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Banking: In search of growth

Feb 26, 2002

The Indian banking system is facing challenging business conditions on the back of dismal credit growth. This is despite softer interest rates. With drying demand from the industrial sector, banks are investing heavily in government securities and are increasing food credit. Non-food credit growth for the sector, year to date till January 11, 2002 registered a growth of 8.7%, as against 12.1% growth recorded in the comparable previous period. Banks’ non-SLR investments including debt and equity instruments of corporates, have also grown at a slower pace of 4.2% during the period, compared to 13.6% growth reported in the corresponding period last year. On the hand, food credit has recorded a strong growth of 25.7% during the period April – October 2001.

Faced with a poor offtake of credit from the commercial sector, banks have invested in government securities (G-Secs) beyond the SLR requirements. Investment in G-Sec was higher by 19.7% in the first 10 months of FY02 (accounting for 38.7% of total assets) as against 17% rise recorded in the comparable previous period. Excessive investment in G-Secs may hamper the flow of credit to the private sector, when the demand for non-food credit picks up with economic revival.

While the banking sector recorded a healthy growth rate of 16% in interest income, earning declined by 11%. This was mainly due to a 21% rise in provision for non-performing assets and a pressure on interest margins. New private sector banks however, managed to show a 12% growth in profits on the back of relatively small rise in provision figure. Also, a 44% jump in interest income fueled their earnings growth.

New generation banks outperforms
 Growth in FY01 in
ParticularsInterest incomeProvisionsEarningsTotal assets
SBI group banks16.6%11.3%-17.1%19.8%
Other public sector banks14.1%21.6%-15.1%14.7%
New private sector banks43.9%8.3%12.3%33.7%
Old private sector banks14.0%29.0%-11.7%15.7%
Foreign banks15.1%25.7%-12.7%23.0%
All schedule commercial
banks (SCBs)
15.9%20.5%-11.3%17.1%

Softer interest rates seem to have done little in fueling credit growth from the industrial sector. Higher level of non-performing assets, preference of household for fixed interest rates, administered rates on small savings and large volume of the government borrowings are reducing flexibility in the downward movement of interest rates.

Reflecting a marked slowdown in the industrial investments, the sanctions and disbursements by All India Financial Institutions (AIFIs) have also registered negative growth rates. During the period April to December 2001, sanctions declined by 32% (18.3% growth in April – December 2000) and disbursements dropped by 17% (rise of 16% in April – December 2000).

The RBI designed major financial sector reforms in order to enhance the operating efficiency of the financial system. The key developments announced during the year included the following:

  1. Bank rate has been reduced to 6.5% with effect from October 23, 2001 and CRR has been reduced to 5.5% with effect from December 29,2001. Reduction in cash reserve requirement has augmented banks resources by about Rs 80 bn. Apart from this the RBI has also aligned the interest paid on CRR at bank rate with effect from November 3, 2001.

  2. The RBI has changed the provisioning requirement for NPAs to 90 days from the earlier 180 days. This would be effective from the year ending March 31, 2004. Banks are however, advised to make additional provisions from the year ending March 31, 2002, to facilitate smooth transition to the new norm.

  3. In December 2001, the RBI issued guidelines for one-time settlement of NPAs outstanding up to Rs 25, 000 to public sector banks. This is to facilitate state run banks to clean up their accounts at a faster clip.

  4. In order to enhance the credit, banks are given freedom to offer loans over Rs 0.2 m at sub-PLR rates to exporters and other credit worthy borrowers. They can also formulate deposit schemes with higher fixed interest rates for senior citizens.

  5. Exposure limit for single borrower reduced from 20% to 15% of capital funds with effect from March 31, 2002 and for groups the limit reduced from 50% to 40% of capital fund. For financing infrastructure projects, the group limit is extendable up to 50%. Higher limit for infrastructure sector is recommended in order to fuel economic growth.

  6. VRS scheme was implemented successfully by state run banks. About 12% (101,300) of total employees of these banks adopted VRS. Banks can write off these expenses over a period of 5 years. Banks are also given freedom to frame their own recruitment strategies as banking service recruitment board was abolished.

  7. Electronic fund transfer (EFT) facility is available within and across cities between branches of banks and across banks. The RBI operates EFT and it is presently available for fund transfer across 13 major cities in the country. Transfer of funds on a same day basis was implemented effective from January 2, 2002 at the four metros with three settlements per day.

  8. Taking into account, the downward movement of interest rates, maximum interest rates payable by NBFCs on public deposit has been reduced to 12.5% from 14%, with effect from November 1, 2001.

NPA analysis
 Growth in gross NPAsNet NPAs as a % of advances
ParticularsFY00FY01FY00FY01
Public sector banks2.6%3.2%7.4%6.7%
Private sector banks2.3%26.8%5.4%5.4%
Foreign banks10.9%17.5%2.4%1.9%
All SCBs2.9%5.8%6.8%6.2%

The government has initiated a step in the right direction by announcing the aforesaid reform-oriented measures, which has improved operating efficiency of banks to an extent during the current year. However, it should take more proactive steps to curtail the rising non-performing assets in the banking system. Creation of asset reconstruction companies (ARCs) and foreclosure laws would help banks in faster recovery of bad loans and would improve their financial performance. Low credit growth for the sector, however, remains a concern.

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