ÒCreativity comes out of chaosÓ, is how Reserve Bank of India (RBI) chief YV Reddy explains the economic miracle that has seen Indian firms overcome hopelessly inadequate physical infrastructure to power his countryÕs economy at unprecedented rates.
ThereÕs not much the central bank governor can do about the jammed roads, overwhelmed ports and intermittent blackouts that afflict his country. Instead heÕs focusing on the financial infrastructure to ensure that neither chaos, nor excessive creativity, gain a foothold in the banking system.
ÒThe emphasis now is to improve the governance of the private-sector banks in India, to improve the overall governance and the functional economy of the public-sector banks, then to promote consolidation in the domestic banking industry,Ó Reddy tells Emerging Markets.
IndiaÕs banks, threatened with an end to their sheltered position in the domestic market in 2009, have made efforts to streamline operations, invest in technology and broaden product offerings. The private sector is almost completely automated, and the biggest public-sector banks are expected to follow State Bank of India in automating all transactions by the end of the year.
The industry is also winning the battle against non-performing assets (NPAs), partly as a result of the economic boom. The ratio of NPAs against total assets slid to 0.9% last year from 2.3% in 2002, while profitability almost tripled in the past five years to Re211 billion in 2005, according to RBI data.
Neverthless, the progress is uneven, and the sector is supporting too many inefficient operators, despite efforts by the government and central bank to push consolidation.
So much to do
Reddy describes the pace of mergers as Òreasonably satisfactoryÓ, but in reality there remains much left to do, particularly among the public-sector banks, which account for two-thirds of the sector. The number of commercial banks in India peaked at 301 in 1999 and had been whittled down to 289 by March 2005.
Perhaps the most vulnerable parts of the equation are the cooperative banks, which have lagged behind in the modernization process and still remain in some respects outside the regulatory framework laid down by the central bank. ÒI think what we have to really look at is simultaneous progress in all sections of the banking industry would be helpful. Particularly the cooperative sector will require the support of the state governments also, so that is going to be the biggest challenge,Ó Reddy said in an interview in London.
The divide within the banking sector is an illuminating reflection of the economic and social chasms within IndiaÕs population. While banks chase successfully globalized individuals and companies on their business abroad, the government is seeking to ensure poorer rural customers are not neglected.
Despite a minimum obligation on banks to direct 40% of their lending towards agriculture and other priority sectors, there remains a chronic lack of competition outside built-up areas. The problem is so acute that finance minister P Chidambaram has decided to subsidize lending to ensure fair credit pricing to the customers who need cheap borrowing the most.
Reddy defended the governmentÕs involvement as a necessary expedient before fuller competition can iron out the interest rate mismatches between town and country. ÒThe banking system is not able to deliver at a price that is appropriate to the risk and itÕs not able to penetrate. Now, it has some infrastructural issues; it has some attitudinal issues; it has some procedural and policy issues. These have to be resolved, but it is not appropriate to say that everybody has to wait,Ó Reddy says.
No pressure
Rajnish Rastogi, an analyst at Crisil, Standard & PoorÕs Indian unit, believes the Indian banking system is set to haul itself up to world-class standards. With the government supporting consolidation, the last major remaining barrier to the formation of operators boasting critical mass is the rules preventing mergers between public and private banks, Rastogi says. ÒThings are falling into place; the leg-work has already been done,Ó Rastogi says, citing deals between Oriental bank of Commerce and Gloabl Trust Bank which may pave the way for a larger wave of consolidation in the coming years as regional banks go national. ÒI think consolidation will happen, even though itÕs not yet emerged as a phenomenon.Ó