Thursday, April 27, 2017

How to redefine and rebuild the banks in India

How to redefine and rebuild Banks?

‘Banks are basically meant to allocate capital to businesses and consumers efficiently.’ Post demonetization, customers feel the pain more than gain in banks. Farmers getting inadequate and untimely credit from banks take to huge private debt only to commit suicides later.

Manufacturing micro and small enterprises, the seed beds of employment and entrepreneurship, are being shown the door by the banks notwithstanding the CGTMSE guarantee up to Rs.2crore. Banks never went beyond the mandated Rs.10lakh guarantee cover for the MSEs.

Large number of customers is slapped with irrational minimum balances in their accounts and levy of penalties at will. RBI is averse to regulate such overtures in the name of micro management of banks being not their role.

With over 38% of the population still illiterate, Jan Dhan and Mudra Yojana as instruments of financial inclusion have only become compulsive agenda for the banking sector. Banks- Public sector or private sector, have their eyes set only on profit. Such profits are dwindling with net interest margins declining following the growing NPAs.

Institutional innovations like the Small Payment Banks, India Post and the likes as also the MFIs have also proved inadequate to meet the needs of the present leave alone the future banking needs of the population.

Cashless banking leading to poor inflow of deposits during the last four months and cashless ATMs demonstrate the erosion of faith in banking in India. Bad banking and good economy cannot co-exist and therefore, it is imperative that innovative institutional solutions should be thought of.

Indian economy targeting double digit growth ere long has competing clientele bases in the current milieu of banking. Domain banking has moved to high tech banking. Men at counters have now become slaves of the machine instead of being masters. Public sector banks have long back forgotten their purpose and their owner proving no better.

Emerging context requires that banking is redefined to meet the specificities of farming, employment, entrepreneurship, infrastructure, and international finance as distinct entities. In fact, Narasimham Committee (1991) suggested consolidation and convergence of the PSBs into six to serve the needs of the service sector, holding government securities, and retail lending; Local Area Banks to cater to the farmers and small entrepreneurs; International Bank to cater to the needs of exports and imports. Development Finance institutions, left untouched, would fund the infrastructure sector. FSLRC also echoed the same in its Report. This is the time to look at the spirit of such recommendations and rebuild the banks to regain the fast eroding trust in banking by the larger customer base of this country.

Breaking the nexus between the farmer and politician can happen only when there is mutual trust between the bank and the farmer. Farm sector, consisting of crop farming (organic, precision, green technologies etc.), dairy farming, shrimp farming, poultry farming, sheep farming and agricultural marketing by itself is inherently capable of cross holding risks, save exceptions like the tsunamis, severe drought for long spells, huge typhoons. It is only in the event of such natural calamities that a Disaster Mitigation Fund should come to the rescue.

The existing commercial banks should shed this portfolio in favour of RRBs and merge all the rural branches with the RRBs. RRBs should be redesigned to take to farm lending in a big way – from farm machinery to crop farming and allied sectors on a project basis. Insurance plays a vital role in mitigating credit risk and therefore, the insurance products should be redesigned and modified on the lines of South Korean model.

All the Rural Cooperative Banks could continue their lending to the farm sector parallel to the RRBs as the lending requirements are huge and farmers require multiple but dedicated lending institutions.

RBI has not been comprehensive in regulating the sector. It is better that NABARD is restructured to play an exclusive refinance and regulatory role over the entire farm and rural lending consistent with its purpose of formation. Its other functions like the RIDF can be relegated to a new institution hived off from the NABARD.


Nurturing entrepreneurship and promoting employment in manufacturing are moving at snail space in the Start Up, Stand Up and Make-in-India initiatives. Prabhat Kumar Committee (2017) called for setting up a National MSME Authority directly under the PMO to correct the milieu.

All the MSEs should be financed by dedicated MSE Bank Branches. All the existing SME branches should be brought under a new regulatory institution. SIDBI has disappointed the sector. It has to first consolidate all its FUNDS into just five: Incubation Fund; Venture Capital; Equity Fund to meet the margin requirements of MSEs when and where required; Marketing Fund to meet the market promotional requirements; Technology Fund; and Revival and Rehabilitation fund.

SIDBI should reshape into refinance and regulatory institution for the MSME sector with focus on manufacturing and manufacturing alone. It should divest its direct lending portfolio to avoid any conflict of interest. Its present lending to real estate and non-manufacturing MSME lending should be transferred to the commercial banks. RBI which is not currently able to cope with the regulatory burden of this sector can transfer it to SIDBI,

Vaanijya Banks (Commercial Bank):
All the existing commercial banks – both in the public and private sector – would do well confining to the project finance, lending to real estate, services sector, housing, exports and imports etc. All the Banks should constitute at the Board level a sub-committee on Development Banking to work on the transition arrangements to the above functionality.

Maulika Vitta Vitharana Samstha (Infrastructure Bank)
Huge NPAs have come from the practice of lending long with short term resource base coupled with lack of experience in assessing the risks in lending for infrastructure projects. ‘All the perfumes of Arabia’ (RBI’s structural debt restructuring solutions) did not sweeten the bloody hands of banks. It is time to revisit the universal banking model and reestablish Infrastructure Bank to fund the infrastructure projects and logistic parks.

These measures would help achieving the growth like never before.
RBI and GoI could constitute a High Level Committee to work on the modalities for transiting to the new structural transformation of the financial sector.