MUMBAI, May 10: The wall separating banks and financial institutions is being pulled down slowly. The latest move by the Reserve Bank of India to allow financial institutions access to funds for short-term maturities is expected to bring them in direct competition with commercial banks.

Banks and financial institutions are already competing on the lending side. RBI has already given greater flexibility to commercial banks in sanctioning loans. As banking observers pointed out, the central bank has brought down the gap between the two for accessing funds. ``Now there will be direct competition between banks and financial institutions for public funds. The central bank consciously kept banks and institutions at arm's length. This is being pulled down now... the difference between banks and FIs are getting blurred,'' said a senior official with ICICI.

Financial institutions are expected to benefit from the RBI move as they would be able to mop up cheap funds which was hitherto the domain of commercial banks. The latest proposal will enable financial institutions to bring down their lending rates. Close on the heels of the recent slack season credit policy, IDBI and IFCI have reduced the prime lending rate from 16.5 per cent to 15. ICICI on the other hand has fixed the short-term lending rate at 13.5 per cent and long-term rates at 15 per cent. However, companies which need funds find this interest rate level on the higher side. On the other hand, commercial banks have brought down the lending rate to 14 per cent.

The RBI steps are expected to bring down the cost of funds of institutions. This has come at a time when many institutions are finding it difficult to cope with the sudden rise and fall in interest rates in the last one year. Institutions like ICICI, IDBI and IFCI had last year floated bond issues at interest rates of 16.5 per cent. After the RBI cut the cash reserve ratio and implemented other measures to boost liquidity, interest rates had fallen, thereby making it difficult for institutions to deploy the funds raised at high costs and get a good return.

By allowing FIs to access bank funds, the central bank has signalled that financial institutions should function like banks, senior bankers point out. This is also another step towards bringing institutions and banks under a single legislation. The RBI is already toying with the idea of merging all Banking Acts, it was learnt. Another school of thought favours inclusion of institutions in the proposed new Act. Currently, ICICI is covered by the Companies Act while IDBI and IFCI are governed by their Acts.

A problem that the institutions have to tackle is that they have floated private banks as subsidiaries. Private banks floated by IDBI and ICICI have already started expanding their operations. Banks and institutions are also separately managing mutual funds and merchant banking outfits. Yet another issue will be statutory requirements like CRR and Statutory Liquidity Ratio on incremental deposits raised by institutions.

``The idea of FIs functioning like banks would have appeared strange in olden days. But not now,'' said an RBI official. In India companies have to pay higher interest rates for long-term funds while short-term borrowings are cheaper. Besides, India is also one of the few countries where there are different institutions for short-term and long-term funds. This status is likely to diminish soon.

With further liberalisation in the banking sector in line with the Narasimham Committee recommendations, there will be more action on this front.

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.