The Second Coming

March 31, 1998 will be an important date in Maidavolu Nara-simhams calendar. That is when he is expected to submit his report to the government on furthering reforms in Indias financial sector.

There is a certain irony in the appointment of the former Reserve Bank of Indias governor in December 1997 to head the nine-member committee. For, much of his next report will wily nily have to assess the progress of the comprehensive recommendations he had made in 1992.

So far, the Narasimham Committee II has had four meetings, appointed several working groups and prepared a number of papers for internal circulation.

 

Of course, the circumstances under which the 70 -- year-old Narasimham will work now are substantially different from 1992. In that year, the focus was on freeing up a sector in which over-regulation had, to quote an understatement in the 1992 report, resulted in a decline in productivity and efficiency. Now, freedom is a given; the need today is to accelerate the pace of change.

If Narasimhams first report, a vital document of 104 pages, was the starting point, the turning point has been the budget of 1996-97 and the credit policy of April 1997. Explains Rajiv Butalia, vice president, IndusInd Bank, one of the private banks that came into existence after the 1992 reforms, The focus of reforms until 1996 was on policy changes. The cash reserve ratio (CRR) and statutory liquidity ratio (SLR) were too high, interest rates were regulated, priority sector targets were heavy which left few resources with banks to lend.

Today, both the CRR and the SLR have dropped from 25 per cent to 10.5 per cent and from 38.5 per cent to 25 per cent respectively, leaving banks with far more money than ever before. And banks have more freedom today in terms of lending, deposit mobilisation and internal organisations.

It is easy to predict that the Asian currency crisis and the WTO pact are expected to influence the second committee report in a big way. But the number of unimplemented suggestions from the earlier report means that bankers and financial institutions can expect some repetition as well. Bankers think some of them could do better with some modification.

One of the crucial proposals was for industry-wide mergers of banks and of financial institutions. When the earlier committee came out with its report towards the end of 1992, the State Bank of India, Indias largest bank, was expected to swallow up its seven associate banks; and Bank of India and Bank of Baroda would become one entity. The logic for such mergers: they would have made these banks and institutions global in size and therefore able to parry international competition.

Many bankers feel there is still scope for restructuring of this scale. I suggest the committee think of revamping the entire system. The number of public sector banks should be reduced from 26 as of now to just six, and these should have an international presence, says PV Maiya, chairman of ICICI Bank, recommending a three-tier banking structure. He, however, advocates voluntary mergers with the choice left to the banks.

At the second level, he wants regional commercial banks for example the Karnataka Bank and State Bank of Mysore to merge, so that they become stronger local banks without international dimensions.

The third level Maiya suggests should be formed with the merger of regional rural banks (RRBs) with local area banks. After writing off their losses, the central and state governments should reduce their shareholding in these banks to nil, handing them over to the sponsor banks, he says. Each of the new banks should have jurisdiction over four districts, which would help it serve the constituency better.

The idea of mergers is not entirely new. S S Bhandare, chief economic advisor, Tata Sons, points out that it was suggested as far back as 1967 by the Saraiya Commission - a body headed by a banker of eminence. Mergers, however, can be a tricky issue, unlikely to yield the kind of successes that bankers hope for. The problems that cropped up after the merger of New Bank of India with Punjab National Bank make a case in point.

As a solution, Bhandare recommends that each bank should find its niche market and capitalise on it. Let banks have a strategic business units approach, hiving off the weak business units to others, he says.

Another key recommendation of the 1992 report that has not been implemented is the creation of asset reconstruction fund (ARF), to help banks cope better with the chronic problem of bad debt. Says the 1992 report, An arrangement has to be worked out under which at least a part of the bad and doubtful debts of banks and financial institutions are taken off the balance sheet so that banks could recycle the funds realised through this process into more productive assets.

If this has not materialised, it is, according to Bhandare, probably because of opposition from state governments which would not want their assets to be liquidated or transferred elsewhere.

Now, however, an official closely connected with the new committee indicates that the idea is very sound and will definitely find a prominent place in the report.

If size and bad debts have had regulators worried about future competitiveness, bankers are particularly exercised about priority sector lending, another point on the governments unfinished agenda. The 1992 committee had suggested that priority sector should be redefined to comprise small and marginal farmers, the tiny sector of industry, small business and transport operators, village and cottage industry and rural artisans.

The deregulation of interest rates on priority sector lending has helped banks a bit. Pointing out that priority sector lending has become profitable, Butalia says: The priority sector concept has softened. But the treatment of export credit as priority sector lending for foreign banks should be extended to other banks as well, he says.

What new grounds should the Narasimham committee cover? In the wake of the South East Asian currency crisis, bankers agree that volatility in forex rates is something that the system now has to learn to live with. Butalia suggests that the risk taking capacity of banks should be raised to withstand such a crisis.

Apart from training and developing the necessary skills, risk taking ability requires the development of derivatives market to hedge the risk. Instruments with fixed and floating yield rates should be available so that banks can move from one to another. Awareness of risk is the first problem with banks, which can be solved through technology, he observes.

Another external factor that will affect banking in India in the future is the WTO pact. Under the WTO provisions, India will have to open up the financial services market for international banks. And though no one expects a flood of them in the initial stages, many global financial firms may ultimately make inroads here, points out Bhandare.

The legal and audit systems too need a close look, if banks have to give a better account of themselves, feel some bankers. For qui-cker recovery of debts, debt recovery tribunals need to be strengthened. If banks are more confident of the safety of their money, they may not mind lending it to companies with less than AAA ratings.

A frequent complaint here is that the government is not able to find enough senior judges to head the tribunals. Maiya finds this explanation ridiculous. The banking system is capable of locating enough retired high court judges for debt recovery tribunals. The industry also would not mind spending the necessary resources if it is sure of recovering the debt, he emphasises.

No one could deny the need for measures to improve the operational efficiency of the banks and to sharpen the supervision of the financial systems, including the banks and the parabanks.

Even as the committee faces a host of issues and the age old complaints against CRR and SLR impositions continue, Bhandare has a novel idea. The first committees recommendations were to be implemented by the government, the Reserve Bank of India and other authorities. That will be true of the new committees report as well, which means the unfinished agenda will stay long. Instead, Bhandare suggests setting up a long-term banking commission to implement the committees recommendations. Such a body should be able to keep its focus narrowly centred on the task, and should therefore be able to deliver reforms at a faster pace. And as one banker suggests, M Narasimham should be asked to head that commission too!