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N. A. Mujumdar

Policy-makers must realise that the growth of the PSBs is as important as the development of the capital market. The policy discrimination against the PSBs and in favour of the capital market must end. The thrust of the RBI policy should be to evolve a network of PSBs, micro-credit institutions, cooperatives, NGOs, and self-help groups to strengthen the credit support to the decentralised sector, says N. A. Mujumdar.

Commercial banks, especially the PSBs, play as important a role in development as the capital market.

PUBLIC sector banks went through a traumatic phase in the 1990s, when banking sector reforms based on the Basle norms were implemented. Over the years, the public sector banking system had become a huge, inert animal which moved only when prodded by the Reserve Bank of India or the Government. This is no longer so, with PSBs today responding promptly to market signals. This remarkable metamorphosis is reflected in the profile of the PSBs which emerges from RBI's Report on Trend and Progress of Banking in India, 2001-02. The RBI deserves to be commended on this highly analytical report, which clearly demonstrates the resilience of PSBs.

"During the year 2001-02, there was a significant improvement in the profitability of the scheduled commercial banks (SCBs) owing to the rise in trading profits attributable to the soft interest rate regime, coupled with the containment in operating expenses, notwithstanding the higher provisions and contingencies... " There was a healthy growth of time deposits, despite the significant lowering of interest rates on deposits. What is more, there was a perceptible decline in non-performing assets: The ratio of gross NPAs to gross advances of SCBs declined from 11.4 at end-March 2001 to 10.4 per cent as at end-March 2002. Net NPAs to net advances declined from 6.2 per cent to 5.5 per cent, over the same period.

Most important among the prudential norms introduced by the RBI to strengthen the banking system is the capital to risk-weighted assets ratio (CRAR). At end-March 2002, 25 PSBs had CRAR exceeding the stipulated minimum of 9 per cent: Only two accounting for 4.3 per cent of total assets of PSBs, did not fulfill the stipulation.

"On the whole, the picture seems to be quite encouraging, especially in the context of a scenario where most analysts take pleasure in debunking PSBs. The recent passing of the Securities and Reconstruction of Financial Assets and Enforcement of Securities Bill, by Parliament, should further strengthen PSBs. Since this legislation provides more powers to banks to recover their dues from their borrowers, it should go a long way'' in reducing NPAs significantly.

It, thus, becomes clear that the macro environment in which the PSBs function is not exactly conducive to enhancing their efficiency. Three features of this macro environment may be indicated. First, the sub-optimal use of banking sector's resources: At end-October 2002, the credit-deposit ratio of the SCBs was only 54 per cent. In any healthy and vibrant commercial banking system, the ratio would be 70-75 per cent. Second, the PSBs are bearing the brunt of the heavy borrowing programme of the government. At end-October 2002, the investment-deposit ratio was more than 41 per cent in contrast to the stipulated statutory liquidity ratio (SLR) of only 25 per cent. In other words, government borrowings are crowding out the productive sectors.

Obviously, the first and second features are mutually-related. The third stems from the objectives of the Tenth Plan: Among the important objectives are, creating five million jobs and reducing poverty to 20 per cent. These objectives cannot be achieved by merely focussing on large and medium industries and exports, as the current policy seems to be doing. The thrust of growth would have to be also on agriculture, small industries, micro enterprises, self-employment avenues and, generally, on what is referred to as the decentralised sector. What should be the strategy to reach out to the decentralised sector? This is the issue which the RBI needs to address.

Profits: Myth and reality

Net profits of PSBs recorded a huge jump from Rs 4,317 crore in 2000-01 to Rs 8,301 crore in 2001-02. Market theologists may exult in this sharp rise, attributing it to deregulation of the banking sector. That would be a hasty conclusion. There is a catch in this: The bulk of the profits are attributable to the bonanza of the low interest rate regime: For instance, of the total net profits of Rs 8,301 crore in 2001-02, nearly Rs 6,000 crore was trading in Government securities. Another Rs 1,547 crore came from forex transactions. Pure banking transactions could claim little profits. In fact, in the case of some banks such as Indian Bank, if trading profits are assumed as zero, they would be in the red.

Deposits growth

There is a similar analytical point in the explanation for the buoyant deposits growth. Time deposits growth at 15.9 per cent in 2001-02 was only marginally higher than the deposits growth of 15.8 per cent last year. In fact, deposits growth become really buoyant this year: Growth in time deposits, up to October 4, at 13.8 per cent was significantly higher than the growth rate of 10.8 per cent recorded during the corresponding previous period. The RBI's explanation of the buoyancy phenomenon is rather superficial: "The steady accretion to time deposits with banks, despite the downward movement in interest, rates, reflects the safe heaven sentiments... ''

The real explanation lies in the fact that with the collapse of the UTI, and with the stock market in the doldrums, the saver, particularly the small saver, is returning to the banking system. One would have thought that with the relatively lower GDP growth anticipated in 2002-03, deposits growth would have decelerated this year. If this has not taken place, it is because alternative investment avenues have become far less attractive. The "return of the prodigal'' kind of thesis seems to offer a more appropriate explanation.

It is necessary to reiterate that fiscal policy should not discriminate against bank deposits, as the Task Force has proposed. Exempting dividend income from personal taxation while taxing interest income from bank deposits is counter-productive in the Indian context. Commercial banks, particularly the PSBs, play important a role in development, as the capital market. Recently, the RBI had asked PSBs to extend medium- and long-term credit to projects. One hopes that a level-playing field between bank deposits and investment in equities would be maintained.

Slimming of the PSBs

Another dramatic transformation which has not attracted much attention, is the sliming of PSBs. The major component of operating costs for commercial banks is the Wage Bill, which witnessed a decline of 6.2 per cent in 2001-02. Twenty-six out of the total 27 PSBs introduced a voluntary retirement scheme (VRS) in 2000-01 and, as a result, there was a reduction in staff strength by about 12 per cent. This has had a salutary effect on improving the profit parameters of banks. With the lowering of wage costs, the ratio of wage bill to total assets of the SCBs fell from 1.8 per cent in 2000-01 to 1.4 per cent in 2001-02. Obviously, such a reduction will have a continuing salutary impact on operating expenditure of the PSBs.

Overall, the PSBs appear to be resilient institutions that have developed an ability to respond to market signals. They have shed fat and adjusted themselves remarkably to a low interest rate regime

Admittedly, the enormous profits made in 2001-02 was because of a fortuitous factor and, therefore, should not be misconstrued as an indicator of efficiency. The low interest rate regime brought about a sharp decline in yields on government securities, say from 14 per cent on a 10-year security to 7 per cent. And this provided profitable opportunities for trading in government securities and the rest is history.

What is now important is that the policy-makers must realise that the growth of PSBs is as important as the development of the capital market. The policy discrimination against PSBs and in favour of the capital market, which is clearly visible throughout the 1990s, must end. Bank deposits and investment and inequities must enjoy a level-playing field so far as fiscal concessions are concerned. Even if the capital market develops — and this is a heroic assumption in the present moribund state of the stock market — it cannot reach the decentralised sector, the development of which has assumed greater importance in the Tenth Plan. Fortunately, the RBI is taking greater interest in developing the micro credit institutions. The thrust of the RBI policy in the coming years should be to evolve a network of PSBs micro credit institutions, cooperatives, RRBs, NGOs, and self-help groups (SHGs) to strengthen the credit support to the decentralised sector. Banking on commercial banks for achieving the Tenth Plan objectives, including sustaining a high rate of savings, should thus become the mantra of both fiscal and monetary policy.

(The author is former Principal Advisor to the RBI.)

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