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A vision for banking

Shankar Acharya, Dec 5, 2001, 10.30pm IST

more than three decades have passed since indira gandhi nationalised the banks.

with the benefit of hindsight and painful experience we can safely conclude thatthe decision was a major error in economic policy, with lasting adverse

consequences. unfortunately, a witches' brew of stale ideology, vested interests andfear of the unknown has stood in the way of a necessary policy reversal. but the

costs of the status quo are mounting daily. we need a vision for the future. thebanking sector has not been devoid of reform. the first half of the nineties saw

significant reform efforts, including: phasing out of almost all interest rate controls,major reductions in reserve requirements of slr and crr, abolition of quantitative,

firm-specific credit controls, phasing in of internationally recognised prudential

norms for capital adequacy, income recognition and asset classification, somedilution of 100 per cent government ownership of public sector banks (psbs),licensing of new private sector banks and more branches of foreign banks,

strengthening of the supervisory framework for banking and the establishment oflegal and operational structures for debt recovery tribunals to speed resolution of

loan recoveries. these were all necessary and important reforms. but they did not

tackle adequately the structural problems of public sector banking. even in the year

2000 gross non-performing assets (npas) of psbs as a proportion of commercialadvances were very high at 14 per cent, compared to only 4 per cent for the new

private sector banks and 7 per cent for foreign banks. net of provisioning, npas of

psbs were higher than 7 per cent compared to under 3 per cent for the other twocategories. by international standards, this ratio should be less than 2 per cent. psbs

also suffer in comparison with the other two categories according to obvious

performance yardsticks such as profitability and expense (especially wage-bill)ratios. psbs also drink frequently at the budget trough to shore up their inadequate

and (sometimes) declining capital, thus compounding our grave problem of highfiscal deficits. this is especially true of a (growing) set of weak psbs. the slow pace

of reform in the financial sector is captured by a friend's observation, whilecommenting on the changes visibly wrought between 1991 and 2001: " if you look

at the range of products available in shops (or crowding our roads!), there has beena huge improvement in variety and technology. but in the financial sector, it is still

the same old sbi, the same old idbi and the same old uti which dominate!" so wheredo we go from here? most importantly, we must recognise that a psb-dominated

banking system (with over 80per cent of bank deposits in psbs) is simply notconducive to efficiency, innovation, fiscal prudence, investment and growth in our

modern, increasingly integrated economic world. the rest of the world has

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understood and acted on this premise. we need to do so also. this is not just an

ideological fad. the need is grounded in the harsh realities of experience. the psbframework does not foster efficiency, innovation, risk-taking and commercial

orientation. bank managements lack freedom in matters of recruitment, promotions

and remuneration. they cannot redeploy labour easily, let alone retrench surplusstaff. loss-making branches cannot be closed. customer service is weak.

accountability is often of the wrong kind. the list is well-known. nor are psbsimmune from scams and scandals. and it is very, very difficult for a government to

allow a psb to fail, however strong the financial and economic case for closure.more than a year ago the government proposed amendments in banking laws to

allow government equity in nationalised banks to be reduced to 33 per cent. but the

case was made on the grounds of fiscal stringency to meet the capital needs ofgrowing banks and a commitment was made to retain their "public sector

character". surely the time has come to be frank. most of the problems of psbs are

inextricably associated with government ownership and control. we don't needbanks with minority government ownership and mainly "public sector character".we need psbs to be transformed into efficient, private sector banks. of course, they

should be professionally managed, accountable to responsible, broad-based

shareholders and a sound regulatory framework in a competitive environment. butlet's be clear; we need to privatise our psbs for the same kind of reasons that

underpin the government's privatisation programme in other sectors. so what's my

vision for indian banking five years hence? ideally, the deposit ratios will havereversed, with 80 per cent in private banks and 20 per cent in psbs. there may be a

strong, professionally managed private bank. the sbi is still likely to be there as a

professionally managed public sector bank with good private sector characteristicsof profitability, flexibility and technological strength. some of the other psbs would

have undergone privatisation. a few may have been acquired by global banks withglobal reach. the weak psbs, which could not be sold, would have been closed(with

protection to small depositors) or converted into "narrow" banks only allowed to

buy government securities. other existing private banks would continue, merge into

new entities or fail according to their performance in the market place. fromtoday's perspective all this may seem like a pipe dream (to some it may be a

nightmare!). but consider the alternative. if we continue our current course of

hesitant banking reforms, financial stress will likely increase, the frequency of bail-outs will probably rise putting a weak fisc under even greater pressure, the system's

capacity to mobilise and intermediate financial flows will fall, harming both the

level and productivity of investment and growth will suffer. the transition to alargely private sector banking system will be far from painless. but at least it holds

out the promise of a rising curve of efficiency, confidence and growth. surely it'stime to close the book on indira gandhi's mistake? ( the author is a professor at

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icrier on leave from his previous assignment as chief economic adviser,

ministry of finance. the views expressed are strictly personal.)