Need of financial inclusion, Infrastructure and proper risk management
Banks have been at the heart of the global financial crisis and bankers
are widely seen as being responsible for the crisis. One of the more
influential ideas, one that has generated a vigorous debate, has been
the thesis put forward by the noted economist and Nobel Laureate Paul
Krugman that the way to reform banking is to once again make it boring.
Krugman argues that there is a negative correlation between the
‘business model' of banking and economic stability. Whenever banking
got exciting and interesting, paid well and attracted intellectual
talent, it got way out of hand and jeopardized the stability of the
real sector. Conversely, periods when banking was dull and boring were
also periods of economic progress.
In a speech , Mervyn King, Governor of the Bank of England addressed
the moral hazard issue: why were banks willing to take risks that
proved so damaging to themselves and the rest of the economy? The
problem, according to Governor King, was that financial institutions
became too important to be allowed to fail. His solution: restrict
banking to its traditional “utility” function - performing basic retail
financial intermediation of deposit taking and lending, and providing
payment and settlement services; and hive off the riskier financial
services such as proprietary trading into a separate entity. In what
has come quickly to be known as the ‘utility and casino' model, the
‘utility' will be heavily regulated and will enjoy implicit government
guarantee while the ‘casino' will be left to the discipline of market
forces.
Back to basic
In Guhan Memorial Lecture last month, Dr. Reddy, former Governor of the
Reserve Bank of India called for ‘back to basics' in banking and urged
that banks must curb the tendency towards further financialization of
deposits they mobilize and must focus instead on lending to real
sectors of the economy, particularly agriculture and the small and
medium industries, that have limited ability to tap the capital
markets. Although neither Governor King nor former Governor Reddy
mentioned ‘boring banking', in a sense both of them were calling for
what can stylistically be interpreted as boring banking.
‘Boring banking' perspective in India?
Dr. Duvvuri Subbarao, Governor, Reserve Bank of India has expressed
view on the same at the International Finance and Banking Conference
organized by the Indian Merchants' Chamber on ‘Banking - Crisis and
Beyond' The conference had examined the problems and prospects of the
banking industry in the context of the ongoing economic crisis. At the
occasion, RBI's governor has discussed the changing face of Indian
banking with its various aspects.
As the pace of globalisation and financial innovation gained momentum,
and encouraged by an extended period of monetary accommodation, banks
entered into areas of activity that had earlier been the preserve of
non-bank institutions. Banks looked for, and exploited, opportunities
to shift profitable but risky businesses to entities outside the
regulatory purview. To economize on capital requirements, banks
developed new structured products to distribute the credit risk, they
also found new special purpose entities and vehicles to handle them.
The structured investment vehicles quickly spawned a vast ‘shadow
banking' network that operated and thrived outside the perimeter of
bank regulation. With few regulatory restrictions and no coordinated
oversight, they were able to take on risks that they did not fully
comprehend. And when the Minsky moment arrived turning the financial
mania into panic, the risks reverted to the parent banks causing
financial turmoil and economic down turn.
According to Dr Subbarao , The boring banking concept does not appear
persuasive even going by more recent evidence and on several counts.
However it does not mean that the lessons of the crisis are irrelevant
for us. The task for the Indian banks is to learn to compete abroad and
to set the terms of competition at home. It is imperative therefore for
Indian banks to learn from the successes and failures around the world,
study international best practices and adapt them to the Indian
conditions. Just as banking around the world is not going to revert to
being boring, neither will Indian banking get boring, added by
governor. In short, boring banking is an oxymoron in the Indian case.
Challenges before Indian banking
Among many , financial Inclusion is key concern. Despite its impressive
progress, commercial banking in India has not penetrated sufficiently
to serve the large mass of rural, illiterate and poor people in any
meaningful way. On other hand , the biggest supply constraint is of
infrastructure - physical, social and urban. The Eleventh Five Year
Plan targets increase in infrastructure investment from around 5 % of
GDP in 2006/07 to 9 % by 2011/12. A big issue in bank financing of
infrastructure is the asset-liability mismatch. A While infrastructure
typically requires long term funding, the deposits of banks, their main
source of funds, are relatively short-term. The problem of
asset-liability mismatch in long term financing is not unique to India;
banks elsewhere too face the same problem. But in advanced economies,
the long-term finance space is filled by insurance companies and
pension and provident funds. If some of the pending legislation gets
through, in India too we can expect new sources of long-term financing
to open up. But until that happens, the burden of infrastructure
financing will have to be met largely by the banks.
To assist the banks, RBI has also relaxed the exposure norms. The one
of the biggest challenge has always related with risk. There are
various types of risks like credit risk, operational risk and market
risk. As of March 2009, all Indian banks have migrated to the simpler
approaches of the Basel II standard. The task on the way forward is to
graduate to more advanced approaches. Towards this end, in consultation
with banks, the Reserve Bank has now finalized a four-year time frame
starting in April 2010 and ending with March 2014.
The challenge for Indian banks, therefore, is to reduce costs and pass
on the benefits to both depositors and lenders, said , RBI Governor in
his remarks.
