Not The Same Failures

banks marked the first one.

Normally it is ungracious not to permit such self-adulatory indulgences except for the embarrassing fact that what is claimed for the current "revolution" in the banking system runs totally counter to the central tenets of the first revolution. The main thrust of financial liberalisation, as we know it, is to undo the damage done to the banking system by nationalisation. The Governor, perhaps, may have been semantically correct, though politically incorrect, if he had described what is happening currently as a counter-revolution. But the difficulty with this formulation is that it would make him a counter-revolutionary -- an honour better to renounce than to announce with the fanfare in this age of public relations.

 

Even believing in transmigration of meaning from one word to the other, a la George Orwell, one wishes that the counter-revolution has succeeded. But has it? Whatever evidence there is -- and it is from the bastion of the financial system, shows that there is hardly any change in the manner banks, mainly those in the public sector, are functioning. On the eve of the financial reform in 1992, the striking feature of the public sector banks has been a relatively low credit/deposit ratio which was a consequence, among others, of high reserve and liquid assets requirements ratio. The low level of credit/deposit ratio then explained why Indian banks had a higher interest rate spread, so as to achieve adequate operating profits, 13 of the 27 public sector banks were involved in losses to the extent of 5 to 10 per cent of their assets; 14 other public sector banks earned a profit between 0--0.5 per cent of their assets. Low income and low profitability were associated also with low asset quality. In all, 7 out of 27 public sector banks had a ratio of non-performing assets(NPAs)-to-total assets in the range of 25 to 45 per cent and 17 banks had a ratio between 15 and 25 per cent.

The government, of course, relieved this dire position through capitalisation in two stages in two years 1994-95. While this eased the immediate problem of solvency, it being only the "stock solution", has been no more than a placebo. The net worth of banks, beefed up by infusion of capital, could have been sustained only if their profitability had improved. But that required a "flow" solution which really lies in a more fundamental restructuring of bank management and operational efficiency. This is evident in the financial position of banks. Between 1992-93 and 1995-96, public sector banks are in red except 1994-95 and whatever improvement there is owes to the State Bank group.

Again, there is only a crawling improvement in regard to NPAs. The number of public sector banks with NPAs between 10 to 20 per cent of total assets increased from eight in 1994 to 14 in 1996, though banks with the NPAs above 20 per cent declined to 10 in 1996 from 18 in 1994. In no banks such bad assets are less than 10 per cent, which by international or prudent standards, is unconscionably high. There is no knowing, however, how far these figures are reliable. A few days back, the RBI has generously asked banks to soften the criterion of NPAs to make their position respectable.

This casts a doubt on the transparency of their balance sheets no less than on the integrity of the RBI management.

The much vaunted supervisory wing of the RBI, bolstered up by the infusion of additional staff and layering of hierarchy with padded jobbery could hardly stem the deterioration of the financial position of public sector banks. "Non-satisfactory" or "unsatisfactory" banks are still around 13 out of 27 public sector banks. Likewise, only eight public sector banks could reach a prescribed capital to risk the adjusted ratio of 8 per cent. Sordid though this condition is in statistical terms, there is nothing to boast of in the organisation management and culture of banks, which could be a standard bearer of a reformed and revamped banking system. If financial reform is to be on a high trajectory, initial conditions like skills in asset management and evaluation of credit risks in the banking system, before the reform process gets under way, have to be substantially altered. One of the main reasons why bank lending rates have continued to remain high, despite the plethora of liquidity in recent months, is the deficiency in skills in a new environment. There is a tendency, therefore, towards risk aversion by preferring lucrative government bonds as investment rather than venturing out to find new creditworthy clients. This tendency is fortified by a spectre of being roped in for fraud, if something done in honest pursuit of business goes sour.

Financial reform thus, is half-baked and tardy, in part because the largest segment of the banking system is still insulated from market discipline. Competition among ban-ks is not keen enough nor effective enough to improve risk management and to handle new financial instruments like derivatives and complex foreign exchange transactions that gain prominence with increased capital flows. Nor is the scope for moral hazards diminished in the evolving system. The prudential supervisory control is not calibrated such that the banking systems becomes an incentive-compatible system

Even though what is happening in the Indian financial system savors of a revolution, one must be chary of calling it so. As Orwell warned us long ago, all revolutions are failures but all failures are not the same. By doing a right thing at the right time revolutions can be warded off and so the failures.