Subir Roy: The next step for Indian banking

It is difficult to see how industrial houses rooted in the ethos of South Bombay will have the enthusiasm to offer savings bank services and microcredit to poor and illiterate farmers

India’s banks are at the turnstiles. They can go out, graduating to greater strength and playing a more useful role in the economy; or they can go round in circles without changing much. The current juncture is important for several reasons. One, new banking licences are to be issued, focusing attention on the intrinsic health of the sector. Two, after the financial crisis of 2008, the developed world is still grappling with the task of devising systemic changes that will prevent a repeat. Three, a key lesson from the crisis is that deregulation and emergence of mega industry players do not, in themselves, assure sustainable growth. No bank is too big to fail.

All this has created space for the Indian system to seek out innovative solutions and policies to address the following goals without relying entirely on hand-me-downs from the developed world. One, extend and expand the electronic payments and clearing system to cover every corner of the country. Two, address the financial and credit needs of all, including the lowliest. Three, ensure that banks remain strong and stable.

Looking back, bank nationalisation beginning 1969, disapproved by free market forces in and outside of India, took financial inclusion several steps forward and gave a critical boost to the nation’s savings rate. But a price was paid in terms of the banks’ financial health and staff productivity. The post-1991 period was marked by policies of recapitalisation and a sea change in norms governing asset classification and income recognition. Thus, today the balance sheets of a good majority of public sector banks look sound and are taken to be so by independent analysts.

In the post-1991 period, the new private sector banks were a major catalyst for change. These led in the adoption of information technology, set new benchmarks for service, and forced public sector banks to follow suit. Although several of the new banks such as Centurion, Times and GTB do not exist any more, those like HDFC Bank and Axis Bank – which are by no means niche players – have set new benchmarks in cost and service delivery, which others have had to chase.

To this domestic experience has to be added the lessons from what has happened in the developed economies. The end of Glass-Steagall (separation of commercial and investment banking), the rise of financial supermarkets, and the spreading of risk through the creation of innovative products shaped what looked like an unending boom. Then the whole thing bombed — the bigger the player, the bigger the fall. There is now a strong case for commercial banks confining themselves to a degree of narrow banking where their primary task is to handle and settle transactions, make payments, offer safe keeping for individuals’ savings and, critically, provide credit to small and medium businesses. Not only are these the biggest job creators, but they also make up the supply chain for corporate biggies and the base on which they sit.    

Based on this knowledge, will it be enough to simply issue a few more banking licences and expect that more competition will do the trick? The post-1991 period has been marked by branch consolidation, and spreading financial inclusion has taken a bit of a back seat. Will more competition of the sort we already have take financial services to those who do not have access to it?

If the past is any guide, continued high growth in a liberalised policy environment will mean rapid growth in corporate earnings as also top-bracket incomes. New banks without legacy employees and technology will be able to start with a clean slate and the right skills. These should not find it difficult to get enough business in metropolitan and urban areas without having to go out to the villages to survive.

It is difficult to see how industrial houses rooted in the ethos of South Bombay will have the enthusiasm to offer savings bank services and microcredit to poor illiterate farmers in the back of beyond. Since non-banking financial companies have created some successful new banks, it can make sense to have a bit more of that. The Shriram Group, with its reputation for innovation (truck finance) and sustainable growth, comes to mind. Beyond that, the hour certainly belongs to the best among the successful microfinance institutions (MFIs). Those that have adopted information technology extensively, have robust internal systems and processes and have not taken a hit in Andhra Pradesh and so have their capital and profitability intact, would qualify. MFIs like Janalakshmi, Equitas, Ujjivan and Bandhan come to mind. Some, among these, should qualify for banking licences, no matter how restricted.

 

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