is at 35 per cent in 1998-99.

Increase in investment in securities exceeds credit growth in absolute amount in 1998-99. Growth in moneysupply (M3) at 19 per cent would be theoretically regarded as disconcerting, but as of now urgency is to tackle the looming deflation by a demand push to the economy. Given this context, we propose the following measures:

Priority sector: Over the years, priority-sector activities and targets for lending have become so complex as to be accommodative to show compliance with any goal. Clearly, simplification is called for.

Basic categorisation of priority sector into small-scale industries, small business and agriculture & allied activities will continue, as these create growth opportunities for local area.

We propose to include the entire export finance in priority sector, not merely export finance to SSI, SIB and agriculture, given the need to augment exports.

We also propose to add entire housing finance in the priority sector because of its linkage with multiple industries.

Both Indian and foreign banks will have to achieve a target of 40 per cent or more of theiraggregate loans to the priority sector. For foreign banks, which hitherto were required to attain a target of 30 per cent, the increased goal is achievable with the inclusion of all export and housing finance.

Banks are free to choose any one or more categories of priority sector activities for financing, based on their strategic strength so long as the target of 40 per cent is adhered to. Indian banks should, however, ensure that at least one-third of the priority-sector advances are in their rural and semi-urban branches.

Banks are advised to lay down a moderate structure of interest rates, including sub-prime levels, especially because of the proposed refinance.Refinance: Current refinance windows are shut. Instead, banks will be eligible to draw down quarterly as refinance their CRR balances (subject to a minimum of 3 per cent being retained), up to 50 per cent of increase in priority-sector loans other than for housing and export finance which are refinanceable up to 100 per centover 1999 March-end outstandings. This facility, which bestows larger spread, should spur banks to seek business aggressively and also bring down effective rates of interest.

Other measures:
Valuation of SLR Securities: As SLR investments by commercial banks are mandatory up to 25 per cent of net demand and time liability, they can be regarded as permanent and not current investment. Mark-to-market basis of valuation of SLR investments as per the current norm has a distorting influence on year-end accounts of banks, adopting a contrived yield-to-maturity. A valuation criterion followed by many international banks is deemed less turbulent on the bottomline and a fair reflection of accounts.

* Accordingly, banks from now onwards will value their SLR investments up to to mandated level at cost. However, any excess over this level should be valued at market rates. Banks should declare to the RBI permanent securities twice a year in April and October.

Depreciation provision, if any, against`excess' holding should be reflected in the published accounts. The current instruction on holding a depreciation provision of 2.5 per cent thus stands withdrawn.

Universal Banking: The discussion paper released by the RBI has evoked mixed reaction, being either narrowly perceived as a remedy for the uncertain future of DFIs, or untimely. Many of the elements of universal banking already exist in our financial system, though insurance business and security dealings are not yet a part.

Nonetheless, we prefer to leave the choice to banks and institutions to go for universal banking or wait out. Where a DFI chooses to merge with or convert itself into a bank, RBI's inspection of books and final approval for the scheme will be mandatory. The newly-formed bank will be subject to Banking Regulations Act, except for the applicability of CRR and SLR requirement on existing bonds/debentures, etc. issued by the erstwhile DFI. Also project loans with maturity of more than three years will be excluded forworking out priority sector obligation.

* Lest RBI's stance be misunderstood, we emphasise the role of smaller banks -- regional and local area categories -- as essential to the communities. They ought to survive alongside the larger ones, but they should seek technology solutions to increase productivity and business, without displacing the value of human contact, as indeed some of our cooperative banks have proved.

Administrative reforms:

Many of our well-intentioned policies get attenuated in practice because of a meandering jungle of regulations, rules and administrative process. The RBI has constituted a Regulatory Review Authority (RRA) under the chairmanship of deputy governor YV Reddy which has sought comments from banks, employees and general public. This is the most open enquiry undertaken by the RBI into its own functioning.

One of the first tasks which RRA may focus on is the huge efforts in collecting data from banks using its regulatory powers, only to allow the dataso collected to languish. One such enormous exercise is collection of `R' returns relating to foreign-exchange earnings/outgoes, to help compiling the balance of payment position, which unfortunately has remained `provisional' for years.

Banks are encouraged to carry out a similar exercise; they must in particular immediately review long processes of disciplinary action following bad loans. Central Vigilance Commission, RBI and banks have come to an understanding on this matter. We expect banks to act to remove fear psychosis at decision-making levels which is scaling away the commercial character of the organisation to the detriment of the economy.

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