Ideas For GrowthInclusion

Cleaning the Banking System is the First Priority

K G Karmakar
Professor, SPJIMR and former MD, NABARD

Central Banks are known for avoiding needless controversies and shun all publicity and the Reserve Bank of India (RBI) is no exception to the rule. With the world economies in considerable disarray since 2008 and whether they like it or not, central bank policies are being closely watched all over the world for possible clues as to the movement of key banking rates. Saddled with a meaningless Budget, a clueless 12th Five-Year Plan and a Central Government that is totally rudderless and bereft of sane administrative acumen, the country limps along, waiting for new scams to erupt and more self-goals scored by non-entities masquerading as leaders. Never before has the common man been so thoroughly alienated from the government. It is increasingly clear that the government is clueless about halting the rapid down-slide of the Rupee and all eyes are on the new RBI Governor to make his mark amidst a set of doomsday economists! Meanwhile, the financial sector is aflutter with the GOI-led initiative to license new banks and the long-awaited RBI draft policy for licensing of new banks. Is this the time to license new banks when the banks are desperately trying to hide their NPAs, most of which are a result of the real estate slump?

With many hopeful aspirants lining up and waiting to be awarded with the elusive bank licenses, a ‘Barkis is willing’ syndrome among the not-so-coy aspirants is emerging and NBFCS, insurance companies, micro-finance institutions and various financial agencies, are examining their prospects of intense scrutiny by the RBI and emerging with the much-coveted license.

But wait a minute, before opening the Pandora’s Box of bank licenses, would it not be fair to allow RBI some time and breathing space to cleanse up the banking system and have a few strong banks emerge, before allowing new banks to be licensed? Why this sudden hurry for new banks without consolidating the banks into a structure that is possible to be regulated more easily? The RBI discussion paper on the Banking System should have come out much before the Draft Policy for Bank Licensing. Amidst this economic disaster, this is surely not an appropriate time to dole out banking licenses despite the pressures of the Finance Ministry and their eye on the impending elections. Let us not ignore the problems of cooperatives and commercial banks which have had to be bailed out or restructured or merged, over the last decade. Let us also not forget that RBI has no regulatory system in place yet for the NBFCs and problems could erupt anytime. There is an urgent need to consolidate the small private banks and the large number of urban cooperative banks and rural cooperative banks before signaling the consolidation of the existing commercial banks. The government’s need for new banks can wait for less-challenging times and that too only after RBI overhauls its regulatory systems which are grossly overstretched and inadequate today and ensures that an adequate regulatory and supervisory system is in place.

There is an urgent need to consolidate the small private banks and the large number of urban cooperative banks and rural cooperative banks before signaling the consolidation of the existing commercial banks. The government’s need for new banks can wait for less-challenging times

Whither Financial Inclusion?

Despite the clarity in the Rangarajan Report on Financial Inclusion, 2008, and despite some efforts by RBI/NABARD, financial inclusion of all adults by 2015 remains a distant dream. The Financial Inclusion Technology Funds (FITF) are not being permitted to be accessed by commercial banks as per the Government of India (GOI) fiat. The Reserve Bank prefers to exclude cooperative banks from financial inclusion initiatives, thus cutting off their access to the Financial Inclusion Fund (FIF) and the Financial Inclusion Technology Fund. And this, despite public statements made by the RBI Governor that cooperatives are best suited for financial inclusion. Add to this, NABARD’s poor stewardship of the FIF/FITF for the last two years and the agenda for financial inclusion appears to be a lost cause. The RBI did come up with the ‘no-frills accounts’ and the ‘BC/BF models’ for financial inclusion but these initiatives have not set the Ganges on fire. These have proved to be damp squibs and commercial banks have not been able to come to terms with these initiatives due to sound operational and logistics reasons.

Dismal Prospects

The latest initiative is to ensure mini-branches in villages with populations above 2,000 and this appears to be useful for political reasons only. How and when these branches will break even (2,000 branches were opened recently in a single day in Uttar Pradesh by the Finance Minister), is anybody’s guess. To sum up, the financial inclusion scenario is virtually lifeless and listless and reviving this, is important as despite the MFI disaster in 2010, SHGS are acutely needed in rural India for ensuring that the really poor are not financially excluded. But even the micro-finance scenario is beset with problems and the sectoral growth is dampened due to the AP fiasco, which refuses to settle down.

The Regional Rural Banks (RRBs) are limping along as they are competing for business in rural India with their sponsor banks and are being treated as poor cousins of the nationalised banks while the ‘Local Area Bank’ experiment seems to have failed miserably and except for a few economists, who are influenced by the American model of local banks, no one wants to revive or strengthen them.

In our banking system, the collapse of a single commercial bank is disastrous and the lessons from the Golden Trust Bank collapse should not be forgotten so soon.

Wings of Hope or Doomsday Despair?

