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Bimal Jalan on the challenges ahead for the banking system

India has a sound, rule-abiding banking system, but challenges remain.

So far as India's banking sector is concerned, I think there has been large growth and it is regarded as one of the best in the developing world for the reason that we adopted a policy measure quite some time ago as a country that we should follow the best international standards, whether you are public sector or private sector. That is very important in terms of capital adequacy, in terms of provisioning of bank loans, in terms of whatever definition you have. Because earlier, you know, in the eighties, early nineties and so on, it was thought that the public sector had special characteristics and you don't have to abide by those rules. If you go by those rules, there was enough room in terms of capital adequacy.

But it is very important for an internationally functioning financial system, whichever institution it has, either public or private sector, that it conforms to the best rules. And as you probably know insofar as the banking system is concerned, that is what you might call the vanilla banking sector as an entity which takes deposits and lends. Not the American type of banking system, which has got subsidiaries and collateral deposits and the kind of crisis that they had. But now now I am talking about the end of the nineties and early 2000s. When there is a Bank of International Settlements in Basel, of which a number of countries are members and they have international norms regarding the capital adequacy. Then if a loan has been rescheduled, you couldn't say that it is a non performing assets or NPAs. But if it has been rescheduled because of the default in payments, then it is an NPA.

But talking about the commercial banking sector that India's NPAs are, in comparison with the rest of the world, somewhat better. All the indicators of what a good banking system is, we would meet those standards. It is a different point about interest rates and I'm leaving that apart. But even there, in terms of spread, that is, the cost of banking is how much you charge above the minimum interest rate. It would compare quite favourably with the rest of the world. In terms of the cost and the cost of raising deposits, for example, the different segments in our system, the cross subsidisation of rural banking from normal banking, I don't want to go too much into it.

My point is that India's banking system is among the best and we have avoided being over-exuberant. As you can see, the 2008 rate crisis affected the profits of the banks, but we didn't go haywire. We did not adopt the kind of mess, the kind of subsidiaries, collaterals and the kind of investment banking systems that some parts of the world like the US adopted. Now all of them are considering a conservative, straightforward system, where a bank is a bank. And the most distinguishing point about a bank, which you must remember, is that banks themselves, irrespective of what capital they have, the reserves they have, are dealing with other people's money. You and I deposit money into the bank and the bank lends it to somebody else.

The lending decision is made by the bank. They are using our money to re-lend as it were. So this is the distinction between say the banking system and some other types of financial system, say stock exchanges. So my summary point is that, the Indian banking system is by any reckoning regarded as exceptional.  It's a sound, rule-abiding banking system. It's not that there are no defaults and no problems, but in aggregate. Some banks will show high profits and some low profits, but that is a separate issue altogether. I think very well of our financial system as a whole and the banking system in particular.

Regarding the proposed banking laws amendment bill Act 2011, which is pending approval in Parliament, I have not studied this legislation very closely.  It isn't fair for me to make a comment, given my earlier association with the banking system. But some parts of it are certainly good. For example the subsidiary idea is a good idea. But of course it has to be reciprocal in some sense. We have to have same freedom to expand our banking system abroad. And that is the way the banking system works. For the rest I have not studied it very closely and I wouldn't like to make any comment.

When it comes to allowing more private banks to open in the country, I don't think it's an issue so long as standards are upheld.  The most important thing that we must remember is again that we are dealing with other people's money. And therefore you need some rules of the game, as it were, that if you are borrowing from banks, or if you are doing something which is creating liabilities on the banking system as a whole, then you have to be careful. The same principle was adopted when we introduced the licensing system for new banks a few years ago. I am all in favour of it. But we have to make sure that there is no conflict of interest. There are many dimensions and the rules are the same and the third and utmost important point is that there must be close surveillance, in terms of transparency, responsibility and accountability.

Then you have the issue of financial inclusion, and bringing un-banked people into the system. There is simply no question that RBI has given this objective of financial inclusion the highest priority. Because it is not only the interest rate question, everybody needs financing if you are in business or farming or any other productive enterprise. There will be a time gap between the return and the investment you make. There is no question that it has to be one of the highest priorities. I am very glad that RBI has given it the highest priorities. But at the root of it there are issues, in the sense that with the expansion of literacy, you have to improve communication skills so that even people in rural areas can access the banks on their own and it can be done. India has been able to launch its mobile telephony. That is my favourite example that we started with a PCO (public call office), where anybody could make a call and then mobile telephony. So the scope is tremendous and I am absolutely sure that it can be done and it will be done.

But we have a very long way to go. In the last 15 years what has happened in the mobile telephony or access to communication and access to banking system, well these two are not comparable in terms of cost. If you set up a branch, it costs a great deal of money and to be viable, it has to return the money. But what I am saying is that it can be done. In fact it has to be one of the highest priorities and just as with education and health and other things we are trying to make forward strides. So this is another area of great importance in my mind.

In theory, it's great that we're seeing informal money transfers happening in un-banked areas through media like the mobile phone. But in practice it's of utmost importance to have security check-ups. If I have your phone number now, I can use it to transfer money from your bank account to somewhere else. Then you need to evolve a system of cross checks and also make sure that the scope for any falsification of your identity is as narrow as it can be, and now obviously we have other things this is going to improve hopefully. We have to create a system which is consistent with the security aspect so that the mobile telephony cannot be misused. Hacking is becoming a primary issue and not only in our country. So we have to learn as we go along. I would go slowly rather than hasten, as security is of utmost importance, particularly for poor people and less well-off persons even in urban areas.

There is no straight answer when it comes to how the role of RBI will evolve in future years. It depends on how well you do this job. There are always trade-offs. So therefore the trade off in the RBI business or anywhere like inflation or growth, there is a trade off and you have to strike the trade off correctly.

The rest of the world is also coming around to the view that the banking system, the pure banking system, has to be in some way guided, related, supervised and assessed by the central banks. Because central banks are creators of money. And they have the ability and authority and experience to supervise the banking system. So I am in favour of that. Even those who have separate financial authority are coming back to the model, America for example. I have no doubt that it will be good for banks which are dealing with other people's money and where interest rates are vital, to be part of the regulatory system. The RBI shouldn't interfere in the day to day. But it has to make sure that your and my money is safe, that the credit-deposit ratio is under control. All these things are very vital in making the banking system good, and something persistent and long term. So I am in favour of such a system and there also RBI, if I may say so, has made tremendous amount of progress. There is no day-to-day intervention and that should be avoided. We should make our process even more at arm's length from the RBI. The RBI should not be involved in management of banks. Our system works, it is working reasonably well, and while nobody can say it is a 100 per cent model, but no other system around the world works as well. We can say that our financial system is much more stable than many other countries'. We have to make sure that the supervisory, regulatory system is transparent and accountable, and is at arm's length. RBI should get into management of banks, or be on their boards and things like that.

In terms of the future, I will say the biggest challenges that any well-functioning, good banking system, which we are: one, financial inclusion, two, making our banking system much more integrated with the financing of the small and medium sector as well as the rural sector. The small and medium sector is of utmost importance to my mind. So you should have a kind of banking system that is approachable by any enterprise, which is productive. All this will take time and we can do it. And one of utmost importance is of technology induction. So the banking system becomes more or less paperless, if possible, but with security. It is not an easy task, but it is a challenge we have come to and will meet over a period of time.

The author is a former Governor of the Reserve Bank of India (as told to Alokesh Bhattacharyya)


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