Financial sector employees and workers joined a strike by trade unions on September 7 with a specific objective: to oppose a possible government decision to expand the presence of domestic and foreign private banks in India’s banking sector. The immediate provocation for their action was a “discussion paper” released by the Reserve Bank of India (RBI) delineating the “pros and cons” of permitting such an expansion. The objectives of permitting private entry noted by the paper are the oft-repeated ones: (i) the size and sophistication of the banking system needs to increase to accommodate the needs of a modern economy; (ii) the geographic coverage of the banks needs to be extended; and (iii) banking needs to be made more inclusive with increased access to banking services for all. Though the RBI does not support a change in policy, the note is bringing the issue back to the table.
The paper is in fact is quite explicit about the last of these objectives declaring that it is considering providing licences to a ‘limited number’ of new banks because: “A larger number of banks would foster greater competition, and thereby reduce costs, and improve the quality of service. More importantly, it would promote financial inclusion, and ultimately support inclusive economic growth, which is a key focus of public policy.”
This is indeed quite surprising inasmuch as the record of extant private banks in terms of meeting priority sector lending targets and offering services to geographically dispersed and underprivileged populations has been poor. Even to the extent that they have approached priority sector targets it has been because the government has redefined priority sector credit to include forms of “indirect finance”. In the case of agricultural credit for example, priority lending can include housing finance of certain kinds and lending to input providers such as seed companies.
This shortfall on the part of the private banks is not surprising, since lending to rural producers in a manner that is inclusive involves lending relatively small sums to a large number of remotely located borrowers. This inevitably raises transaction costs and given market or government determined ceilings to interest rates charged on priority sector credit, profits tend to be low or at times negative. If lending to rural borrowers has to be profitable it has to be at extremely high interest rates (as is the case even with microfinance institutions) that discourages the use of such credit for productive activities. If not, low profits or losses on such lending have to be cross-subsidised with profits earned by lending to other lucrative markets. The result would be lower profits on average, which public sector banks may be willing or persuaded to accept, but private banks, domestic or foreign, are unlikely to tolerate. Hence the inherent tendency among the latter is to circumvent norms with regard to lending to the priority sectors or to disadvantaged groups. Suggesting then that allowing entry of new private sector banks would make the financial system more inclusive is to go against both logic and experience.
If at all competition is being encouraged it must be for other reasons. But this too is surprising since competition in the financial sector has associated with it the potential for increased fragility. If easier entry conditions lead to competition between similarly placed financial firms, they would seek to attract depositors by offering higher interest rates. This forces them to lend to sectors offering higher returns which normally are sectors undertaking risky investments in pursuit of larger profits. When the principal financial intermediaries attract depositors by paying higher interest rates, there is an imperative to invest in assets offering high returns that are also risky and prone to default.
Moreover, as the experience in a number of countries shows, the liberalization of entry conditions, especially for foreign investors, does not lead to increased competition but to consolidation. The RBI’s discussion note recommends removing or diluting controls on the entry of new financial firms, subject to their meeting pre-specified norms with regard to capital investments. This aspect of liberalization would apply to both domestic and foreign financial firms, and caps on equity that can be held by foreign investors in domestic financial firms are likely to be gradually raised and done away with. Easier conditions of entry do not automatically increase competition in the conventional sense, since liberalization also involves freedom for domestic and foreign players to acquire financial firms and extends to permissions provided to foreign institutional investors, pension funds and hedge funds to invest in equity and debt markets. This often triggers a process of consolidation.
When Mexico chose to liberalise entry conditions for foreign investors into its banking sector in 1996, only 7 percent of total bank assets were controlled by foreign banks. Roughly one half of these foreign-controlled assets were in banks that did not engage in retail lending. These foreign de novo banks, as well as large foreign banks with no prior presence in Mexico, quickly began to purchase Mexico’s largest retail banks. By March 1997, 14 percent of bank assets in Mexico were controlled by foreign banks. By December 2002, the share of Mexican banks under foreign control increased to 66 percent. Today, the banks not under foreign ownership are few in number and extremely small. Thus measures aimed at enhancing competition could actually backfire.
Finally, what is of interest is the RBI’s willingness to consider permitting ownership of banks by business groups. We must recall that among the factors that motivated the nationalisation of leading private banks in 1969 was the evidence that a miniscule share of total credit was going to the agricultural sector and that two-thirds of advances by banks were being directed either to firms belonging to the same business group as the bank itself or to firms in which directors of the bank had an identifiable connection. Providing the basis for a return to such a situation is obviously contrary to the inclusion objective.
Thus, whether we look at it in terms of enhanced competition or in terms of financial inclusion, easing the terms of private entry would deliver results quite contrary to what the discussion paper expects. If yet ,the central bank is putting the issue on the table, it must be because of pressures – internal or external - it is unable to resist.
