Banking on confusing signals

Apr 16 2014, 02:35 IST
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SummaryWhat ministry of finance & RBI do today leaves little room for genuine discretionary banking

The previous two articles in this series dealt with the urgency of liberalising India’s financial system beginning with insurance. Although India’s stance on foreign investment in banking is not as bad as it is in insurance, its posture on foreign banks, FDI in banking, subsidiarisation, new banking licences to established corporate investors, financial inclusion, macro-lending limits, etc, send out confusing signals. It does little to help encourage sound banking, attract more FDI and more foreign banks. It doesn’t do much to bolster the rapidly eroding capital base of the banking industry (except at public expense) or boost the banking system’s ability to expand credit delivery in line with the growing needs of the economy on a prudential basis without heightening systemic risk.

The key problem in banking is one of regulation, where RBI is more a problem than the solution, ensnared as it is by legacy and history into providing a highly discriminatory, unfair and tiered structure of regulation. That structure results in: first, protecting and micro-managing state-owned banks (SOBs) to protect the government’s equity investment and its implicit guarantee obligations to all depositors in SOBs; second, protecting the interests of domestic private banks, although paradoxically these supposedly ‘domestic’ banks are now almost all 74% foreign-owned by FIIs though they are still domestically managed; and third, artificially restricting the entry and expansion of foreign banks that India so desperately needs by imposing requirements for subsidiarisation and for financial inclusion that even the SOBs after nearly 50 years of operation have not been able to meet.

Worst of all, the current system encourages more new domestic private entrants into the already over-crowded banking space when India’s actual need is for fewer, stronger and larger private banks with a gradual phase-out of SOBs in order to get unlimited deposit liability risk (of nearly 100% of GDP) off the public fiscal balance sheet. The government can no longer afford the R25,000-30,000 crore that will be needed every year to augment the equity capital of the SOBs to stay in line with Basel III norms.

Thus, India’s strategic approach to restructuring its banking sector is the direct opposite of what it should be, i.e. not to crowd in more private domestic banks while imposing impossible conditions on them, but to privatise SOBs more aggressively and phase them out, to apply impartial and equal regulation to all banks regardless of their ownership, and dramatically expand the entry of

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