R Gandhi: Indian banking sector - role in triggering future growth
Valedictory address by Mr R Gandhi, Deputy Governor of the Reserve Bank of India, at the
6th ICC Banking Summit, Kolkata, 14 June 2014.
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Assistance provided by Ms Rekha Misra, Director, Dr. Saibal Ghosh, Assistant Adviser & Shri Radheshyam
Verma, Research Officer is gratefully acknowledged.
Good evening, Ladies and Gentlemen!
2. It is both an honour and a privilege to attend this important Conference at the Indian
Chamber of Commerce (ICC) in Kolkata. From humble beginnings in the early 1920s, the
ICC has come a long way and has presently evolved into a leading national chamber
operating from Kolkata. With banks being the mainstay of the financial system, I am sure that
the deliberations in the Conference would have provided important insights to all attendees
on how the banks' role is getting re-oriented in the new milieu. The Conference has a healthy
mix of participants spanning not only representation from the Government and eminent
commercial bankers, but also people from auditing firms and general audience. I am sure
that this diversified representation would have provided a varied perspective to each of the
issues being debated and thrown up possible solutions.
Financial sector and economic growth
3. Banks' primary purpose is to mobilize otherwise idle savings for the purpose of lending to
productive investments. A lot of research work has been undertaken to study the relationship
between the financial sector and real sector economic growth. The old model of economic
growth as a function of land i.e. capital, labour, technology and entrepreneurship has been
modified. The new paradigm of economic growth is that it is a function of savings rate, return
on investment and cost of intermediation. We can easily see the role and importance of the
financial sector with regard to all of these three factors. Thus while there is consensus about
finance having significant impact on the quantity, quality ie productivity and the efficiency of
capital, jury is still out in determining whether it is the banks or capital market which drives
economic growth. Research opinions and conclusions are equally divided. Very often the
examples of the United States of America and the United Kingdom are quoted to prove that it
is the capital market which drives growth. To counter that, the examples of Germany and
Japan are quoted to establish that it is the banks which drive the growth.
4. Banks constitute the backbone of a nation's financial system, performing manifold
functions through liquidity, maturity and risk transformation. Indeed, it needs no gainsaying
that the health of the economy is, in a way, the mirror reflection of the banking system,
especially in bank-based financial systems such as ours. Of course, the reverse is also
equally true. I am reminded of a saying that a bank is like heart of the human body and the
capital it provides is akin to the blood in it. So long as the blood circulates seamlessly, the
organs remain sound and healthy. However, if for any reason, the blood were not supplied to
any organ, then that part would be rendered useless. Not surprisingly therefore, there is
always a conscious attempt on the part of the Reserve Bank to provide adequate liquidity
and credit to all productive sectors of the economy.
Indian experience
5. India has the distinction of long history of both banks and capital market. Economic history
of India narrates how both have been vibrant in many important cities, though Mumbai did
dominate all others. However, slowly and steadily, especially in the last twenty five years or
so after the financial sector reforms, the banking sector has emerged as THE source for
investment funding.
6. What has been the actual contribution of banks for engineering investments in the Indian
economy? Bank credit increased from 5 billion as at end March 1951, to 13 billion by
March 1961, 47 billion by March 1971, 254 billion by March 1981, 1164 billion by March
1991, 5114 billion by March 2001, 39420 billion by March 2011 and 52604 billion by
March 2013. What has been the contribution of capital market in these years? During the
1970s, while capital market helped raising 10 billion worth of equity, bonds and debentures,
banks extended credit worth 207 billion in that period. During the 1980s, the corresponding
figures were 233 billion and 910 billion. In the 1990s, they were 1172 billion and 3950
billion respectively and in 2000s they were 2115 billion and 34206 billion respectively. In
the fiscal 2011 and 2012, 318 billion by the capital market and 13284 billion by banks.
7. Actually banks do extend funds by way of investment in the bonds and debentures. As
these are heavily in government bonds, rather than in those issued by corporates and the
split figures are not readily available, I have not included them here.
8. While we can lament the lackluster performance of the capital market, a redeeming feature
has been the growth of private placement market in the past twenty years. Though the issues
thereat had been predominantly in the form of bonds and debentures, the growth in size has
been very reassuring. It gained popularity from mid 1990s; from 1995-96 to 2000-01, this
market raised 752 billion, in the next ten years, it helped raise 7614 billion and in fiscal
2011-12 and 1012-13, this market raised 2009 billion.
9. While we are happy that banks have been doing such a wonderful yeoman service for the
growth of the economy, will we be happy to continue to depend on bank financing as the
predominant mode? Are we compelling the banks take too much risk, thereby endangering
the depositors' money?
10. However, taking note of the predominant position of banks in the Indian financial system
and taking a realistic view, can we expect the bank finance to comprehensively cater to all
types of investment needs? Irrespective of whether it is short, medium or long term, or
whether it is loan, debt or equity financing, or it is with low, medium or higher risk
propositions? Should we turn our banks like the universal banks in Germany, catering to
every type of investment demand of the entire economy?
