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The Rediff Pre-Budget Interview/K P Padmakumar

'Budget is expected to create greater lending opportunities for banks'

Commercial banks in India fear a further lowering of the bank rate and cash reserve ratio by the Reserve Bank of India any time now. A consequential fall in the banking lending rates would add further pressure on the bottomline of banks.

The position of banks which have a high-cost liability structure will be impacted adversely. With banking sector generally awash with funds and good corporates by and large deserting the banking system for their credit requirements, the bankers are now saddled with the problem of identifying safe lending opportunities.

With the credit absorption in agricultural sector not showing any perceptible increase and the reforms introduced in the non-banking financial institution sector seriously eroding the levels of operation of these institutions, the banking sector's ability to increase credit portfolio has eroded significantly.

The poor investment climate and the dormant state of the primary market in consequence have also contributed to the general decline in credit offtake. With phenomenal changes taking place in the operating environment of banks, the bankers are struggling hard to cope with these changes.

The emerging scenario calls for unorthodox initiatives by the banks in tune with the changes in the environment. Federal Bank chairman and CEO K P Padmakumar, who recently took over as chairman of the Private Sector Banks' Association, spoke on these issues in an interview with D Jose in Thiruvananthapuram in the run-up to Budget 2000. Excerpts:

What, in your estimate, is the status of banks after the reforms so far?

To any perceptive observer of the banking scene in India, what is striking is the fast pace of changes in the operating environment, which the reform process has introduced. Many sectors suffered due to their inability to cope with competition, which the reform process has heightened, while others suffered due to the general industrial recession Indian economy experienced during the last two years.

The deceleration in world trade and the Far Eastern economic crisis have also contributed to the unimpressive performance of many sectors of the economy. As banking is a play on the economy, Indian banks have in consequence been greatly affected by these factors.

Sectors like steel, textiles, real estate and non-banking finance companies, which have been badly affected in the process of demand recession and reform induced changes, have contributed significantly to the non-performing assets of the bank.

Side-by-side, the Reserve Bank of India has been, as part of the overall strategy of integrating the Indian financial system with that of the world economy, lowering the interest rate structure through the CRR and Bank Rate cuts.

The consequential reduction in lending rates which the banks were forced to do took immediate effect while the higher cost liabilities to which they had locked themselves, remained by and large unchanged.

This naturally saw the spreads declining sharply at a time when capital adequacy related reforms required the banking industry to improve their net worth for leveraging growth.

In a reducing spread scenario, what can sustain profit is volume growth. Poor credit offtake and the capital adequacy concerns seriously affect the ability of the banks to achieve higher volume growth of business.

The dilemma facing the Indian banks is therefore finding the right mix of assets and liabilities, sustaining profitability and achieving growth, keeping capital adequacy sharply in focus.

How have the banks coped up with the challenges?

We see varying degrees of preparedness by Indian banks to face these challenges. The situation calls for re-looking at strategies on an ongoing basis both in regard to asset allocation and diversification.

What is becoming increasingly clear is that without multiplicity of income streams, Indian banks will find it difficult to survive in the emerging scenario. To multiply the income streams, it is imperative that banks have to go for a total re-look at their technological preparedness, skills and ultimately the quality and the strength of the balance sheet.

It is difficult to say at this point of time how many of the banks will be able to do this and I would only say that only the nimble-footed banks with clear focus on strategies alone will become the winners.

What do you think is the major problem that the banks face today?

As I mentioned earlier, the dilemma Indian banks face today is essentially one of identifying the right strategy for growth, sustaining profitability and keeping their capital adequacy in tune with the mandatory requirements.

Indian banking as we know is a diaspora of varied players with varying degrees of strength and weakness. A study of their problems has to look at their genesis and their preparedness for change.

On the whole, I would say banking sector is one which is perhaps facing the most challenging task of reforming itself in an environment where the operating contours are getting redefined almost every day.

As the sector is a play on the economy, unless overall holistic growth of the economy takes place, the sector will have a lag effect of the systemic asymmetries in the economy.

The investment climate has to improve and the primary capital market has to revive to promote capital investment in the real sectors and in consequence the credit demand has to improve.

Banks have to upgrade their skills, especially in risk evaluation. A thorough revamping of the legal system, which will transform the present-day defaulter-friendly climate to one that is lender-friendly, has to take place for banks to get enthused about their lending activities.

Unless the recovery scenario improves, onward journey of banks will continue to be very difficult with corporate defaults likely to increase as the reform process gathers momentum.

