Derisking high credit growth

Updated: Oct 30 2005, 05:43am hrs
The credit policy, while acknowledging that lazy banking of yesteryears has given way to aggressive lending-led banking, has made sure the system as a whole and individual banks are safer than they were so far. This has been done in an innovative manner : making prudential norms pro-cyclical. From now on banks will have to make 0.40% provisioning on standard assets, as against 0.25% so far.

To ensure that capital is used well, especially by capital-scarce state-run banks, the RBI had recently allowed banks to treat investment fluctutaion reserve as part of tier-1 capital. So the impact of the additional provisioning of about Rs 1,000 crore for the entire sector is well balanced. This step ensures credit quality without impairing the current pace of growth. One hopes that during phases of slow credit off-take, the provisioning on assets is automatically reduced. This measure, along with the supervisory review process on sectoral exposures, will stregthen risk systems, and in that sense, the policy has a strong flavour of Basel II.

With regards to the much hyped inflation - it is just 2.1% excluding POL - and liquidity - excess liquidity is being replaced by a situation of balanced liquidity - the RBI has reacted appropriately by raising the reverse repo rate and the repo rate. This will empower banks to first stop repricing assets, which has been a bleeding spot for their bottomlines. More importantly, short-term rates will align and rise, and one hopes the 73% lending that is currently happening at sub-PLR rates will reduce substantially.

But it is clear the real concerns are not inflation and liquidity, but global uncertainity. The document has allocated a disproportionely large space to global uncertainity and has identified three different reasons for it. In a telling statement, the RBI governor observes, "These factors have imparted an apparent stability to the financial system, while sowing seeds of potential disequilibrium that might require a larger adjustment at a later stage". No one can speak louder and clearer than that.

Hence, it is a bit curious that the fact that the country's balance of payments is under a stress for the first time since 1991 has not been addressed in policy terms. With the trade deficit double at 6 - 7% of the GDP, the BOP stress affects both the current account and the capital account and economic agents expect currency depreciation. From this perspective, a less than decisive action on rates may even signal that RBI is not concerned about the rupee's deprecation.

Further, a large part of growth has been driven by low real interest rate-sponsored consumption. With no clear calibrated response on rates, aggressive capex demand going forward may warrant sharp rate rises, reviving memories of 1996-97!

In institutional terms, the RBI governor is slowly but surely implementing his long standing agenda of seperating the central bank's role as monetary authority from its role as the government's debt manager, which has and still compromise its autonomous authority.

By setting up a Financial Markets Department, the RBI is functionally carving out an autonomous monetary authority within itself. The significance of this measure will be realised much later much more.

A long-demanded short sales of government securities has finally been conceded to, with the introduction of intra-day short selling in government securities. While guidelines are awaited, there is no doubt that this measure will lead to higher volumes and more systematic price discovery.

The author is chairman and CEO, Jammu and Kashmir Bank