The Ministry of Finance has been prodding the RBI to take steps to license new banks and the Finance Minister has taken personal interest in doing so. Financial inclusion is on the GOI agenda and efforts to create new banks, are being ramped up. But RBI, being the regulator, is in the hot seat as the opening up of urban cooperative banks licenses in the latter half of the 1990s led to a disaster with the RBI failing to supervise these banks effectively. Also the private sector banks have preferred to operate in cities and smaller towns and have failed to penetrate into rural and semi-urban areas. Despite RBI’s determined efforts, ICICI Bank, HDFC Bank, AXIS Bank, Mahindra Kotak Bank, Yes Bank, Indusind Bank have preferred not to open up branches in rural areas. With various business houses lining up for lucrative banking licenses, RBI is very apprehensive about the slew of regulatory problems that will emerge. As it is, the priority sector/ agricultural sector targets are not being achieved by most commercial banks and the private sector banks are being permitted by the RBI to window-dress their lending to these sectors and buy up portfolios from various cooperative banks to dress up their balance sheet. As it is, these statistics are far from accurate. RBI’s apprehensions are well-founded and it is not the cooperative banks that are encouraging money-laundering but the private sector banks (as showed in a recent sting operation in Delhi). If various business houses and NBFCS are allowed to set up banks, their clout with the powers that be in Delhi, would enable these new banks flout RBI directives with impunity. That is why RBI is rather apprehensive about opening up licenses for new banks. They would lose control over the banking system and that would be an unmitigated disaster. With the economy in a tail-spin, is the timing right for licensing new banks? A common sense approach would perhaps postpone fresh bank licenses.

A Way Out

While the GOI concern for rapid financial inclusion is appreciated as it could pave the way for smoother implementation of rural development and poverty alleviation efforts, thereby reducing wastage of critical funds, some other worries are emerging. But with regulatory disaster staring them in the face if new bank licenses are doled out to powerful business houses, RBI apprehensions are not ill-founded. An ‘out-of-the-box’ solution will have to be found so that both the concerns are addressed while doling out new bank licenses. Certain axioms for the entire banking industry need re-visiting today.

Consolidation of Private Sector Banks

There are too many small private sector banks (25) operating in the country and they are a regulatory nightmare. More private sector banks, that will try and avoid expansion into rural/semi-urban areas, are not needed right now. The process of consolidation of these banks has never been advocated and that is what RBI should be doing instead of trying to consolidate nationalised banks. Only five big private sector banks should emerge out of these 25 banks and business houses could afford to buy into a controlling interest in these private sector banks after restructuring. The RBI should set stringent entry sector norms for big business houses so that they behave and do not destabilise the economy.

There is a need to create a postal bank after amending the Postal Act, as the post offices are barred from lending money under the existing Act and could provide the needed muscle to financial inclusion in rural India which the cooperative banking system has failed to deliver

Merger of Regional Rural Banks

There are 82 RRBs in the country and many States have multiple RRBs while certain states like Delhi, Goa, etc., have no RRB. The Reserve Bank and GOI need to consolidate the RRBs on a State-wise basis into a single State Rural Bank for each of the States, with the existing shares of the Central Government (50 per cent) and the sponsor banks (35 per cent) being taken over by the State Government and each State having a State Rural Bank to assist small-holder farmers and small rural businesses. If the State does not perceive any economic advantage in taking over these banks, then NBFCS could take control on a State-wise basis only, and no further consolidation should be allowed. RBI can prepare stringent terms and conditions to expand the RRB network in every State.

The Indian Postal Bank

There are 155,000 post offices in the country and 135,000 of them are village post offices with very limited staff. With the advent of ‘hawala’ money transfers, the number of money-orders has reduced and with the ubiquitous mobile telephones, people rarely write letters. There is a need to create a postal bank after amending the Postal Act, as the post offices are barred from lending money under the existing Act and could provide the needed muscle to financial inclusion in rural India which the cooperative banking system has failed to deliver, even after infusion of funds as per the Vaidyanathan Committee recommendations. The post office accounting system is sound and the Indian Postal Bank makes business sense as the postal system in its present form will soon be redundant due to the mobile revolution.

Proposal for LIC Bank

The Justice Shrikrishna Committee (2013) has suggested revisiting the LIC Act, 1955, and bringing this behemoth under the Companies Act along with the State Bank of India (SBI). SBI was allowed to open up two insurance arms, one each in life and non-life business so why LIC should not be allowed to open up a bank? This will have two immediate consequences. LIC can spread into rural India easily and open up vast number of rural branches, which will also do bank assurance business as the spread of insurance is poor in rural India. The new LIC Bank (they have shares in a few banks like Corporation Bank, etc.) could ramp up business levels and rural deposits, leveraging into their brand name and image. Within three years, they could easily emerge as one of the top five banks in India.

