SMALL BANKS, Big Expectations: The Global ANALYST

The Global ANALYST, November 2015

 Big Expectations
M G Warrier

“In order to get sustained growth we need more competition, especially from new entrants who are in a better position to reach hitherto excluded parts of our economy.”
Dr Raghuram Rajan, Governor, RBI
The proposal to licence small finance banks can be seen as a continuation of making certain provisions of Banking Regulation Act, 1949 applicable to cooperative societies through enactment of Banking Regulation Act(As Applicable to Cooperative Societies) during 1960’s.
The existing banking structure in India, comprising public sector banks including State bank of India and its Associate Banks, old and new private sector banks including the new entrant from the MFI family, namely Bandhan Bank, Regional Rural banks, Local Area Banks, primary(urban) cooperative banks, state and central cooperative banks dispensing credit through thousands of primary cooperative credit societies, evolved over several decades, is elaborate and has been serving the credit and banking services needs of the economy. This structure has multiple layers to cater to the specific and varied requirements of different customers and borrowers. The banking structure has been instrumental in the mobilisation of savings and promoting economic development in India. In the post financial sector reforms (1991) phase, the performance and strength of the banking structure  has improved perceptibly.
Financial soundness of the Indian commercial banking system compares favourably with its counterparts in the advanced and emerging countries. The credit for this goes entirely to the post-independence political leadership of the country which allowed functional autonomy (RBI Governor Dr Raghuram Rajan recently referred to this as ‘De facto autonomy’) to judiciary and the central bank all through, including during the stressed period of emergency, when democracy was in captivity. Reserve Bank of India on its part never assumed a confrontational position against GOI on any issue at any point of time.
Instead, where felt necessary, RBI delayed implementation of its own decisions, which its professional wisdom approved as right, till it could take GOI into confidence. Such delays, at times have resulted in avoidable losses to the country and brought down the reputation of RBI by a shade. RBI top management has all along been taking the position of a caring teacher, when occasionally, some individuals in government assumed recalcitrant positions on crucial issues. The approach helped the central bank to play its regulatory and supervisory role with confidence.
This explains the philosophy behind RBI’s moves in changes in regulatory norms and institution building in the financial sector. There is a general perception among analysts and economists who comment in the media about the recent moves by GOI and RBI to increase the banking network by introducing new players as something new. Let the records be put straight by mentioning that the process of reforms in the banking institutional structure is an ongoing one in India and within RBI, studies for making the performance of banks better are taken up from time to time.
The discussion paper “Banking Structure in India- The Way Forward” released by RBI during August 2013(accessible from RBI’s website was the result of one such effort. The paper claimed that the primary motivation for the exercise of reviewing the Indian banking structure was to cater to the needs of a growing and globalizing economy as well as deepening financial inclusion, recognizing the importance of incorporating lessons from the global crisis, even when the Indian banking system had remained largely unaffected by the global crisis. The document gives the progress so far and RBI’s thinking about the future of the country’s banking structure.
Concept of small finance banks       
The proposal to licence small finance banks can be seen as a continuation of making certain provisions of Banking Regulation Act 1949 to cooperative societies through enactment of Banking Regulation Act(As Applicable to Cooperative Societies) during 1960’s. Cooperative societies engaged in the business of banking and satisfying certain criteria were compulsorily brought under the purview of Banking Regulation Act and those which wanted to remain outside RBI regulation were given option to do so subject to certain conditions like ‘not accepting deposits withdrawable by cheque’. After cooperative banks, Regional Rural banks (RRBs) and Local Area banks were set up in the small banks’ category with specific mandates to cater to the savings and credit needs of  certain categories of clientele which did not get adequate attention from bigger banks.

The new category of small finance banks now being licenced belong to a different category and there seems to be a new   approach on the part of RBI in selecting the eligible applicants for issue of licence to this type of banks. The cautious stance while selecting new promoters for licensing big private sector banks and the effort to bring many players who are already doing banking-like business into mainstream banking seen in the selection of candidates for payment banks and small finance banks reveals a broad pattern in RBI’s thinking.

As the existing private sector banks (old and new generation) have not made much progress in increasing their share in banking business which remains at around 25 per cent, the balance being still with public sector banks, bringing more players may not help much in increasing outreach or promoting financial inclusion. Bringing existing players from the microfinance institutions(MFIs) and supporting organisations like India Post to instil professionalism in mobilisation of savings and providing credit to small borrowers make more sense.

Small finance banks and financial inclusion     

More than three years back, I had concluded my first article in this magazine, which was on financial inclusion, with the following observation:

“The speed with which changes are brought about in the approach to governance and financial sector reforms will define the timeframe within which India will be able to come out of the present impasse. Coming out, India will. Present eruptive symptoms show that ‘we, the people’ will not show the patience with which they waited for generations to gain independence, for realizing basic human rights. Financial inclusion will expedite empowerment towards achieving this goal. The segment of the generation which benefited maximum from LPG(Liberalisation-Privatisation-Globalisation) policies, those who were in the age group of 15-35, circa 1991 should take the responsibility to take India out of the mess in which the lazy generation to which I belong has landed the country. It will be in their self-interest.”

I am looking back with satisfaction the developments on the economic front in recent times in our country.

Writing about this year’s economics Nobel winner Angus Deaton, Justin Wolfers, professor at the University of Michigen makes the following observation about data:

“…For too long, econometric analysis had proceeded as if data were simply handed down from a statistician-loving higher power. The reality is far uglier: Data are imperfect, surveys can be unrepresentative, people misreport, and attempts to recontact survey participants often fail. Deaton confronts these issues head-on, and he has taught economists  how to extract meaning from imperfect data.”

The quote is relevant not only in the context of the dilemma faced by planners, social scientists and regulators equally in understanding poverty and financial inclusion. Even the feedback given to Prime Minister Modi about the progress made in implementation of Pradhan Mantri Jan Dhan Yojana need to be viewed again, after going through this observation by Justin Wolfers. Prime Minister was informed that additional deposits of Rs 32,000 crore had accrued into newly opened accounts under the scheme. PM said, “Hum abhee tak ameeron ke gareebee dekhe hei…Ab hum gareebon ke ameeree dekha…”(So far we have seen the poverty of the rich…Now we saw the wealth with the poor…)Without contesting facts, let us also remember that banks with lakhs of crores of deposit base, in any case will be opening new accounts and accepting fresh deposits. This is not to belittle the achievement under the scheme with provision for zero balance accounts for ensuring financial inclusion, but to view data with an open mind.

The way forward

The RBI Discussion Paper of August 2013 is based on in-depth in-house studies and the present RBI position on future banking structure takes into account the findings of those studies. This enhances one’s confidence in the central bank’s professional competence in addressing various issues such as enhancing competition, financing higher growth, providing specialized services and furthering financial inclusion. It is in this context one has to view the present transition of the Indian banking system back to a new variety of multi-agency approach  which has been covered in some detail, last month in this magazine.
(The writer  is a former General Manager, Reserve Bank of India and author of the 2014 book “Banking, Reforms & Corruption: Development Issues in 21st Century India")


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