TAMIL NADU

THE CHALLENGES BEFORE INDIAN BANKS

THE RESERVE BANK of India's Report on Trend and Progress of Banking (2003-04) released recently places the major issues of Indian banking in a sound perspective. The financial sector reform process has moved forward. Its primary objective is to create a strong and resilient banking system, one that has been exposed since the mid-1990s to greater competition at home and is getting ready to take on global competition. The RBI is right in taking credit for tightening regulatory and supervisory norms that have ensured greater accountability and market discipline among participants. International benchmarks on best practices, wherever appropriate to the Indian situation, are being adopted. The Indian financial system is now close to global standards. Much of course remains to be done in the areas of risk management and corporate governance but an elaborate roadmap has been drawn up to move Indian banks towards Basel II norms, which are currently being applied by major global financial institutions and their regulators.

Another significant development is the shift from micro to macro regulation. That has made it all the more necessary for banks in India to get their act together and face multiple challenges arising out of the focus on deregulation and liberalisation. Deploying funds in quality assets is a major challenge; management of revenue and costs is another. Issues of corporate governance and the need for appropriate disclosure are related tasks that have received increasing attention at home and abroad. Within the broad ambit of corporate governance, a major issue that is also highly topical, relates to concentrated shareholding in banks. Ownership concentration has led to moral hazard as owners of banks sometimes develop unsavoury linkages with the business. The RBI is clearly referring to some recent spectacular failures in private sector banking. Diversified ownership is an imperative, and the central bank has proposed new guidelines to ensure that the ultimate ownership of private banks will remain diversified. On this and the related issue of foreign banks acquiring Indian banks, the central bank must forge a consensus with the Government so that the policy stance becomes coherent. One of the outcomes of a policy encouraging a well-diversified ownership structure of banks will be the presence of a large number of individual shareholders. In such a situation, the need for corporate governance will be even more keenly felt.

Banks are today in a much better position financially than they were four years ago. But the turnaround is largely on account of a fortuitous combination of sharply declining interest rates boosting their treasury incomes and operating profits. Consequently banks have been able to make large loan loss provisions and clean up their balance sheets with relative ease. However, interest rates are now on the rise. Treasury incomes, which have been in the nature of a windfall, are out. Banks will therefore have to depend largely on their traditional business of lending for their income. Credit growth during the first half of this year, traditionally a slack season, has been one of the highest in recent years. Loans to the retail sectors, including and especially home loans, have been the main contributory factor. With interest rates on the rise, the cost of home loans will go up. The RBI has already cautioned banks against indiscriminate lending to home loan borrowers. Banks will therefore need to seek new avenues to lend. Agriculture and small and medium industries ought to be the priority areas. The challenge is to overcome age-old obstacles to credit delivery especially in these sectors.

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