The proposal to set up a new apex body to strengthen the mechanism for maintaining financial stability requires clarification

The Finance Minister might not have laid out large sums for the financial sector but his budget speech has references to important policy initiatives. These deserve attention irrespective of the fiscal support that they may be getting.

Providing additional capital to some public sector banks, however, continues apace. After allocating Rs.1,900 crore as Tier-I capital for four banks in 2008-09, the government is infusing this year another Rs.1,200 crore in select banks. For 2010-11, the budget provides Rs.16,500 crore to ensure that the assisted public sector banks attain a minimum 8 per cent Tier-I capital by March 2011.

Capital funding of PSBs

Obviously the government's practice of bolstering the capital of public sector banks, though inevitable at this point in time, has its limitations. As banks expand their activities, especially in the lending area, the pressure for resources will mount. The alternative to raising funds from the government is to access the capital market. Almost all PSBs are now listed and their share offerings have generally been well received. The snag is that these banks cannot expand their capital base substantially without letting the government stake fall below 51 per cent. Hence, other innovative ways have to be tried.

The NDA government had drafted a legislation that would allow the government to bring down its stake in a PSB to a third of the paid-up capital. Simultaneously, thepublic sector character of these banks will be preserved. It is highly unlikely that such a proposal can be revived in the foreseeable future.

Mergers not a solution

More recently, the government has been looking at consolidating the banking industry. The idea of encouraging mergers among banks to create ‘global sized' institutions sounds attractive but may not be the right way to boost capital adequacy. The merged entity's capital will be just sufficient to support the aggregate business. A merger does not necessarily free capital from either of the merging banks. Any of the existing PSBs is unlikely to have ‘spare' capital. Moreover, there are fundamental objections to the merger route. The Finance Minister has advocated gradualism, preferring individual banks to decide. The RBI feels financial inclusion is a more important objective than bank consolidation.

Inclusive banking

The decision to recapitalise the regional rural banks is unexceptionable. The last time these banks were recapitalised was in 2006-07. However, the problems of the rural banking sector have to be viewed in its entirety.

The thrust today is on developing delivery channels that are more cost effective than the traditional ‘brick and mortar' bank branches.

Dealing with this subject under the broad category of ‘Inclusive Development', the Finance Minister said that the government wanted to extend appropriate banking facilities, including insurance and other services, to habitations having population in excess of 2000 by March 2012. These services will be provided through business correspondent and other models with appropriate technology back up. Around 60,000 habitations are expected to be covered.

To develop the requisite technology, it is proposed to augment the resources of the Financial Inclusion Fund and the Financial Inclusion Technology Fund (in NABARD) by Rs.100 crore each.

The Finance Minister's statement that the RBI will consider giving bank licences to more private sector players has received a mixed reaction. Large sections of the media have construed his statement as an open invitation to large industrial houses to start banks immediately.

The RBI has done well to clarify that there is no policy change on bank licensing. In any case, it is highly unlikely that there will be a U-turn on the decade old policy that has prevented cross-holding of bank shares by industrial houses. Voting rights are capped today. One of the main justifications for bank nationalisation was to free large banks from large industrial houses. That might have been driven by ideology but the case for segregating bank ownership from business houses has been strong, not only in India but in the U.K. and the U.S.

Besides, the small number of private banks that were ushered in the 1990s have not had a uniformly sound track record.

Those promoted by the erstwhile development financial institutions have prospered. A few merged with bigger banks and the Global Trust Bank was rescued by the government-owned Oriental Bank of Commerce.

Move for new apex body

The proposal to set up a new apex body to strengthen and institutionalise the mechanism for maintaining financial stability requires clarifications. Much will depend on how the Financial Stability and Development Council is conceived and goes about co-ordinating the functions of various regulators.

At present, the RBI is responsible for financial stability. Newer financial sector regulators such as the IRDA have an enormous responsibility in that area. The government, however, seems keen on avoiding ‘turf wars' between different regulators. Instances of overlapping regulation are growing in number as disintermediation of the financial sector gathers pace. Increasing sophistication and innovation will deliver hybrid financial products that will have features of, say, banking, insurance and capital market. Regulatory jurisdiction may become a contentious issue.

Already unit-linked insurance plans have been in the news with competing claims by the IRDA and SEBI for regulatory jurisdiction. And there is likewise ambiguity in the case of interest rate futures traded on the stock exchanges. The product has features of banking and capital market.

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