11. Or, alternatively, should we develop capital market so that it can cater the increasing
need for investment and also risky investments? Like those in the USA?
12. These are sets of questions that we need to ponder over and take strategic decisions.
Twelfth plan
13. 12th Five Year Plan aims to usher in faster, more inclusive and sustainable economic
growth. It notes that today, India can sustain a GDP growth of 8 percent a year. Increasing
this to 9 or 10 percent will need more mobilization of investment resources; better allocation
of these resources through more efficient capital markets; higher investment in infrastructure
through both public and PPP routes; and more efficient use of public resources.
14. Twelfth Plan has ambitious target for investments to usher in high growth rate of
8 percent during 2012-17. It aims to mobilise resources worth 5.4 trillion. The total public
sector investment in infrastructure envisaged in the Twelfth Plan is 16 trillion by the Centre
and 12.89 trillion by the States. Investment by the private sector, which includes PPP
projects, makes up the balance of 26.83 trillion, which is 48.14 percent of the required
investment during the Twelfth Plan, a much higher share than the anticipated 36.61 percent
during the Eleventh Plan. Accordingly the Plan aims for an eclectic mix of development of
capital market, more specifically debt market, besides exhorting bank finance.
15. Being from the Reserve Bank, let me ponder more over banks' role in the coming years.
Banking sector reforms
16. Leading economists most often cite the importance of sound financial sector reforms as
being central to a healthy banking system that aids economic growth. India is the largest
country in South Asia with an extensive financial system characterized by varied financial
institutions, comprising of both banks and non-banks. Banks are the mainstay of the financial
system with bank assets comprising, on average, around 70 percent of GDP during the
postreform period. The commercial banking segment comprises of 26 public sector banks in
which government has majority equity stake, 20 private sector, including 7 de novo (which
became operational after initiation of economic reforms in 1991) private banks, although RBI
has recently done away with this distinction and over 40 foreign banks, which operate as
branches.
17. Prior to the inception of financial sector reforms in 1991, the Indian financial system can
best be characterized as highly regulated and financially repressed. The prevalence of high
reserve requirements, interest rate controls and allocation of financial resources to
predesignated sectors adversely affected banks' resource mobilization and allocation.
18. The period 1992-97 laid the foundations for reforms in the banking system. The reforms
comprised of five major planks: cautious and proper sequencing, mutually reinforcing
measures, complementarities between banking reforms and other associated policies (e.g.,
monetary, external, etc.), developing financial infrastructure and nurturing and developing
financial markets. Some of the salient reforms undertaken in the financial system, included,
among others, lowering of statutory reserve requirements; liberalizing the interest rate
regime, first on the lending side and later, on the deposit side; infusing competition by
allowing more liberal entry of foreign banks and permitting the establishment of de novo
private banks; institution of prudential measures (capital adequacy requirements, income
recognition, asset classification and provisioning norms for loans, exposure norms,
accounting norms) and enhanced disclosures and levels of transparency in their annual
audited statements to promote market discipline.
19. Over the period of reforms beginning 1992 through 2013, real bank assets have grown at
a compound annual rate of about 10%; the growth rate of deposits and credit both in real
terms, during the same period has been roughly of the order of 10% and 12%, respectively.
20. I am happy to note that the issues deliberated today are those that are likely to shape the
future of the industry, going forward. I would like to take this opportunity to share with you my
views on some of these and other related concerns, which, as I see it, will shape the
contours of the industry in the years ahead.
Financing of infrastructure
21. The first issue, which immediately comes to my mind, is the issue of infrastructure
financing. I am sure that this issue will also be uppermost in your minds as well. Inadequate
infrastructure exerts a cascading impact on the economy, negatively affecting productivity,
employment, personal income and international competitiveness and costs. The 12th Five
Year Plan as mentioned earlier has estimated the infrastructure requirement at around
INR 56 trillion, with a gradually increasing role for the private sector. Given the limited fiscal
headroom and the long gestation lags involved in its fructification, there is a need to rope in
long-term providers of funds.
Can banks chip in? Yes and in fact has already done so. As the capital market's significance
has been waning, bank finance for infrastructure steadily grew. The outstanding bank credit
to the infrastructure sector, which stood at 72 billion in 1999-2000, has increased to
7860 billion in 2012-13, registering a compounded annual growth rate (CAGR) of over
40 per cent against an overall CAGR of bank finance to all industries at 20 percent during the
same period. However, this kind of growth and the general economic downturn and policy
conundrum have resulted in concentration risk for banks (Infra funding is as high as 15% in
the banking books); banks are saddled with large scale stress assets in the infra segment.
