Asset poverty is both a symptom and a cause of underdevelopment. Overcoming this requires investment and accumulation of capital, which takes time. On the other hand, inefficiencies associated with lack of knowledge and training ought to be easier and quicker to overcome, in many cases. Indian banking seems to be underperforming in this respect. In my last column (The non-performing asset problem, December 1, bit.ly/1PXs9Ua), I discussed the possible connection between high levels of non-performing assets in the banking sector and credit risk management (CRM) practices. Of course, business cycle effects and political factors also play a role, but there is an argument to be made that CRM is not done as well as it could be and should be.
After finding the small survey I reported on in my last column, I looked for more evidence on CRM in Indian banking. Surprisingly, I did not find any detailed empirical study done by the Reserve Bank of India (RBI). The RBI provides guidelines and sets standards for a broad range of banking functions, including CRM, but it does not seem to have any recent, publicly available assessment of CRM in the Indian banking sector. For that matter, I did not find any major academic work on this either, only a handful of smaller studies. The reason I highlight this is that this seems to be an area where improvement in practices would have a high payoff throughout the economy. Why this is not happening is a question I return to at the end.
First, some more evidence. Swaranjeet Arora reports on a survey of 200 employees of banks in and around Indore, evenly split between four categories: State Bank of India (SBI) and associates, other public sector banks, old private sector banks and new private sector banks. Based on responses rating five aspects of creditworthiness analysis, Arora found that there was no significant difference in quality between the two categories of public sector banks and between the two categories of private sector banks, but the private sector banks were perceived by employees to be doing a significantly better job than public sector banks.
A different study, by Renu Arora and Archana Singh, surveyed 337 managers of 12 public sector banks in and around Delhi. Half of the banks were classified as large and half as small, and about half the responses were in each category.
The survey looked at 32 different variables pertaining to CRM and associated practices, and on almost half of these variables, the smaller banks were assessed to be doing significantly worse. The level of detail of the analysis allows some inferences on specific improvements such as in data management and internal audit processes.
A third study, by Muneesh Kumar, Anju Arora and Jean-Pierre Lahille, also used a survey to construct a CRM index at the bank level, for 24 public sector and 9 private sector banks. Like the Arora-Singh study, they found that larger banks did better on their CRM index, but in contrast to the Swaranjeet Arora analysis, they found public sector banks did better on the whole, according to their CRM index.
There are differences across studies in location, precise data collected, and timing, as well as methodological differences. What is striking, however, is the dispersion of quality of CRM practices across banks. This kind of dispersion of productivity or efficiency has often been observed in Indian manufacturing, where size also matters positively for productivity. But manufacturing and overall productivity in the sector are much broader and heterogeneous categories than CRM within banking, which is a specialised function within a specialised sector—one that is supposed to be highly regulated. Just bringing everyone up to current best practice could provide large gains.
An obvious explanation is that lack of competition in the banking industry feeds into organisational practices that allow persistence of inefficiency in banking practices such as CRM. Increasing competition in banking is tricky, since financial sector failures can have serious systemic consequences. But if entry is encouraged (something now happening, albeit slowly, in Indian banking) in concert with a greater emphasis on quality rankings, there would be more pressure on banks to improve the quality of their operations on multiple fronts, not just CRM.
At one time, when the economy was booming, it seemed that India could get away with “lazy banking,” but those days are over, and will not return. Capital has to be allocated efficiently for accelerated growth, and efficient financial intermediation is crucial for that to happen. Better CRM practices are one small part of that needed improvement.
Why do these changes not happen? Organisational inertia, compounded by lack of competition, is certainly part of the answer. But there is also a tendency to paint economic reform with a broad brush, and focus on big changes.
These are obviously important. Witness the long and arduous process of overhauling India’s tax system, of which the GST is only the latest and currently most salient example. Or the massive rewrite of financial sector laws that is in its early stages. But small specific changes, like better CRM in the banking sector, can be politically less challenging and have large long-run benefits, and they deserve greater policy attention than they often receive.
The author is professor of economics, University of California, Santa Cruz