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Business Commentary/Dilip Thakore

Bureaucratic banks ill-suited to help India's economic growth

The slash in the bank rate by a full percentage point to 9 per cent decreed by the Reserve Bank of India when the central bank's monetary and credit policy for the second half of the current fiscal year, announced on October 21, has put the nation's public sector banks in a spot. With banks able to borrow more cheaply from the RBI, and with the cash credit ratio which all banks are obliged to maintain with the RBI lowered by 2 per cent releasing an additional Rs 96 billion ($ 26.66 million) per year, the banking system is awash with lendable funds. "The objective (of the policy) is that banks should expand credit and bring about a reduction in interest rates," RBI Governor C Rangarajan had said.

The new monetary and credit policy has already brought about a sharp reduction in lending rates. But this benefit has been restricted to the 100 corporates in India which with their high credit rating are able to obtain working capital finance at rock-bottom rates of 8 to 9 per cent. However, the long term prime lending rates -- LTPR -- of Indian banks has not fallen significantly -- down by a mere 0.5 to 1 per cent to 12.5 to 13 per cent. Which means that the cost of project finance in India remains much higher than in most foreign countries. And it is important to note that the LTPR is available to credit-worthy bluechip corporates. For the rest of Indian industry, particularly small- and medium-scale enterprises which need credit most, the cost of borrowing is significantly higher.

But while there has been some response to the RBI governor's stated objective of bringing about a fall in interest rates, it is doubtful whether there will be any significant response from the banks to the other stated objective of prompting an expansion of credit. For the simple reason that during the past three decades since nationalisation, public sector bank managements have become accustomed to rationing rather than marketing credit. Project appraisal and risk and credit assessment skills are conspicuously deficient in the public sector banks -- PSB -- which dominate the banking sector.

This is clear from the huge bad debts of the PSBs. Non-performing assets -- NPAs -- of the PSBs average 17.5 per cent against the global average of 7 to 8 per cent. And it is hardly a secret that the bad debt portfolios of some banks (such as the Madras-based Indian Bank) are as high as 40 per cent. Long used to sanctioning loans to borrowers of doubtful integrity and capability at the behest of grassroot politicians and for other extraneous considerations, it is doubtful if the PSB managements will be able to expand credit according to prudential banking norms.

The poor capability of PSBs was recently highlighted by the highly respected New York-based Moody's Investor Service which, in a report entitled Banking System Outlook: India states that six years after the nation's economic liberalisation and deregulation policy initiative, the will to deregulate the banking sector is conspicuously lacking. 'So far, the political will for drastic reforms has not really materialised with the status quo suiting both public sector banks and the authorities,' says the report.

The status quo certainly suits managers and clerical employees of the PSBs. Instances are not unknown of playsafe managers who have never approved a loan in their entire careers rising to the senior-most positions in nationalised banks. And, as is well-known, the clerical staff of PSBs are protected by powerful unions and hardly ever put in a honest day's work. Yet despite their abysmal productivity and poor customer management skills, they are among the most well-paid white collar employees in the country. In the vanguard of protesters against the privatisation of even chronically loss-making PSBs, clerical employees of nationalised banks were all set to go on a three-day strike on early December 3 (now called off) to press for higher pay and a reversal of the proposal to set up local area banks for rural lending.

And if bureaucratic government-style banking suits PSB employees, it suits the nation's political class even better. It is hardly a secret that politicians at the central and state levels relentlessly interfere with the managements of PSBs and exert tremendous pressure upon bank managers to advance loans to their cronies and favourites. Readers with long memories may remember the celebrated instance when Sanjay Gandhi forced the managing director of a PSB to advance a loan without any collateral to one of his quasiliterate cronies. Or how a State Bank of India manager, Nagarwala, paid out Rs 6 million in cash when a telephone call purportedly from then prime minister Indira Gandhi directed him to do so.

Indeed, so blatant is the influence of politicians in PSBs that there are grounds for suspicion that the NPAs of nationalised banks are far higher than the reported average of 17.5 per cent. Conveniently, bank managements are not obliged to divulge details regarding their bad debts. And most PSB managers privately concede that a large number of so-called performing assets are in fact NPAs.

The chilling truth about the PSBs which hold 95 per cent of the nation's bank deposits, is that they are a mess. They need to be given full autonomy right away as a prelude to privatisation. The consequence of three decades of nationalisation is that PSB managers have forgotten the basics of the banking business which is quite elementary. It is to attract savings as deposits and to lend these savings profitably to enterprises which are likely to be winners in the marketplace. Unfortunately, this ability to spot winners and to encourage them to grow in the national interest is sadly lacking among the rule-bound, risk-averse bureaucrats masquerading as bankers in India's shabby public sector banks.

Dilip Thakore