Indian Banking System
Moving towards international best practices
Says S K Gupta,Chief General Manager(Bengal Circle),State Bank of India

Q How would you look at the 25 years of Nationalised banking from today's perspective?
A.There has been a paradigm shift in mindsets both at the Government level and at the policy framing level in the banking industry over the years since nationalisation of Banks in 1969, particularly during the last decade (1990-2000). Having achieved the primary objectives of nationalisation as envisaged by the Government policy framers at the time viz. a marked shift from class to mass banking, increasing the reach of the banking industry graphically through massive branch expansion, credit to the agriculture and rural sector and to function as an active arm of the Government for poverty alleviation, the most important issue before the industry at present is survival and growth in the vortex of strong cross currents that the economic liberalisation has generated. The wide spread branch expansion programme resulted in a massive recruitment drive over the years for manning the operational units opened at the Government's directive. As a result the nationalised banking industry at present is characterised by a massive branch net-work and a bloated and highly unionised work force which combined with a low level of technology, has impaired the manouverability of these organisations vis-a-vis the lean, compact, techno savvy, market driven and nimble footed new generation private banks which have come into the market over the last 5/6 years. These new entrants into the market are consistently chipping away at the market share of the nationalised banks especially in metro and urban centres thereby exposing the bottom line of the nationalised banks to severe strain.

Q.What are the ill effects of bank nationalisation?
A.Majority holding by the Government in nationalised banks has led to a very high level of Government control and formulation of policies based on the dictates of the Government. While the nationalised banks have toed the Government line in extending large chunks of credit under the Government sponsored poverty alleviation schemes and to the agricultural and rural sectors, lack of adequate legal wherewithal for recovery has resulted in these banks being saddled with very high level of non-performing assets, which have severely eroded their bottom line. Another important fall out of nationalisation has been the impairment of decision making at the highest levels in the nationalised banks because of the overwhelming presence of the Central Vigilance Commission which has the power to question even bonafide decisions taken purely on business considerations. This omnipresent spectre of accountability has adversely affected prompt decision-making in the nationalised banking sector. Moreover, with the advent of nationalisation, the banks have been seen as benevolent employers where the emphasis has been more on employee welfare rather than employee productivity. This has resulted in large scale and across the board complacence amongst the work force, which in turn has impeded market orientation and customer service in these banks.

Q.How do you see the banking industry responding to the changes?
A.It is now well understood that a healthy banking sector is the bedrock of a stable financial system. The renewed focus on the banking sector has been driven by two major considerations. Firstly, the growing universalisation and internationalisation of banking operations have altered the face of banks from one of mere intermediator to one of provider of quick, efficient and consumer centric services. Secondly the widespread banking problems that have plagued large areas of the globe have raised a clutch of questions relating to linkages between banking reforms and reforms of other segments of the financial sector, exposure to sensitive sectors etc. It is therefore imperative especially in a developing economy like India where assets of the banking sector constitute a substantial proportion of financial sector assets, to promote robust financial practices and policies in respect of banks. In the wake of the recent financial crisis in different parts of the globe, there has been a renewed focus world wide on containing risks. The banking industry in India, in the new millennium, is also moving towards international best practices in banking supervision for achieving and maintaining stability and also to combat competition from global players effectively. It has been decided to raise the stipulated minimum capital to Riskweighted Assets Ratio (CRAR) from March 2000 and to make a general provision of 0.25% on standard assets on global portfolio basis and not on domestic advances alone.

The Government, in recognition of the fact that the nationalised banking industry needs to augment their capital base to cope up with the changing operational environment, has permitted the banks to access the capital market both at home and abroad and has also permitted a reduction in the minimum Government shareholding in nationalised banks to 33%. This landmark decision has wide ranging implications since the financial health of these banks would now be subjected to intense scrutiny of both the domestic and international rating agencies when the banks access the capital market for raising fresh funds to shore up their capital base.

Further, given the increasing internationalisation of banking operation, Commercial Bank are often subject to significant mismatch between assets and liabilities with implication of several type of risks in view of which Assets Liability Management (ALM) Committees headed by top management functionaries have been set up. Moreover the increased complexity in banking operations and the need to prevent financial crisis of the type witnessed in South East Asia recently have necessitated upgradation of various risk management procedures and practices in the banking industry. A risk management system has therefore been put in place in the banks to enable them to take care of credit risk, interest rate risk, market risk and operational risk.

Another crucial issue which is engaging the constant attention of the banking industry is the alarmingly high level of Non Performing Assets (NPA). A significant part of the problem arises on account of the carry over of old NPA in the priority sector and certain sunset industries. Another major anxiety before the banking industry is the high transaction cost of carrying Non Performing Assets in their book. The nationalised banks have not been able to bring about the desired reduction in NPA due to the extant Government policies and the prevailing legal framework. The resolution of the NPA problem requires greater accountability on the part of the corporates, greater disclosure in the case of defaults, an efficient credit information sharing system and an appropriate legal framework pertaining to the banking system so that court procedures can be streamlined and actual recoveries made within an acceptable time frame.

Q.How do you see the banking industry in the new millennium?
A.There is an increasing movement worldwide towards building a safe and sound banking system backed by a strong supervisory/regulatory regime in accordance with the core principles for effective banking supervision. The core parameters by which the banks would be evaluated both by domestic supervising authorities and by global rating agencies are CRAR, net NPA and Return On Assets reflecting asset quality, profitability and the capacity to withstand financial shocks. The banking industry in the new millennium will also have to ensure greater transparency and disclosure in their financial statements for the information of market players, investors, depositors and rating agencies. Such disclosures would enable the users of that information to accurately assess the bank's financial condition, performance, business activities, risk profile and management practices. The nationalised banking industry would be subject to tremendous pressures to perform as otherwise their very survival would be at stake.

Information technology is slated to play a key role in the banking sector in the new millennium as it would not only ensure smooth passage of interrelated transactions over the electronic medium but will also facilitate complex financial product innovation (such as derivatives). In India the consumers would be exposed to a wide array of banking products and services. The nationalised banking industry in India will have to get its act together if it has to survive in the new millennium since it would be subject to intense competition not only from the new domestic players but also from established global outfit especially in a total convertibility scenario in the not too distant future. The sustained pace of liberalisation would necessitate that the nationalised banking industry sheds its flab, get leaner and more agile and acquires the much needed market savvy and customer focus which are the crucial ingredients of success in the brave, new world. The writing on the wall is clear: SHAPE UP OR SHIP OUT.

Q.Do you think the uncertain political climate has hindered the development and unshackling of the banking sector in India? What is your opinion about 'Open Economy Policy' in India?
A.Considering the increasing pace of reforms and competitive pressures, it is imperative that focused attention is required on issues regarding strengthening of the banking system, streamlining banking procedures, upgradation of technology and networking and structural changes in the system. However, the question of soundness of the banking system cannot be analysed in isolation. In an open economy the banking system, being a part of the larger financial system would be exposed to contagion and ripple effect on account of financial disturbances or systemic failure anywhere in the world. Moreover the dividing line between banking and non-banking entities would also get increasingly blurred as they move more towards Universal Banking.

Q.Have you any observation on any other issues?
A.There is a need for enhanced corporate governance in the banking industry. The structure of corporate governance needs to transparent and consistent, striking a balance between promoting safe and sound banking on the one hand and the feasibility required for effective competition on the other.