Keywords: Indian economy, RBI, private banks
Post-liberalized India and India in 1969 is totally different, so any comparison is invalid. Moreover the likes of SKS(ROA of about 6, much more than SBI's 1.6) has proved that banking in financially excluded section of society is viable proposition which can be done economically. It is not full-proof method, many changes and regulations are needed, but we need such new ideas. And it is the new bank and increased competition which can bring to the table what is needed. Today's rural india is not what we use to see in 1969, FMCG industry are thriving there which shows that this region have potential which needs to be tapped, with greater profitability.
No businessman would invest his funds where there is no profit. One can see that NO private banks have opened any branches in rural areas nor they are lending to priority sector in rural areas. It is the public sector banks that are present in rural areas. If today there is improvement in rural areas, it is only due to the presence of public sector banks. Though money lenders may be lending at a heavy ROI but allowing private entities would lead to exploiting the rural poor. It will lead to concentration of wealth in hands of few increasing the gap between the rich and the poor. We should think of utilising the 110 odd crore human resource in a profitable way than to hand over our resources to foreign entities who will just take all the profits and wealth out of our country.
Anything that brings competition, improves infrastructure directly or indirectly in this competitive economic world should be encouraged. Moreover I support it because it would help to meet financial inclusion and hope majority of poor section would get financial access.
Nationalization of banks in 1969 was just Political expediency. Yet probably the erstwhile share holders did find relief from the endless demands of employees, politicians and bureaucrats to bend the rules to suit their demands! In American banks, top level managers seem more interested in their own bonuses than helping economic growth and safety depositors funds. Private Public partnerships in the Financial sector with adequate legislative and judicial oversight may be the best for India's orderly economic growth. Otherwise, it will be a case of "Fence eating the crop!"
It is a sad day for the common toiling citizens in impoverised India, which is more than 70%.I do not understand where it would lead to seeing the situation of economic scenario in USA,Europe vis-a-vis Brazil, a very less known name in India other than its football fame!
The opening up of the India Banking sector to private players (including foreign players)appears to be an act of haste to be repented in leisure later. No matter whatever be the idealistic high sounding principles of any private entity seeking foray into this sector it can be safely said that the human greed at some point of time would attain predominance over professional conduct clouding corporate governance principles. Examples of recently failed US Banks and instances of the likes of Satyam should have put to rest the experimentation sought by the RBI. The country still has massive segment of rural / semi urban populace that still needs state intervention to take care of their basic needs. Financial Inclusion project is an offshoot and a recognition of this need. The ideals of 'nationalisation' dawning a new era of mass Banking is yet to spread far and wide. The exisiting Public Sector Banks' structure reeling under the pressures of compliance with Basel norms, mounting NPAs and an apathetic legacy have to turn around and shift to a new paradigm. Already the market has witnessed entry of quite a few tech savvy upmarket players in the Banking arena who captured the cream ofthe business in niche segment leaving the banks to fend for themselves with whatever is remaining. The playing field does not seem to be on a level. Bringing in additional players eating into the remaining business would rip the system apart and throw the exising Banks out of gear. Not to mention of the harm that may befall the public in general in the event of a situation experienced in the US. The India economy can ill afford one. We also seem to have forgotten the not very old case of 'Global Trust Bank', also under the RBI's supervision under Section 35 of the RBI Act along with other PSBs, where the RBI in much haste got the maligned entity merged with the Oriental Bank of Commerce and breathed a sigh of relief. No one in the public has been made aware of reasons for the banks failure, who were the culprits and what action has been taken towards accountability. RBI may publish a white paper on the Global Trust Bank episode to give confidence to the public. Given the state of the Indian economy in particular and the world economy in general and the ground realities it is advisable to continue the existing structure of the intact and allow the PSBs to rediscover themselves and usher in a paradigm shift until we discover another dark sheep like the 'Global trust bank'. It is my sincere appeal to the RBI to nip the vested interest bud at an early stage and protect the innocent countrymen and the country.
"Fractional Reserve Banking" is discriminatory, as the money in the hands of the Bankers is at least,10 times MORE VALUABLE,than the same amount in the hands of others. Because this alone,Private banking needs to be banned.
Full Privatisation in such a critical sector is definitely harmful. Taking bribes under the table to deliver loans will get elevated to higher level with higher losses and absolutely no service to common man . Transparancy has to come from all not just from state.
The government and bureaucracy is corrupt and incompetent. Even if India shifted towards state capitalism, there will be several execution problems. Privatization has delivered results, is a proven model, and a much better alternative to big government. Be open and let it flourish.
Private banks will ensure better services that the state owned banks are way behind in. Also, many more products would become available and costs would come down. There is a lack of transparency in the state banks that would be turned around with more private banks on the scene. Also, many thefts are occurring at the state banks almost unabated.
When an Indian Group (Hinduja for instance) acquires a bank network outside of India, do you complain as well?
