- By Charan Singh
Union Budget 2019 India: In an emerging country like India, banks play an important role in financing industry unlike the developed markets where stock markets play a more significant role. In the journey of economic development of India, sources of funds for businesses have transited from money lenders and family to that of banks and financial institutions. In December 2017, assets of financial sector accounted for 136 percent of GDP, and bank assets were 60 percent of GDP, according to the IMF. This transition is mainly because of nationalization and consequent government ownership of banks in 1955, 1969 and 1980.
In recent years, public sector banks (PSBs), accounting for nearly 70 percent of total banking activities have been under stress because of rising non-performing assets (NPAs). The Government has been bailing out and recapitalizing PSBs regularly, and trying to strengthen their operations and governance.
The analysis of stressed assets in recent years, in PSBs, reveal that infrastructure, construction, mining and quarrying, iron and steel, cement, basic metal and engineering goods, account for most of NPAs. In the early years of development, India had dedicated institution for infrastructure, and commercial banking was separate. The skill set of the staff was also different, and specialized in a particular segment.
In the current scenario, same bank staff, probably under-trained, makes a commercial assessment of the project, irrespective of the purpose of loan, like financing a car, educational loan or construction of a bridge. This, inadequately assessed loan then results into a NPA. Therefore, the Government could consider, once again, visiting the concept of having Infrastructure Bank, with staff specialized in assessing viability of such projects.
The PSBs, providing universal banking, had almost started cloning each other in schemes and operations, and with no product differentiation, were crowding each other in the same market space. Therefore, in recent years, reforms in the financial sector, included mergers and acquisitions of PSBs, in view of consideration that large size of the new entity would lead to economies of scale to contain costs and generate profitability.
However, accounting gains from such mergers are yet to be estimated but fewer bank branches in same geographical space can be expected, implying meaningful competition. A few big Indian commercial banks, through such consolidation, could also provide robust competition to large foreign banks. This would augur well for business and growing influence of India in global trade. However, as mergers have unique challenges and limitations, except a few more mergers, the Government could consider alternatives.
In view of the fact that recapitalization of PSBs is a burden on national exchequer, role of PSBs also needs to be revisited. Earlier, when banks were nationalized, the need for brick and mortar branch was necessary, as well as penetration in the remotest part of India. In view of spread of mobile and internet banking, small banks, payment banks, postal bank, self-help groups, micro finance institutions, direct benefit transfers, does the country still need so many PSBs to extend credit in rural areas? Therefore, like disinvestment in public enterprises, the Government could consider, denationalization of PSBs.
Still, another way could be to privatize PSBs by allowing higher volumes of shares listed on the stock exchange. Finally, in a bold decision, given the renewed mandate in the Parliament, the Government could consider offering some select PSBs for sale to the private sector banks. These initiatives would reduce burden on the national exchequer.
In the financial sector space, non-banking finance companies (NBFCs) play an important role, mainly intermediating between commercial banks and small business enterprises. NBFCs account for nearly 15 percent of the balance sheet of scheduled commercial banks in March 2018. NBFCs have a distinct characteristic different from commercial banks, in terms of ownership, general governance, constitution of board, sources of funds, and therefore, licensing.
The RBI, does a soft touch regulation of NBFCs, despite NBFCs mainly sourcing resources through RBI-regulated commercial banks in recent months and exhibiting strong inter-relationship. The RBI as a prime regulator of financial sector is totally focused on ensuring liquidity, solvency and robustness of commercial banks but not of NBFCs. As NBFCs are a different set of financial entities, generally covered under shadow banking provisions globally, are not strictly regulated elsewhere in the world.
But, in view of their sensitivity for our commercial banks and economy, due to their entrenchment in small and micro business, the Government could consider having a separate and dedicated regulatory framework for NBFCs, with a stricter licensing stipulation, standardized reporting mechanism, and difficult, entry and exit. To ensure level playing field, and principles of symmetry, the profits and losses should both be private, and the entrepreneur should be held accountable and responsible for any systemic risks that a respective NBFC causes to the economy.
The micro finance sector in India has also expanded significantly in the last two decades. In view of successful implementation of Prime Ministers Jan Dhan Yojana, role of MFIs is expected to increase significantly in rural and remote areas. The Government could also consider a dedicated regulatory body for MFIs which insists on standardization of reporting data, as well as ensuring adequate training of officials to undertake operations at grass root level.
In view of the above arguments, given rapid growth in the financial sector in the last decade, and the financial sector challenges that have emerged, Government could consider setting up a Financial Sector Reforms Commission to examine various aspects of banking sector, NBFCs, MFIs, and FinTech. The role of supervisor and regulator, given rapid developments in technology should also be considered, and a road map prepared for the financial sector in India.
Finally, the new Government should consider setting up a history project on Banking in India. The banking history of India dates back to sixteenth century with Bank of Hindustan established in 1770. In India, 10 PSBs have a history of more than 100 years such as Allahabad Bank (1865), Punjab National Bank (1894), Corporation Bank (1906), Canara Bank (1906), Indian Bank (1907), Bank of Baroda (1908), Punjab and Sind Bank (1908), Central Bank of India (1911), Union Bank of India (1919), and most importantly, State Bank of India which traces its origin to Bank of Calcutta, 1806.
Our Indian banks have survived through numerous challenges like the Mutiny (1857), Two World Wars, Great Depression (1933), India’s Independence struggle, India’s Partition (1947), Nationalisation (1969 and 1980), and recent global recession (2008). It is obvious that there must be good things in our banks that they have survived severe ordeals and tribulations for more than a century, and therefore, would have cogent lessons to offer to banking industry, both domestic and global. May be the distilled wisdom from history of Indian banks will help to frame banking norms, better than Basel norms. We could name them, Bharat Banking Norms.
The author is a CEO of Noida-based think tank EGROW Foundation