RBI’s Annual Report for 2007 - 08 – The State of Banking

N.A. Mujumdar

The Annual Reports of Reserve Bank of India (RBI) are the most authentic documents on the state of the financial sector in India and the Report for 2007-08 is no exception. No banker, or for that matter, any one dealing with the financial sector, can afford to miss it.

Macroeconomic Performance

The state of banking has to be viewed against the broader background of the macroeconomic performance. The last three years have witnessed an extra-ordinary performance of the Indian economy. The buoyancy of the Indian economy is reflected in the fact that the year 2007-08 was the third successive year when the economy achieved a growth rate of 9 per cent and above. This was the highest growth rate achieved during any three year period in the history of Independent India. This growth momentum was sustained by the continued acceleration in savings and investment rates and productivity growth. The savings rate increased from 26.4 per cent of GDP in 2002-03 to 34.8 per cent in 2006-07, while investment rate rose from 25.2 per cent to 35.9 per cent. The average saving and investment rates at 31.4 per cent of GDP during the Tenth Plan period were the highest in any of the Five Year Plan periods. The trend was maintained during 2007-08, the first year of the Eleventh Plan, when the gross fixed capital formation rose to 33.9 per cent of GDP. The average real per capita income growth rose from only 3.3 per cent during the Ninth Plan (1997-2002) to 6.1 per cent during the Tenth Plan (2002-2007), which was the highest growth achieved during any plan period

In this environment of rapid growth, Indian Banking has emerged as a strong and stable system. The Annual Report highlights three district characteristics of the contemporary banking scenario: soundness of the system, the need for further capital augmentation and remaining uncontaminated by the recent global financial contagion resulting from sub-prime turbulence in the United States.

First, “The asset quality and soundness parameters of the Indian banking sector have improved significantly in the recent period, and are now comparable with global levels” (page 26). Foreign banks operating in India and Indian banks having presence outside India have already migrated to the standardised approach for credit risk and the basic approach for operational risk under Basle II with effect from March 2008. All other scheduled commercial banks would migrate to these approaches under Basle II not later than March 2009. Special emphasis has been laid on liquidity and asset liability management. The policy initiatives have focused on strengthening the corporate governance practices in banks and improving customer service. Thus harmonization with international best practices has largely been achieved.

Second, there has been a runaway expansion of bank credit in recent years: the annual expansion of non-food credit during the three years 2005-06 to 2007-08 averaged 27 per cent. Such expansion was perhaps necessary to sustain the high growth of GDP mentioned earlier. If credit has to expand at more or less similar rates, banks will have to replenish their capital to meet the capital adequacy norms under Basle II norms. Hence replenishing of banks’ capital resources becomes an ineluctable necessity. Newer avenues of raising capital have now been provided to banks to accord them greater flexibility in meeting the Basle II requirement (page 28).

Third, what started as a subprime mortgage crisis in the United States in 2007 is still being felt a year later, in a surprising variety of places – such as markets in which banks make loans to one another, short-term commercial paper, municipal bonds etc., and not only in the Unted States. These events have raised a number of difficult questions about how the subprime problem could have deteriorated to the point of threatening global financial stability. Fortunately, India has escaped this catastrophe because of a number of factors. The credit derivatives market in India is still in an embryonic stage. The originate-to-distribute model in India is not comparable to the ones prevailing in advance markets. “Financial stability in India has been achieved through perseverance with prudential policies that prevent institutions from excessive risk taking, and financial markets from becoming extremely volatile and turbulent” (page 28). There are restrictions on investments by residents in such products issued abroad and regulatory guide lines on Securitisation do not permit immediate profit recognition RBI’s preemptive regulation in respect of sensitive sectors, namely capital markets, real estate and commodities, have also helped the financial sector to remain orderly, and financial institutions, especially banks, to remain sound: for instances, prescription of a board mandated policy in respect of real estate exposure of banks, and increasing risk weights of sensitive sectors and so on.

Credit Flow to Priority Sectors

RBI also took initiatives to improving the credit flow to priority sectors, to encouraging micro-finance and promoting financial inclusion, and financial literacy.

The guidelines on lending to priority sectors were revised with effect from April 2007, the underlying principle being to ensure adequate flow of bank credit to those sectors of the society/economy that impact large segments of the population and weaker sections, and to the sectors that are employment intensive such as agriculture, and tiny and small enterprises: The credit targets for these sectors have remained unchanged at 40 per cent and 32 per cent for domestic and foreign banks, respectively. However there is a small change in the calculation to be made. From April 2007, these are calculated as a percentage of adjusted net bank credit (ANBC) i.e. net bank credit plus investments made by banks in non-SLR bonds “held to Maturity” (HTM) category. Public sector banks achieved the overall target for priority sector lending at end March 2008. Two of 23 private sector banks and four out of 28 foreign banks did not achieve their respective targets

Micro Finance

Micro finance has been recognised as the effective tool that could raise the incomes of the poor, contribute to individual and household security and change the social relations for the better. In India the SHG-bank linkage programme has emerged as the major micro-finance programme, which is being implemented by commercial banks RRBs and cooperative banks. As at end-March 2007, 2.89 million SHGs were bank-linked with outstanding bank loans of Rs. 12,366 crore. Banks also financed non-governmental organisations and micro-finance institutions (NGOs/MFIs) for on-lending under micro-finance. As at end March 2007, 550 MFIs had outstanding bank-loans amounting to Rs.1585 crore.

Financial Inclusion

In simple terms, financial inclusion may defined as delivery of banking services at an affordable cost to the vast sections of the disadvantaged and low-income groups to which banking services have remained inaccessible. RBI’s broad approach to financial inclusion aims at “connecting people with banking system and not just credit dispensation”. Banks have under taken a number of measures for bringing the financially excluded population into the structured financial system. Providing a basic banking “no-frills account” with nil or low minimum balances as well as charges, is one such example. The number of no-frill accounts opened by banks has recorded a quantum jump from less than 5 lakh in 2006 to nearly 16 million in 2008. Again RBI permitted banks, in January 2006, to utilise the services of non-governmental organisations (NGOs/SHGs), micro-finance institutions and other civil society organizations as intermediaries in providing financial and banking services through the use of business facilitator (BF) and business correspondent (BC) models. For meeting the cost of developmental and promotional interventions for ensuring financial inclusion, two funds have been constituted with NABARD: Financial Inclusion Fund (FIF) and Financial Inclusion Technology Fund (FITF), with an overall corpus of Rs. 500 crore each.

Agricultural Debt Waiver Scheme

In his Budget Speech for 2008-2009 the Finance Minister announced a Debt Waiver and Debt Relief Scheme for farmers. The scheme covers direct agricultural loans extended to marginal and small farmers by commercial banks, regional rural banks, cooperative credit institutions, and local area banks. Further, the Finance Minister indicated in May 2008 that the cost of the scheme is likely to be around Rs. 71,680 crore. The mode of financing the scheme reveals that the Central Government would reimburse to the lending institutions the amount so waived.

Concluding Comment

The emphasis given in the Report to lending to agriculture, Micro, Small and Medium Enterprises (MSEs), to financial inclusion, Micro Finance Institutions (MFIs), reflects the response of RBI to the strategy of inclusive growth in the real sector embodied in the Eleventh Plan.

Click here for Previous Monthly Columns