What is the way out for the banks to survive the surplus liquidity problem? This needs tackling both at the macro- and micro-level. At the macro level, as I mentioned earlier, the investment climate has to improve and here, the critical issue is infrastructure-related developments and resurgence of the primary capital markets.

If this happens, the present day surplus liquidity in the system, which to my mind is primarily due to lack of demand for credit, can overnight become an issue of borrowers chasing banks once again.

At the micro-level, banks have to focus on sectors which have huge potential for asset creation. One example is the burgeoning middle class in the country.

Have you identified any other thrust areas for the future?

We in Federal Bank have identified the middle class as a very important thrust area and we have come out with a host of retail loans aimed at the middle class group.

Banks also have to, as discussed earlier, look at diversifying their income sources through increased lendings to venture capital, especially in the IT sector and also for the emerging e-commerce business.

I am a strong believer that business-to-business and business-to-consumer transactions, especially in the services sector, will leapfrog in the immediate future through the e-commerce route.

How could you then be able to meet the servicing costs of small retail loans?

The small retail loans are almost always priced relatively higher taking into account the higher servicing cost. The defused risk status and the multiplicity of sectors to which the lendings are given, will enable the bank to keep a decent spread on these lendings.

What might the budget have in store for the banks?

The budget is expected to contain tough measures aimed at reducing fiscal deficit to encourage savings and improve the investment climate. Either prior to the budget presentation or soon thereafter, a bank rate cut seems to be in the offing, giving fresh signals of southward movement of the interest rates.

This will no doubt mean further reduction in the spreads enjoyed in the banking industry and the consequential reduction in interest rate which the banks will be forced to make on deposits. This will make bank deposits less attractive as a savings medium.

This is one important challenge the banking industry has to prepare itself for and as has happened in almost all developing countries which initiated the reform process, bank deposits as percentage of savings are destined to fall.

Banks will therefore have to innovate products, which can compete with the products offered by the mutual funds and through relationship building keep the portfolio of retail depositors intact.

Upgrading the quality of service, anticipating customer needs will become a sine qua non. One also expects a reduction in the surcharge on the corporate tax, tax on agricultural income and measures to induce increased savings and investments. All this would mean revitalisation of the corporate sector and I believe greater lending opportunities for banks.

Don't you think a reduction in lending rates would provide a solution to the surplus liquidity?

As I said earlier, the present liquidity or high liquidity in the system is more a case of lack of demand, than of over-supply. Mere rate reduction may not lead to higher credit off-take.

The issues involved are more structural and are primarily related to investment in the real sectors. While lower rates may encourage a relook at the project cost, what is really needed is the change in the investment climate and a holistic approach to infrastructural development.

What is the state of private sector banks in the country? Are they able to compete with the public sector banks?

As I said earlier, we see varying degrees of preparedness among private sector banks in assimilating the changes in the operating environment and redrawing strategies.

Almost all of them have not lost their niche market strengths, which their strong regional presence bestows on them. Many of them are upgrading their technological preparedness to meet the challenges and are also acutely aware of the fact that their niche markets are poised to disappear.

What is your view about the attempts to take over strong private banks?

What the reform process dictates is that all operating units have to have critical mass and commanding presence and efficiency of operations. It is my belief that the banking sector is no exception to this rule. Consolidation of players is perhaps inevitable.

Do you feel the need for protective cover against takeovers?

It is against the basic tenets of economics and the reform process, which our government has initiated.

What is your agenda as the chairman of the Private Sector Banks' Association?

Private sector banks have historically played a crucial role in the development of banking industry in India. Most of them have strong emotional attachment with the clientele they serve and the contributions made by them in the economic development of many parts of the country are significant.

All the private sector banks have to imbibe the changes the market situation demands, become technologically savvy and assume critical mass of business and sustain profitability.

Our agenda is to address these issues squarely and remain competitive. Diversification of portfolio, improving balance sheet strength and transparency of operations should be their guiding factors and I believe that they will continue to have commanding presence in their areas of operation if the above parameters are met.

What is your comment about politicians' complaint about the low CD ratio in Kerala?

A poor CD ratio of banks in Kerala is according to me a reflection of the investment climate in the state rather than the disinclination of banks to lend. Kerala's economy is highly dependent on the agricultural sector where the credit absorption capacity is limited, thanks to the fact that majority of the plantation sector borrowers rely less on bank credit. Speaking of the industrial sector, one doesn't have to elaborate on the lack of lending opportunities as hardly any new viable initiatives are seen which banks could fund.

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