Further, there is the structural problem of using short term nature of the bank funds for very
long term funding. Banks did evolve a midway solution, of medium tenor funding for 12 to
15 years. This, though solved the initial problems, is fundamentally a weak arrangement and
the recent stress period has brought the cracks into open. Banks will have to appropriately
structure their infrastructure lending keeping in view their asset-liability mix; they also may
have to raise long term resources. They should develop long-tenor fixed rate or floating rate
products or develop appropriate hedging instruments to tackle counterparty and other risks.
Takeout finance is another possible solution, as do Infrastructure Debt Funds (IDFs). These
initiatives are presently at a nascent stage, but hold long-term promise.
22. Over the longer-term, an efficient and vibrant corporate bond market is a sine qua non for
ensuring viable financing of infrastructure. By facilitating long-term funding for the sector, it
can provide much-needed debt capital that will be beneficial to both borrowers and investors
alike. This will also ensure deep and broad financial markets, one of the key pillars of RBI's
financial sector policies.
Financing of SMEs
23. A second issue I would like to touch upon is the financing of micro, small and medium
enterprises or MSMEs, as we call them. In 2011-12, the sector accounted for a significant
proportion of manufactured output and over 12 per cent of our GDP. In addition to their
strong export orientation, they also have a strong employment potential, providing bread- and
butter to nearly 100 million people, perhaps next only to the agricultural sector. With a big
chunk of them being located in rural areas, it also offers tremendous potential for rural
development. Given their forward and backward linkages with the corporate sector, I view
them as "silent" engines of growth, especially in slow economic cycles.
24. Numerous studies have documented that, given the lack of reputation and tangible
collateral, debt financing, mostly from informal sources, comprises the primary source of
external funds for these entities. Given the often onerous documentation requirements for
banks, these entities tend to get a raw deal when it comes to bank finance. The Fourth
Census of MSME revealed that only 5.2 per cent of the units (both registered and
unregistered) had availed of finance through institutional sources; the majority of units - 93%
of them in fact - had either no finance or depended on self-finance. A World Bank Enterprise
Survey in 2011 also reinforces these conclusions. The moot point is that the credit flow to
MSMEs from institutional sources is not commensurate with the economic activity
undertaken by them.
25. A RBI Discussion Paper in 2013 had propounded an innovative combination of banks
and private equity, with a potential role of state in providing credit enhancement
mechanisms/ solutions as a way out of this credit constraint. It also put forth the proposal that
small banks can provide a useful role by catering to the needs of this segment, for example,
through relationship banking.
26. There is also an oft-heard complaint from bankers that MSMEs are often quite
lackadaisical when it comes to settling their dues. It needs to be recognised that MSMEs
often act as ancillaries to large industries, and their cash flows are lumpy. The business
orientation of large industries often affects the MSMEs directly, in turn hampering the
recycling of funds and business operation of MSME units. Banks need to take a proactive
view, carefully analyzing the linkages of the MSME units, when sanctioning funds. The
existing provisions of the Interest on Delayed Payment Act, 1998 for these entities have been
suitably modified taking on board their unique characteristics. In addition, banks have been
advised to sanction separate sub-limits within the overall limits sanctioned to the corporate
borrowers for meeting payment obligations in respect of purchases from MSME sector. The
Parliament has passed the Factoring Regulation Bill that is expected to address delays in
payment and liquidity problems of micro and small enterprises. I am sure that these
measures will contribute in no small measure towards alleviating the extant constraints that
plague this sector.
Mobilising resources
27. As we have seen, country needs enormous resources for its development. How do we
raise them? Banking sector has a major role here, in mobilizing the savings of the people. As
at end March 2014, the scheduled commercial banks had mobilized deposits to the tune of
76 trillion. There are 146 scheduled commercial banks (including the Regional Rural
Banks) in the country, with more than 1.2 lakh branches undertaking this activity. However,
to support economic growth, we need to reach out more and hence there is a need for more
banks to be functioning in India. Not just more banks, perhaps we need more variety of
banks. I am not talking about public, private, foreign bank variety here. I am talking about the
variety of functions that they will undertake, the niche in which they want to excel.
Accordingly, the Reserve Bank has decided to license more banks. Two licenses we have
given recently. We intend to offer this on tap basis. We are working on new set of guidelines
for both full service commercial banks and differentially licensed banks. We hope that with
more number of players, the banking sector will mobilize more resources for funding faster
economic growth, will bring in financial inclusion and thereby support inclusive growth in a
sustainable way.
Conclusion
28. I have touched upon several issues that are of contemporary relevance and are expected
to remain important for quite some time in the near future. Conferences such as these offer a
platform for interchange of views in a structured and systemic manner, whilst taking into
consideration the regional-specific concerns as well. I hope that the organizers will not stop
at this one-off Conference and instead, will arrange follow-up discussions to further brain
storm the issues and ensure that the discussions reach their logical conclusion.
29. Thank you.