Making the banking sector more vibrant

In 1999, the RBI set up a Regulations Review Authority (RRA) for reviewing regulations, circulars and reporting systems, based on feedback from the public, banks and financial institutions. This process, besides streamlining and increasing the effectiveness of several procedures and simplifying regulatory prescriptions, paved the way for issuance of Master Circulars (MCs) and reduced reporting burden on regulated entities.

MCs significantly improved general understanding of central bank rules and procedures, and increased transparency. The transition from MCs to Master Directions became effective from January 2016, heralding availability of central bank rules and regulations for each subject matter on real-time basis.

The RBI set up the Second Regulations Review Authority in May 2021 to streamline regulations and reduce the compliance burden on regulated entities. While the second RRA is being ably assisted by an advisory group drawn from the industry, there are certain systemic issues for which actionable suggestions are offered.

The year 1972 witnessed crystallisation of a formal definition for ‘priority sector’. Over the last half-a-century, priority sector loan (PSL) guidelines have undergone several deep changes resulting in a regime which is akin to the income-tax rules.

The current PSL guidelines require domestic commercial banks (excluding regional rural banks and small finance banks ) to achieve, in a fiscal year, a target of 40 per cent of adjusted net bank credit or credit equivalent of off-balance sheet exposures as on the corresponding date of the preceding year, whichever is higher. However, many banks fall short of the stipulated targets as shown in the Table.

Therefore, the current stipulation needs to be curtailed. In fact, the Narasimham Committee-I had recommended reducing the scope of directed credit under the priority sector from 40 per cent to 10 per cent, which couldn’t be accepted, and Narasimham Committee-II had taken note of this. However, economically speaking, it makes sense, and many bankers would support this, albeit not overtly.

Moreover, the system of target setting has lost its sacrosanctity. Many banks which fail these targets prefer depositing the shortfall with apex financial institutions because they get risk-free and effortless annual return, or trade in priority sector lending certificates.

Major changes

It is also widely acknowledged that loan availability in rural areas has undergone metamorphic change with microfinance, digital lending, Direct Benefit Transfer, etc., entering the turf. Further, with growing rural to urban migration, dependence on agriculture and allied activities will continue to reduce.

In view of these, besides reducing the current target of 40 per cent to 20 per cent gradually, the constituents of PSL should be pruned to include just agriculture, micro and small industries, retail trade and small businesses, as it was originally. The personal loans segment should be taken out of its purview.

The bailout through public recapitalisation can be replaced with ‘bail-in’ via contingent convertible capital instruments (commonly referred to as CoCos). CoCos are non-traditional hybrid capital instruments. Their twin objectives are (a) loss absorption and (b) recapitalisation, when a bank ‘is’ in trouble, or when it is a ‘going concern’. CoCos can absorb losses either by converting into common equity or writing down the principal, subject to activation of “triggers”.

Currently, banks cannot mobilise term deposits (TDs) for over 10 years maturity. This limits their capacity to make long-term loans for projects, particularly in the infrastructure space. And, sprucing up infrastructure is an urgent developmental objective of the country with funds always lagging requirement. Therefore, amendments may be made in the Banking Regulation Act, 1949 to enable banks to mobilise deposits for 15-20-year maturity.

It is widely acknowledged that digital transactions have been increasing rapidly, especially after the November 2016 demonetisation. The phenomenon has led to people maintaining higher balances in their savings bank ( SB) accounts than before. As can be seen from Chart 1, 2016-17 clearly marks an inflexion point.

However, the low return that the SB accounts offer is further eroded by inflation, besides the interest earned beyond ₹10,000 is taxable.

In view of these, even though the SB interest rate has been deregulated, there needs to be a minimum rate that banks should offer, and this rate be fixed at 4 per cent, that is, the mid-point of RBI’s targeted inflation rate of 2-6 per cent under the inflation targeting framework.

In recent years, the central bank has made certain changes that have invited the ire of the business community. One such issue is the restriction on opening of current accounts. According to reports, banks have closed lakhs of current accounts.

To put the issue in perspective, funds diversion has been the scourge of Indian banking since many decades, at times due to stressful business environment, governmental policy changes and technological obsolescence. But this cannot be wished away in a single stroke of regulatory ink.

A single account in a single bank/branch may not suffice to meet the varied needs of an honest businessman. Besides, with the advent of account aggregators, transaction details of borrowers can be open to lenders as part of standard loan agreement. So the argument that borrowers under stress are tending to squirrel away sales proceeds through multiple accounts cannot hold water.

Instead of jettisoning business, the central bank could aim at resolving the issue with stakeholders’ consultation. Corrective action should eschew coercion. Besides, the Covid-19 woes afflicting business should not be exacerbated by changes that can wait for another day.

Going forward

Regulations cannot be cast in stone. Dialogue is at the heart of regulation. Achieving good regulatory outcomes is almost always a cooperative effort by the government, regulators, the regulated and the broader community.

As borrowing and lending try to break free from banks, currency going private, many in-house activities outsourced, personnel becoming increasingly ‘uberised’, office space getting shared and data being available for a song, the central bank can hardly afford to get stuck in a time warp. ‘Can’ and ‘not ban’ should be the motto. Re-engineering, not retiring, should be the credo, going forward.

Rath is a retired Chief General Manager, RBI, and Das is a retired Senior Economist, SBI