On the firing line

It does not take much reading between the lines to find the prognosis of the second Narasimham Committee report is that the banking sector remains inefficient, unprofitable and structurally flawed. In short, the financial system with four-fifths of its funds flowing through banks is ill-prepared to meet the demands of the domestic economy and the challenges of the global market. There is no more damning indictment of the condition of banks six years after the reforms process was begun, than the recommendation for possible enhancement of capital adequacy ratios above the Basle norm. What has brought about this anxiety to raise capital funds of banks above the eight per cent considered desirable in 1991? The Asian financial crisis is one obvious reason. The committee makes specific mention of volatility in exchange markets, domestic and foreign asset price risks and interest rate variations in this context.

But the concern about capital funds also ties in with a number of other issues raised by the committeeand the kind of reforms put in place so far. There has been more movement on what it calls the 8220;arithmeticals8221; ratios and accounting procedures than operational and structural improvements. The pace of modernisation and technological change, especially in branches, is agonisingly slow. Bank unions are partly to blame as also man management policies. All this will have to change fast. There is definitely enormous scope for consolidation in the banking sector resulting eventually in the emergence of a few mega-players oriented internationally, a larger number of national banks and smaller banks with regional specialisations. The wave of bank mergers in the US seems to corroborate the committee8217;s view that big is beautiful and 8220;size is an important determinant of banking strength8221;. However, what is specifically ruled out is the merger of the strong with the weak or mere empire-building if the outcomes in both instances are not leaner, tougher, more competitive entities. And before any of this can comeabout, there will have to be some hard policy decisions.

The level of non-performing assets remains unacceptably high and such reductions in the backlog as have taken place are the result of an unsustainable policy of massive recapitalisation by the government. The committee sits on the fence when it comes to social banking by advising against specific targets but not actually saying the system be abandoned altogether. Obviously, until other provision is made and a viable framework for rural credit delivery is devised, social banking will have to stay but with tighter procedures. Not enough is made of politically-directed decisions and cronyism to which a large part of NPAs can be traced. Professionalism at board and management levels and the separation of policy-making and executive functions will contribute to better decision-making. Closing down unviable and weak banks in the public or private sector is the kind of message needed to hasten the reform process everywhere. Far better to cleanse the systemnow in an orderly fashion than be forced to do it during a crisis at a later stage.