IIBF Monthly Column

Impact of Certain Budgetary Announcements on the Banking Sector

Banks have been demanding that deposits should also be eligible for exemption under Section 80 (C) of the IT Act. This has been accepted and it has been proposed that deposits of more than 5 year period will be eligible for exemption under Section 80 (C). Till recently the market has witnessed a softening of interest rates. A view of the market yield (G'sec) curves would show that up to 5 years the curve is gradually upward slopping and long term trends are uncertain1. In view of the uncertainty about the rate movement, banks have not been accepting deposits of more than 3 years. Currently the market has signalled a rise in the interest rates and there is certain tightness in the liquidity front. Given these facts the rates on 5-year deposit will be higher and could increase the cost of funds with banks. A related issue is the EET. The Government has not yet spelt out its long term view on the subject and there is a possibility that exempt amounts will be taxed on maturity. Such taxability could pose procedural difficulties to banks and discourage depositors from seeking this avenue for I.T exemption.

It has been proposed that co-operative banks other than PACS and PCARDBs be brought under the tax net. Given the weak financial position of the co-operative banks, this may not be a welcome proposal for the cooperative banks. During June 2004, pursuant to an announcement by GOI, NABARD and IBA had issued guidelines on treatment of accounts of farmers in distress and default to provide succour to farmers in distress. Accordingly most agricultural loans were compulsorily rescheduled by capitalising the income which was previously un-recognised as per IRAC norms. The interest so recognised was capitalised, and was, along with the principal overdue (whether on account of distress or for other specified reasons) restructured in to a 5 year loan with a 2 year moratorium (repayment and payment holiday). This could have made most of the co-operative banks look in better health and the profit for the year 2004-05 may have been higher than the aggregate net profit reported by all State Coop Banks at Rs. 3732 crores. In case of the DCCBs, the aggregate profit was Rs.108 crores. Return on assets (aggregate for the sector) was less than 1%. The amount of tax that the GOI may get from such proposals will be much lesser than the GOI announced funding of recapitalisation of Rs 14,000 crores, as recommended by the Vaidyanathan Committee, to ST cooperatives. As regards UCBs, the net profit aggregated to Rs. 178 crores in 2004-05. Barring the top 50, the rest of UCBs are not in the best of financial health. It is in this background that newspapers have reported that coop banks have desired that the tax proposal may not be accepted.
A related issue is the taxability of RRBs. Section 22 of the RRB Act says that, "For the purpose of the Income-tax Act, 1961 or any other enactment for the time being in force relating to any tax on income, profits or gains, a Regional Rural Bank shall be deemed to be a co-operative society". The fact that co-operatives will be taxed could make the RRBs vulnerable.

The Budget has provided Rs. 1700 crore for a 2% one-time interest subsidy for crop loans. Both RBI and NABARD have issued guidelines to the effect that in respect of loans up to Rs. 1 lakh, issued for Kharif and Rabi 2006 interest @2% on the principal will be credited forthwith. Since the ARDR, the banking sector has implemented many concessions, waivers, series of OTS and restructuring of loans. Recently an interest waiver was approved by the GOI for Kharif 2002. This was followed by the relief measures announced in 2004. There is no doubt that farmers need such support. Yet these pronouncements do not go well with the objectives of financial sector reform. Evidently the issue is larger than mere subsidy being announced from time to time and revolves around risk management system for Indian agriculture. In this background and given that credit is the main driver of Indian agriculture, it should be ensured that the banking system is not made the vehicle for distribution of subsidies. More importantly, the authorities should immediately develop price and yield risk hedge products and encourage the farmers to access them. Introduction of options in the commodity market and development of option related insurance products (similar to forward cover available to the merchant in foreign exchange transactions) are two necessary steps in this direction.

Though banks have been empowered to decide the ROI on loans by themselves, the Budget stipulates 7% ROI on loans up to Rs. 3 lakhs. Considering the fact that the average land holding size in the country is less than 2 hectares, it is estimated that loan availed by almost all farmers for crop loans will be less than Rs. 3 lakhs. As such the majority of the crop loan portfolio will get priced at 7%. The Government has indicated that through NABARD it will subvent the co-operatives (considered in this context, the proposal to tax the profits of the co-operatives may not be a revenue generating proposal). However, commercial banks will have to meet the loss of income by themselves. Given the paucity of capital, this will impact the banks adversely (approximately Rs. 2000 crore per annum?). Another possible outcome of this could be that other agricultural loans may also be priced at 7%. As farmers depend on agricultural income to repay the instalments on term loans, they would like to use the fund available under crop loans at 7% for all their needs rather than borrow at a higher rate of interest for other agriculture purposes. A study by NCAER of the Kisan Credit Card has already established the tendency among farmers to use the short term credit for investment purposes. In this background, a lower rate of interest on crop loan will impact term credit and the targeted 30% growth rate in agricultural loans may not be easy.

The concept of Joint Liability Groups (JLGs)for financing tenant farmers is a welcome initiative. (In fact this was one of the items covered in the package announced for extending relief to farmers in distress in the year 2004. Perhaps an initial target of Rs.50 crore was also mentioned). The number of landless agriculture labourers being very high, these initiatives should be pursued. JLG need not be structured like SHG and could be made up of smaller groups. Unlike SHG, the bank finance limit may be a function of combined credit requirement for crop loans rather than a multiple of deposits mobilised.

The levy of service charge on banking services will affect customers. In the past credit cards did attract service charges. With the increase in the percentage of service charges (from 10% to 12%), cards could become more costly. Demand drafts, transfers, L/C, etc. attract commission charges now. The incidence of service tax will make them more costly. Banks, often, send their staff for specialist training conducted by training institutions. It seems that this will also attract service taxes.

Deposit rates have not been in sync with yield curves.
Trends and Progress of Banking in India 2004-05. RBI.

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