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Banking: Steps in right direction

Feb 24, 2001

Credit growth for the banking sector is showing encouraging growth. During the period April-January 2001, banks aggregate credit to the commercial sector grew by 11.8% on a YoY basis compared to 10.0% in corresponding previous period. Higher credit off-take signals a positive sign for improvement in interest income of banks. The higher credit growth was mainly on account of increase in non-food credit by 11.9% from Schedule Commercial Bank (SCBs) (compared to 10.5%) during the same period. The non-food credit reflected a higher growth of 18.1% compared to 16.0% projected. Despite higher flow of non-food credit growth, industrial production figures showed a disappointing picture. During the first nine months of FY01, industrial growth decelerated to 5.7% compared 6.4% in corresponding previous period.

To improve the industrial growth and boost India’s competitiveness abroad, the RBI recently announced an interest rate cut of 50 basis points both in bank rate (7.5%) and CRR (8%). Since banks still constitute the most important financial intermediary, reduction in interest rates would facilitate lower transaction cost. As a result, cost of production of the corporates (for capital intensive industries) is expected to come down significantly.

The RBI has designed the major policy reforms in order to enhance the efficiency of the financial system. The key developments included the following:

  • Reduction in government holdings: The government introduced the Banking Companies (Acquisition and Transfer of Undertakings) and Financial Institutions Laws Bill, 2000 to reduce the proportion of government holding in the equity of nationalised banks to 33%. This is to enable them to raise fresh equity from the capital markets to enhance the current capital adequacy ratios apart from improving the operating efficiencies. Although, the government has announced to bring down its stake in nationalised banks, it is not willing to give away management control. This is likely to affect adversely the operating environment in these banks.
  • PSU Banks to be allowed to buy equity: As a part of the banking sector reforms, the government will allow PSU banks to buy its stake in other banks. Currently, only shares not held by the government is freely transferable. Now since the government proposes to reduce its holding in these banks to 33%, it would need prospective buyers for its stake. The move will also allow mergers and acquisitions of state owned banks.
  • Investment in capital markets: The RBI has formulated transparent guidelines for banks investment in capital markets (including shares, debentures and units of mutual funds) and financing equities. Against the existing norms of 5% of incremental deposits, banks are now allowed to invest 5% of the outstanding advances. This is likely to improve banks investment income in the favourable capital markets scenario. During the period April-December ’00, the investment of banks (in debt and equity instruments) registered a lower growth of 13.7% YoY (compared to 21.1%). This was due to unfavorable capital market conditions. For making efficient investment decisions banks are required to build up adequate expertise in equity research, formulate transparent policy and procedures.
  • NPA recovery: The RBI aims at speedier recovery of non-performing assets (NPA) of banks through renewed efforts. Net NPAs of banks during the year are expected to be higher due to the proposed change in the provisioning requirement by the RBI. A non-performing asset is a credit facility in respect of which interest has remained unpaid for more than 2 quarters after it has become past due. The term ‘Past Due’ denotes grace period of one month after it has become due for payment by the borrower. The credit policy of 2000-01 has proposed to discontinue this concept with effect from March 31, ’01.
  • Entry of new banks: The RBI has revised norms for entry of new banks in the private sector. However, large industrial houses are not permitted to set up new banks. Also, the number of licences to be issued in the next three years may be restricted to two or three of the best acceptable proposals (including permission to NBFC for conversion into banks).
  • Investment valuations: The valuation guidelines for investment portfolio of banks have been re-classified with effect from September ’00. Accordingly banks, which earlier had to mark 100% of their portfolio to the market, now can mark 75% of their portfolio. This is expected to reduce the banks’ mark to market losses on investment portfolio in the future.
  • Consolidation: The RBI has initiated move towards consolidated supervision by incorporating the balance sheets of subsidiaries into the parent company’s accounts. The public sector banks have also been asked to annex the balance sheets of their subsidiaries to their own balance sheets with effect from the year ended March ’00. This initiative is likely to present a correct picture of the bank’s financial performance to shareholders.
  • Entry into insurance: Banks and non-banking financial companies (NBFCs) are allowed to enter insurance business with prior approval of the RBI. Entry into insurance business is restricted to financially sound banks with a minimum net worth of Rs 5 bn apart from other criteria with respect to capital adequacy and profitability. However, any bank or its subsidiary can take up distribution of insurance products on fee basis as an agent of an insurance company. Although, the payback period for insurance venture is wide, it is expected to contribute a significant proportion to banks revenues in the next 5 years.

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