Strengthening Indian Banking and Finance: Progress and Prospects *
"We need greater productivity and efficiency to achieve the targets we set for ourselves, whether it be the macro-economic target of achieving 8 per cent growth in the Tenth Plan period or making our banking system strong and efficient and on par with international banks", this was the central message of the inaugural address of Dr. Bimal Jalan, Governor, Reserve Bank of India at the twenty-fourth Bank Economists’ Conference. The Conference was held between December 27 and 29 in Bangalore.
Plan target not difficult to achieve
Referring to the targets set by the Tenth Plan of 8 per cent growth, poverty alleviation and improvement in human development indicator and the cynicism expressed about their achievement, Dr. Jalan unequivocally said, "I believe that the overall macro-economic situation has seldom been better in achieving the targets set by the Tenth Plan. Th e conditions cannot be more appropriate to meet the challenges in both the banking and the real sectors."
Contending that the growth target of 8 per cent envisaged by the Tenth Plan document was not at all difficult to achieve, the Governor pointed out that India had never faced a more favourable situation than it was at present. The Governor said that the conditions were right despite many adverse external factors. The inflation was low, for instance, despite the most severe drought in the country; India’s foreign exchange reserves were at the highest and healthiest level despite a hike in the oil prices, border tensions, global slowdown and tensions prevailing on the Iraq front. In fact, the reserves were also healthy as they were not built up by increasing external debt, he pointed out. The Indian economy was also nudging towards 5-5.5 per cent growth despite lower agriculture production, slow industrial recovery and a global downturn. There was abundance of liquidity and the interest rates at long and short maturities were the lowest ever despite a high fiscal deficit and a high borrowing requirement of the government. In other words, if domestic and external resources could be a constraint in achieving growth targets, India faced none and therefore the environment was most conducive for growth, he pointed out.
To underscore the positive factors, the Governor recalled the earlier times when the presence of any of the constraints, such as, drought or higher oil prices, would have caused India to face tight liquidity, higher interest rates, high fiscal deficit, scarce foreign exchange and higher exchange controls. "But today we face none of these and there is no difference of opinion that we are in the best possible situation to achieve the targeted growth", he stated unequivocally.
Increase productivity and reduce costs
The answer to the cynicism despite many favourable conditions lied in low productivity, the Governor said and added that "For every rupee of capital spent by the government or by the private sector, we produce less," he stated. He added that inefficiency in the use of resources, tolerance of waste and slothfulness contributed to low productivity. "Our savings rate is the highest but our rate of growth is low. Our cost of doing business is relatively high and returns are not commensurate with investments made" the Governor said and added that this was true also of the banking sector which suffers from high cost and low productivity as reflected in high spreads. The important challenge of managing transformation would, for the banking sector, mean moving from high cost, low productivity and high spread to being more efficient, productive and competitive. For this, the banks need to address four main areas viz., corporate governance, economic value added, technology upgradation and H RD. Of these, HRD is the more difficult area to tackle. In public sector institutions, there are more challenges to face. "Taking examination to get into the system is the biggest challenge but once you get in there is no challenge" he observed. Increasing productivity and lowering cost per unit of output were the two biggest challenges faced by India, more specifically the banking and the financial system.
Keep depositors' trust
In addition to low productivity, the Governor dwelt upon the other two issues, namely prudential norms and supervision and regulation. He commended the progress made by India’s banking and financial system in prudential norms and added that India was contributing at the conceptual level in the international forum and was in fact the chairperson of the committee contributing to the thinking on adoption of BASEL II norms in emerging economies. Apart from these, India had also made signif icant progress on transparency, capital adequacy and disclosures. While the achievements were significant, India lagged behind in management of non-performing assets.
He stated that there were two reasons why the banking system should follow international norms. One, concern for depositors’ money and second to face international competition.
The Governor pointed out that banking was the only institution that invested other people’s money. On capital of 10 rupees they can lend 100 rupees. Bankers must be conscious of this and follow prudential norms of the highest order so that the public money is not threatened. "Banking system’s edifice is based on trust, and that should not be eroded" he stressed. At the international level, the non-adherence to globally accepted prudential norms would result in the international system doubting the repaying capacity of the Indian banks and make them uncompetitive in the international market. The Governor pointed out that no international forum would grudge the time table a country sets out to achieve the global standards. He added that India was fruitfully participating in all international discussions on these issues and was evolving a framework for consultative process among the emerging economy.
Need for greater accountability
The Governor further stated that there are two different trends in area of supervision and regulation. Both, greater stress on supervision and regulation of the banking system and deregulation of financial markets with openness and transparency existed side by side. He also said that two economic factors were special to banking and financial system. Unlike real sector, the impact of failure in a bank or financial unit has a more pervading effect. When an externality affects a banking unit, the depositors, borrowers and markets feel the impact immedi ately. Secondly, when something goes wrong, the only way to handle this is to take prompt corrective action. Deterioration in a bank or a financial unit does not have a linear course but has multiplying effect. This exponential effect is not seen in the real sector.
This situation can be tackled only by taking prompt corrective action. He said that in India, however, action is often postponed in the name of "doing good". Regulation is weak in some part of bank sector and prompt corrective action lukewarm. This needs to be corrected by strengthening the legal framework and removing multiple levels of control and specifying a clear-cut supervisory authority. Depoliticisation of bank and bank's accountability of the depositors should be clearly emphasised.
* Excerpts from remarks of Dr. Bimal Jalan, Governor, Reserve Bank of India at the twenty-fourth Bank Economists' Conference on December 27, 2002 at Bangalore.