Another important measure of the strength of the system is its profitability levels. The high level of NPAs has been a proximate cause for the low profitability levels of our public sector banks. Other factors have been the large number of unremunerative branches, low productivity, over manning and arcane methods of operations apart from the impact of directed credit and high pre-emptions of funds. Spreads in the Indian banking system remain high and yet profitability levels are low. There has been some improvements in recent years is net profits for Public Sector Banks (PSBs) as a group (partly as a result of some recapitalisation in some of them). With increasing competition from foreign and private banks, margins will come under further pressure and issues of customer orientation productivity and efficiency in relation to profitability will come to the fore.
14. Action on strengthening the foundations of the system by improving asset quality enhancing capital and improving profitability would need to go along with structural changes in the system. One of the more important developments that has been taking place in international banking is the revival of the phenomenon of universal banking in terms of which the distinction between commercial investment and development banking is getting blurred. In this country also we are moving towards this concept. Commercial banks have been making in larger measure than before, term finance to industry and providing investment banking services apart from setting up subsidiaries in such diverse areas as mutual funds securities trading and factoring. At the other end of spectrum the development finance institutions (DFIs) are increasingly getting into the areas of working capital finance and have also set up banking and mutual fund subsidiaries. The financing requirements of Indian corporates, whether from the DFIs or from the banks, are now being seen as an integrated operation. Non-banking financial companies (NBFCs) have proliferated in India in areas like consumer finance, hire purchase, equipment leasing and housing finance. How their activities should be integrated into the financial system and regulated is an issued which needs to be examined.
15. The financial structure is thus evolving towards a continuum of institutions rather than discrete specialisation and the facilities that are being provided are to be seen as aspects of a spectrum of financial services in keeping with relationship banking. Universal banking in fact provides for a cafeteria approach or, if one were to vary the metaphor it would take on the role of a one stop financial supermarket. These developments also have implications for the framework are content of regulation.
16. With regard to the structural framework of the banking system, there is a need to help move towards a structure as the CFS suggested, with a few large Indian banks with an international character, some large national banks and the rest consisting basically of regional/local banks. There is also a need to impart greater competition as between public sector banks and private sector banks.
17. In recent year, there have been a large number of mergers in international banking and in the process large institutions have become ever larger as a response to the challenges of competition and as an aspect of synergising operations and achieving scale economics. Mergers should in the normal course, be driven by business needs and should lead to the growth of larger banks both in public and private sector. There is general recognition now that size is an important determinant of banking strength. Mergers amongst strong units can be both a means of strengthening them as also providing for greater opportunities for competition.
18. A merger of strong units would indeed have, to borrow a phrase from another discipline, a force multiplier effect. it is sometimes argued that mergers could provide for a strong bank taking over a weak one. On the other hand, such mergers could well result in an adverse impact on the asset quality of the stronger unit as a result of acquiring the contaminated portfolio of the weaker unit in the absence of any system of writing off the NPAs of the latter before the merger.
19. It needs however to be recognised that mergers to be meaningful and useful should not be a mere arithmetical merger of balance sheets and staff of the banks but should yield benefits in terms of staff and branch network rationalisation. Unless these benefits can become available, mergers of public sector banks would tie down managements with operational issues and merely distract attention from the real issues without giving any commensurate benefits.
20. The problem of the weak banks is a separate and important issue and needs to be addressed squarely. As a working definition, a weak bank could be regarded as one whose accumulated losses and net NPAs exceed its capital funds or in respect of PSBs whose operating results less income from recapitalisation bonds reveal losses for three consecutive years. Some public sector banks fall in this category and, if the depositors funds are not at risk (as they would otherwise have been ) it is because of the implicit guarantee provided by State ownership of the institutions. There could be some weak banks which are potentially viable with some weak banks which potentially viable with some corrective measures being applied even as there would be those whose affairs are not capable of early or complete correction. In the latter case, the costs and implications of various alternative approaches, not excluding closure in some cases, would need to be carefully examined. In this connection, the concept of narrow banks has been suggested as a possible solution for the short term. Narrow banks could be allowed as an opportunity to facilitate their rehabilitation. The strategic revival plans formulated by some weak banks and approved by Government and Reserve Bank of India (RBI) as well as the Memoranda of Undertaking (MoUs) entered into by Management and Staff Unions is indicative of this approach. The issue of closure would need to be examined if it were concluded that the narrow banks approach does not enable rehabilitation of some banks.
FLYING HIGH
MAVERICK