Consolidation of Cooperative Banks

As the infusion of funds amounting to `135 billion into the STCCS, as per the Vaidyanathan Committee norms, has failed to revive the 3-tier credit cooperative structure, the LTCCS infusion of funds has been conveniently put into cold storage. But the 110-year cooperative credit structure needs to be restructured with each State having a State Cooperative Bank. The merger of the entire cooperative structure in rural and urban areas, on a State-wise viability basis, has to be done soon so as to ensure better supervision and regulation. This would involve the forced merger of 1,606 UCBs, 31 SCBs, 20 SCARDBs, 371 DCCBs and 92,000 PACS. The Prakash Bakshi Committee, 2013, recommendations, based on the follow-up of the Vaidyanathan Committee recommendations made earlier, have been successfully challenged in courts and have not addressed the concerns and problems of cooperatives.

Revisiting the Deposit Insurance Scheme (DIC)

While the Jagdish Kapoor Working Group, 2000, recommendations for an FDIC-type institution in India may not have found favour with the powers that be, it must be mentioned that the DIC coverage is poor and does not compensate depositors, who have entrusted their accumulated savings to the banks. The rural cooperative banks and primary agricultural cooperative credit societies have provided zero coverage to their depositors and that is a matter of regulatory concern. To help small deposit holders, and as a measure of abundant precaution, all single deposits amounting to Rs 1 million each, should be protected by deposit insurance. New bank licenses should not be distributed before this protection is made available to protect the savings of the common man. This is essential in the absence of any safety net mechanism for the poor in India. USA could weather umpteen bank closures and failures as the state is responsive and the dole is available. Our poorer Indians face certain disaster in case of any bank failure.

Technology-Oriented Banking or Relationship-Based Banking?

In an effort to reduce operating costs and avoid endless queues for harassed urban people, the ATMs and net-banking initiatives are essential. But all this comes at a tremendous cost in computerisation and modified operating procedures. This may reduce costs eventually but there is a price to pay and that is the banking relationship does not really grow. For the rural poor and those yet to be financially-included, banks have failed to develop cheap rural ATMs or mobile-banking tools. In Kenya, the Philippines, and other African and South American countries, mobile banking has worked as a financial inclusion tool and provided much-needed banking facilities to the rural poor. In India, banking has yet to be de-mystified and made available to the common man and financial inclusion is largely available to urban people only. Relationship-based banking is only for high net worth Individuals. The aam aadmi is relegated to faceless banking or group banking.

Perspectives

The concerns of GOI and RBI are justified and need to be carefully studied as the need for financial inclusion and banking regulatory concerns are genuine and the above proposals made will not disturb the existing banking system unnecessarily. The Indian banking system is in urgent need of consolidation. Some of the RBI suggestions make sound banking sense and the de-nationalisation of banks is a good entry point for corporates and business houses interested in banking. But without consolidating the entire banking structure, it will be a regulatory nightmare for RBI. RBI just does not have the manpower to regulate the banks effectively today. A good bank supervisor needs about 10 years of solid supervision skills and considerable IT experience. With private sector banks being non-transparent, bank supervision is not very effective. Online supervision has also not been very effective.

To help the rural banks, cooperative banks and commercial banks, a large number of Rural Credit Bureaus, on a district-wise basis, need to be created so as to track all money transactions in a district. This could be easily created by using the Financial Inclusion Technology Fund with NABARD, provided there is a vision and felt need. The investment banks do not deserve any consideration and it would be better to revive IFCI, IDBI, IIFCL, IDFC and NABARD and SIDBI. Creating new institutions without understanding why existing institutions have failed to perform, is perverse logic and smacks of opportunism.

The last point is about the supervisory norms to be followed. Why should all banks follow Basel III norms? My recommendations would be to have five international banks, which are geared to become Basel III compliant and are able to compete with the best banks in the world. The SBI and its subsidiaries and 20 nationalised banks could be restructured into these five banks. All private banks can be restructured into 10 national-level banks and these could be Basel II compliant. The 26 State Rural Banks (Delhi and Goa are small States and need not have rural banks) and 28 State Cooperative Banks could be Basel I compliant, and that ensures 69 banks under RBI’s regulatory/supervisory fold.

These should be allowed to settle down for three years before six new banks are licensed. And more than 75 banks should not be licensed by RBI after 2016. I hope that of the six new banks which deserve licenses, The Indian Postal Bank and the LIC Bank do qualify so that financial inclusion and rural micro-insurance have a chance to emerge. While I wish that The Microfinance Bank of India can emerge in the distant future (may be based on the Bandhan model
in Eastern India), the SHGs are better served by the SHG-Bank Linkage Programme and not by the MFIs who have become too greedy and have lost their social welfare origins.

K G Karmakar

K G Karmakar, PhD, Distinguished Fellow, SKOCH Development Foundation, was Managing Director of National Bank for Agriculture and Rural Development (NABARD). With over 30 years of professional experience as an executive in various banking and financial institutions such as State Bank of India, Reserve Bank of India and NABARD, Dr Karmakar has specialised in agriculture/rural credit, corporate planning, micro-credit, project management and rural infrastructure development. He has many publications to his credit such as: Agricultural Project Management for Bankers; Rural Credit and Self-Help Groups and Microfinance in India. He has published more than 60 articles related to rural credit and rural development, some of which has been presented in national and international seminars.
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