Saturday, October 13, 2012

Financial Sector Reforms on the Edge.

Entry of FDI in Insurance is fine; but in pensions, it is fraught with high risk. Europe and US provide ample evidence for the anxiety. But there are other reforms in the Financial Sector waiting.

IMF in its latest study felt that the financial sector globally has not gone far enough on the financial sector reforms and the system is no safer now than it was when it crashed in 2007- 08. The message was in favour of more high quality regulation and called for a ‘reboot’ of the system onto a safer path".

The latest Financial Stability Report from the RBI also confirms that the risks to financial stability have worsened although financial institutions are largely resilient to credit, market and liquidity risks. Technology, the facilitator for speed and accuracy, started turning riskier than ever. While partial nationalisation of banks post crisis did the bailouts both in US and UK, it has its caution. When Basel III demands infusion of funds on an ongoing basis, FRBM would render the Government’s efforts riskier than ever pinching the taxpayer aggressively. Holding the same argument as for Insurance while permitting 49% FDI, why not lessen the Government share in public sector banks and pave the way for market efficiencies to allow public investments in Banks?

It would also appear that the small banks would have to find a way for a comfortable exit when the going is good and the market sentiment is favourable if they have to conform to the capital adequacy standards and other provisions of Basel III or opt for Mergers and Acquisitions. But the small banks adopted technologies faster and proved better reach to their clients. Their exit would harm the interests of several customers loyal to them.

At a recent Conference at PRMIA, Hyderabad a view has emerged that the asset liability mismatches are likely to move to a different trajectory when the depositors would like to move more to shorter terms and alternate investment paths compared to savings of long term nature. When the longer term deposits gradually exit, in the absence of development financing institutions, it would be difficult to fund long term loans needed both for the infrastructure and real estate sectors. Will the Government be able to keep on refurbishing capital at each knot of the shortfall in nationalized banks that constitute a little over 80 percent of the total banks in India? How should Banks respond to risk capital concerns in the emerging markets?

All along, risk management practices in emerging economies have been driven by regulation and intense supervision. The other side of risk, namely, the reward is forgotten. When does the coin turn to the other side and what the Banks need to consider and remedy? There is a crying need for revisiting the financial sector reform agenda at this crucial moment.

The conservative regulator, distancing from capital account convertibility, and non-introduction of derivatives saved the Indian financial system and economy from the contagion effect of global recession in 2008. But we could not stay far from it for long and throughout 2011and till now in 2012, the policy makers blame the global effects of Euro fall and job losses of US in the wake of continuing recession-effect for the ills of the Indian economy. "The financial sector is putting pressure on the government," the BIS Report 2012 adds. "Governments, with their deteriorating creditworthiness and need for fiscal consolidation, are hurting the ability of the other sectors to right themselves. And as households and firms work to reduce their debt levels, they hamper the recovery of governments and banks. All of these linkages are creating a variety of vicious cycles." The rate cuts did not lead to enhancement of credit indicating declining risk appetite on the part of the banks. Even the CRR cut in the previous monetary policy announcement led only to investment surge and safe havens from the banks.

The rising NPAs arising from three factors – global impacts, slower growth on domestic front and some irresponsible lending, unlike the pre-reform shadow of directed lending programmes, are serious concern. Due diligence of firms and their directors, expectations of financial flows are turning out faulty with billions of rupees getting unearthed in frauds and collusive part of banks being questioned in the process. ATM frauds are on the rise. Manipulations are maneuvering the systems.

Capacity Building on low key:

Man to machine recruitment policies and rising attrition levels have contributed to rising costs of training and capacity building efforts. Cost-effective training into domain and non-domain areas like basic banking, technology, risk management, insurance and sector specific skills is still not reflected as investment in human resources in the balance sheets of banks.

In fact, Narasimham Committee suggested in its very first report that the government should gradually reduce its share in the PSBs. Instead, we saw its increasing participation and interference. May be that the present Finance Minister, an ardent reform advocate making bold now, would revisit the reform agenda.

It is not the size of the Bank but the quality of service and proximity that become crucial to financial inclusion agenda and therefore, the small and big banks, the public and private sector need to co-exist. The holding company concept with all checks and balances may become relevant for getting critical mass in shape in the financial sector. The less-attended cooperative sector needs also dedicated support for a clean-up and reform process. This calls for specific budgetary commitments from the Finance Minister with a specific restructuring agenda. The economist in politician is seeing the twilight on the sky. This is the best time for ushering in another bout of financial sector reforms.