Almost a decade ago, the Narasimhan Committee laid the foundation for the reform of the Indian banking sector, with a significant thrust on enhancing its efficiency and viability. As the international standard became prevalent, banks unlearned their traditional operational methods of directed credit, directed investments and fixed interest rates.
In this process, the Indian banking industry was provided a foundation of strong prudential regulations, with transparency and customer service as key concerns. Internationally, the consensus on preserving the soundness of the banking system has veered around certain core themes. These are effective risk management systems, adequate capital provision, sound supervision and regulation, operational transparency, sound public policy interventions and maintenance of macro economic stability. In line with these, there have been constant efforts by the policymakers both at the Centre and Reserve Bank of India (RBI) to make the entire gamut of financial systems transparent and to spur growth with the involvement of larger players.
It is necessary to be transparent as the most basic forces affecting the shape of the banking sector are the same as those affecting the rest of the economy. The quickening pace of technological innovation has had a profound effect on the financial sector, which is information intensive and most of whose recent innovations have been in processing and transmitting information.
The impact of deregulation and innovation on Indian banking has been profound, widening the range of products and services. Financial transactions have grown rapidly in relation to GDP. There has been a transformation in the way banks are run, the way they structure and offer products. Alongside, the business and risk profiles of banks are undergoing a change. The number of subsidiaries set up by banks that were 37 at end March 2008 increased sharply to 131 by end March 2008. Banks have also spread their presence geographically, sometimes through third party partners.
According to RBI, at present the supervisory approach of the central bank with respect to commercial banks is to exercise oversight through two tracks?formal and informal. While the formal track comprises of-site inspections and off-site monitoring, the informal/unstructured approach includes interaction with banks? executives at the senior and top management levels, for market intelligence, ad hoc collection of information and so on.
Aided by technology and telecommunications, banks have reached out to millions of customers through the internet, mobile connectivity and ATMs even at places where they may not have physical presence. In this context, it is all the more important that the bankers respect the need to be transparent to their customers and to third parties in all their transactions. The same goes for the banking regulator RBI, which needs to be transparent in all its policies for the bankers. Bankers say that though they are very often consulted about the various pertinent issues before a policy about a certain matter is formed, it is still RBI that has the last word and often surprises the markets.
Unlike the US Fed whose internal discussion is released for public knowledge, RBI policymaking in certain key matters remains a closed-door affair. This includes its interest rate policies. Still, there are changes in the attitude of the central bank?RBI now regularly puts a lot of draft proposals on important issues in its website and invites public responses and suggestions. However, some bankers say they sometimes remain in the dark about how the RBI gives shape to some of its important policies. For example, while RBI?s draft proposals on the structure of the proposed holding companies of banks for their insurance and asset management companies generated a great deal of debate from a lot of prominent players of the industry, no final decision has yet been taken by the RBI.
In fact, the court battle between the Sahara group and RBI over the former winding up the activities of its non-banking finance company drove home the fact that some of the decisions of the central bank can also be questioned and modified in the court of law.
The year 2009 will possibly see one of the most important regulatory issues relating to RBI?s decision to give more freedom to foreign banks in picking up stakes in local banks.The banking industry is not sure whether, with the ongoing global financial turmoil, RBI will be able take a call on this issue.
The Indian financial landscape in the last two years has changed significantly, posing new challenges for the regulators. For RBI there has been a shift in the regulatory focus from micro regulation to macro management based on prudential elements, with a view to strengthening the banking sector and providing it with greater operational flexibility. Also the ongoing global financial crisis in the aftermath of the US subprime crisis has evoked re-thinking on several regulatory and supervisory aspects of the banking industry.
Though it is a matter of debate among the different constituents? like user groups, bankers and academicians?as to how much transparency the Indian banking and financial sector has achieved, it can certainly be said that much has been done, but yet more can be done.