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Banks feel hike in capital adequacy ratio will cut NPAs in the long-term

The Reserve Bank of India has recognised that there need to take short-term corrective measures, such as increasing the interest rate or a further increasing the Cash Reserve Ratio, particularly since high rate of monetary growth doesn't help general price stability.

However, the central bank is uncertain how to nurture real economic growth at the current rate of inflation. The events of the last few months illustrated the delicate balance that has to be struck between conflicting factors when deciding on changes in monetary policy measures in the short-term.

In its half yearly monetary and credit policy statement, the RBI said industrial slowdown still persists despite the adequate availability of bank credit. As far as possible, the bank officials said, nothing should be done to dampen signs of recovery in the real sector. This is backed by the fact that the growth of bank credit to the commercial sector has not proved to be a primary cause for expansion in money supply in the current year.

Money supply growth, attributable largely to growth in the banking sector's credit to government, is too high in relation to the expected growth of the real sector of the economy, the RBI said.

There was a substantial increase in food credit extended by scheduled commercial banks at Rs 34.64 billion up to October 9 as against Rs 14.55 billion in the corresponding period last year.

Non-food credit also showed a considerable increase in the last two fortnights up to October 9 in the region of Rs 69.72 billion (2.2 per cent) as against Rs 46.86 billion in the same period last year.

The total flow of resources to the commercial sector from banks went up by 4.5 per cent -- at Rs 157.59 billion -- during the period from what it was during the corresponding period last year. The total resources flow to commercial sector including capital issues, GDRs and borrowings from institutions was much higher -- at Rs 417.92 billion up to October 9 this year as against Rs 346.45 billion in the corresponding period last year.

Meanwhile, leading bankers welcomed the mid-term review of monetary and credit policy, describing it as fire-fighting equipment for the Indian banking sector to survive.

But State Bank of India chairman M S Verma said there was no need now to take short-term measures -- like changes in the bank rate or the cash reserve ratio. The bank credit offtake has just started showing an encouraging trend in recent weeks and this should not be disturbed.

With the phase-wise implementation of Narasimham Committee recommendations as suggested by RBI in its credit policy today, he said that in the next two to three years, Indian banks would fall in line with standard followed by international banks. The proposed hike in the capital adequacy ratio may initially increase the banks' non-performing assets, but there will be a fall later following increased lending to good clients.

Bank of Baroda Chairman K Kanan said that there was a need to keep constant watch on factors like inflation rate, interest rate and exchange rates, particularly in light of proposed recommendations to be implemented for banking sector reforms.

"We are strengthening our financial system and everybody, including the government, has to play a role," he said.

Kanan said banks were now worried about how to raise capital as the market couldn't help bring in the money, while the government lacked the finances to recapitalise the banks. In this context, he suggested that the government should provide tax incentives to banks to make various provisions in its balance sheet, including pensions and salaries.

But Union Bank Chairman A T Panir Salven said no tax incentives are required for the banking sector since making provisions against sticky loans is a duty. The policy is a fine architecture of putting in place the Narasimham Committee recommendations in the next two years, he said.

The RBI's Credit and Monetary Policy 1998-99