The logic behind nationalisation led to the infamous Indian Bank scam which cost thousands of crores of tax payers money. and did cut throat competition between private banks rise the deposit rates to unsustainable levels before 1969 ? the data for the pre 1969 years does not support this argument.
Lack of proper and fair bankruptcy laws and legal bottlenecks in debt recovery (esp in rural India) is preventing many large pvt banks to expand into rural areas. As a result, the marginal farmers are at the mercy of money lenders and very high interest rates. If the debt recovery mechanism is rational and modernised as in the west, then the 'inclusive' banking is possible. Where ever this kind of rational system with market forces determining the prices, etc are distorted due to archaic and 'socialistic' polcies, then the sufferer is usually the marginal users who are forced into the grey markets and money lenders.
The private banks are doing good service to high networth customers only and their services for normal customers are not upto mark even though the charges for certain special services are very high compared to those in public sector banks. It is my personal experience that nowadays PSBs are also wooing customers and are offering good services which are at par for all types of customers; The services of pvt. banks for ordinary customers are degrading day-by-day even though they may be better in case of high value customers; Government should not allow the mushroom growth of pvt. banks since the common man's lifelong savings will be at stake.
We should learn from the condition of American economy which is in shambles today because of giving free hand to foreign bankers.
Private foreign banks should be allowed to boost competition among their peers in India. Only competition will force the banks, or for that matter any business enterprise, to provide services at affordable price. Prohibiting the entry of foreign players into Indian market in the disguise of 'helping poor' is cheap tactic to keep those lazy tellers and inefficient managers employed in the nationalized banks.
Let us not forget the past htstory of the factors that led to bank nationalisation in the early sixties.Providing red carpet welcome to the entry of domestic and foreign private players in the banking sector amounts to widening the gap between the rich and the poor.In the name of financial inclusion,the Centre should not aid private ones to fatten the purse in the name of poor rural people.
I'm from an extremly rural area. Here banking services are considered as facility for some elite group of people only. People are in the grip of greedy moneylenders as they do not have other options. This policy can bring the banking services to common one. But as government and policies keep on changing, who will be responsible for complete accountability of private and foreign players in future. There must be some regulatory body specially for this. Let us hope my village will also get banking services soon...... Let it be private.....
I am quite dismayed reading your "reasoning" that because there is little or no profit in financially serving the poor, that it is only the Govt. that fill the gap. This is quite malicious, and completely against simple logic. I refer you to private telecom, then look at food (a govt. controlled enterprise). The essential fact, known to all reasonable humans, is that human ingenuity will find a way to make it profitable -- this is the essence of capitalism. This is why it's the only system that works -- ask China. A government, an essentially nonhuman (lack of ingenuity) machine, is the last thing you want in such a situation. The capitalist (not the monopolist, oligarchy, e.g., mining sector) is forced to find a way to make it worthwhile, to generate VALUE.
I belong to a tier 3 city. I observed that after arrival of 2 private banks in my city, the competition between banks definitely increased leading to improved efficiency within govt own banks which were in pathetic condition few years back. Anything which can bring some competition among govt sector is most welcome. It is not that our system is bad, only thing is that our govt employee don't believe in work. I have found people in smaller city crying for bank loan. It is better to pay higher interest rate than paying good amount to agent and take loan from govt bank which has become a common and accepted norm in smaller town. And by the way can any one explin me the reason for strike from union? I just feel that they will loose their dictatorship and undertable money after the arrival of private banks.
Undoutedly nation needs more banks,but we should not be obssesed with private sector presence to be'the only way'. Model like 'one ruppee bank' by SBI, Mobile banking,internet banking(through CSC,s under e-governance project),bussiness correspondence model, etc. Will go long way to lower transanction cost and ensure financial inclusion. Also regulator can learn from 'Mexico travesty' to strengthen checks on banks.Lets not close the door,but move forward with noble will and intensions.
The concern laid down here is very well established. Its a fact that at the end of day once the private sector or foreigns firms do get an entry due to relaxed norms, it is an eventuality rather than just a possibility that they will be tempted to be narrow minded in their focus on where they want to do business-- rural or urban. It will be no surprise that if they end up doing what ever current mnc's/private banks are doing and that is-- pretty much nothing or a mere lip service to bring the semi urban,let alone rural areas, under the perview of mainstream banking.
Even in metropolitan areas most of the transactions are still in cash. Having greater number of banks will encourage greater use and more transparency. There will be more money to go around. After all money in a bank or in the stock market creates more jobs and improves the GDP, than being in a pillow!!
Why shouldn't a banking system similar to the Grameen Bank of Bangladesh be considered for rural and backward areas which can handle Govt. subsidies and unemployment compensation to poorer people?
It will be a bad day for the nation if the regulator succeeds in persuading the government to give more licenses to foreign banks and corporate houses to enter the banking indsutry. The regulator has become soft towards the new generation of private sector banks. They want our money but not our presence.
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