In recent weeks, RBI has published two reports, the Annual Report and the Report on Currency and Finance (RCF). The focus of the two volumes of the RCF is the overwhelming emphasis of sound risk management architecture for the banks. In fact, RBI is surprisingly candid by admitting that Indian banks currently depend more on the traditional mode of hedging credit risks by simply restricting fresh exposures, particularly to the agriculture and SME sector. Interestingly, in the same vein, the apex bank goes on to say that Indian industry unlike their counterparts in developed countries continues to rely heavily on the banking sector for resource mobilisation. This, according to RBI, must change as the banks need to scourge for increasing resource requirements of the agriculture and the SME sector, which have no other alternative of finance, apart from the traditional banking channel. Clearly, this is a classic example of credit rationing on the part of lenders possibly resulting in tendencies for ?financial exclusion? of borrowers who could otherwise contribute to growth in the economy.
The RCF dwells extensively on the declining credit flow to agriculture, particularly term loans, as unavailability of such loans impairs agricultural borrowers? credit absorption capacity, which would eventually affect the growth of crop loans as well. In fact, the report enunciates that in the long run, the agricultural sector needs to have a comprehensive public policy on risk management that should encompass a clear assessment of adverse monsoon conditions and appropriate relief to farmers under such an eventuality, creating an accountability matrix for suppliers of vital inputs to this sector, and eliminating price-subsidies with increased outlays on these risk mitigation techniques for farmers. The RCF also underlines that one of the major constraints in increasing credit flow to agriculture is the lack of suitable collateral. Most often land is the only asset available with the farmers. Subsequently, asset backed collateral by using land as the collateral can go a long way in acting as a facilitator of credit to agriculture. However for this, the computerisation of land records is a necessary condition. In the same vein, the report points out that providing asset based loans to SMEs could also be a cost-effective solution. This method is common in US among commercial banks in the US. The assets include commercial account receivables, inventory, business equipment and machinery, recurring revenue contracts, and commercial real estate. In asset based lending, banks typically provide SMEs a revolving line of credit based on a percentage of each of the qualifying asset classes.
Interestingly, the report also points out that taking advantage of the erstwhile low interest rates, diversification (banks shifting from traditional to broad-based lending) and fiscal incentives of the government (housing loans are allowed for tax exemption), there has been a huge splurge in retail portfolio in the past couple of years. However this could be a matter of concern given that the sector itself is vulnerable to many macroeconomic factors, such as oil prices hike, real estate prices hike, fall in employment leading to reduction in consumer sector?s power to spend, general increase in inflation and the like. Finally, the RCF is blunt when it comes to the role of rating agencies in accentuating the recent sub-prime crisis. The report is categorical in saying that in view of the limited penetration of ratings and the absence of reliable ratings for different assets, the Indian banking industry will not be able to fully exploit the flexibility of Basel II. The report also emphasizes that in view of the issues being raised about potential conflicts of interest in the activities of rating agencies as they are paid by the same entities which they rate, there is a need to change the incentive structure of these agencies. However, the most significant suggestion is that the functioning of the rating system could improve significantly with more competition and subsequently establishment of private rating agencies.
The author is with TATA AIG Life. These are his personal views