K C Chakrabarty: Supporting explosive growth - effective linkages
between the banking sector and real sector
Keynote address by Dr K C Chakrabarty, Deputy Governor of the Reserve Bank of India, at
the Inaugural Session of the 8th Annual Banking Summit, organised by the Associated
Chambers of Commerce and Industry of India (ASSOCHAM), New Delhi,
21 November 2012.
* * *
Assistance provided by Smt. Theresa Karunakaran in preparation of this address is gratefully acknowledged.
Introduction
Shri Rajkumar Dhoot, Hon'ble Member of Parliament and President, ASSOCHAM,
Shri M. Narendra, Chairperson, ASSOCHAM National Council for Banking & Finance and
CMD, Indian Overseas Bank, Shri Sunil Kanoria, Vice President, ASSOCHAM and
Vice Chairman, SREI Infrastructure Finance Ltd.; Mrs. Shubhada Rao, Senior President and
Chief Economist, Yes Bank Ltd.; Mr. Subhash C Aggarwal, CMD, SMC Group; Ms. Sudha
Ravi, Co-Chairperson, ASSOCHAM National Council for Banking & Finance and CEO,
PHL Finance Ltd., Shri D. S. Rawat, Secretary General, ASSOCHAM, distinguished guests,
ladies and gentlemen. It is a pleasure and privilege to be here at the 8th Annual Banking
Summit organized by the ASSOCHAM on the theme "Poised for Explosive Growth".
Present scenario
Post the wide ranging structural reforms of the 90s, the Indian economy has, until recently,
been churning out impressive growth rates and is now firmly ensconced in the exclusive club
of countries with GDP in excess of one trillion US dollars. However, as the dark clouds of
economic gloom hover above the horizon with doomsayers painting a dismal picture for the
future of the world economy, time is ripe for taking a hard look at the economic outlook for
India at the present juncture and examine what we need to do in order to keep the Indian
growth juggernaut rolling.
The pundits of doom are having a field day as the global scenario remains bleak with the
Eurozone slipping into recession once again and the debt crisis continuing to batter southern
Europe and gnawing at the economic performance of export driven Germany. An ebullient
America had seen some green shoots of recovery, but the unemployment numbers, since,
have not been encouraging and it is now facing a fiscal cliff. On the domestic front, though it
is not all clear skies and sunshine with the growth engine slowing down, the growth is still
way above that of the developed countries. India has been largely protected from the global
economic crisis through a combination of strong regulation and supervision and policies
which leaned against the wind and best suited our country, society and culture. Having said
that, we cannot claim to have remained totally immune from global headwinds. The Indian
economy, which had accelerated since the reforms, recording a growth of more than 9%
before the crisis, has slumped to 5.5% in the first quarter of 2012-13, with sequential
downward revisions in estimated growth rate, which is now expected to clock around 5.8% in
2012-13. This, however, is a far cry from our actual potential.
With economic liberalization, we have moved away significantly from the "Hindu rate of
growth" which had stagnated around 3.5% during 1950-80. According to Dun & Bradstreet
report titled "India 2020", India is poised to become a $ 5.6 trillion economy by the year 2020.
The report adds that Maharashtra, Gujarat and Andhra Pradesh will be amongst the most
developed states in the country by 2020 and would, together, contribute 32 per cent of the
overall GDP. The states which were, hitherto, lagging behind such as Madhya Pradesh,
Bihar, Orissa, Rajasthan and Uttar Pradesh, are also expected to contribute significantly to
India's growth story during the current decade.
The 11th Five Year Plan carried the objective of faster and more inclusive growth. Rapid
GDP growth, targeted at 9.0 per cent per annum, was regarded necessary to generate
income and employment opportunities for improving living standards of the masses and to
generate the requisite resources for financing social sector programmes aimed at reducing
poverty and enabling inclusiveness. The economy performed well on the growth front,
averaging 8.2 per cent in the first four years. Growth in 2011-12, the final year of the
Eleventh Plan, which was originally projected at around 9.0 per cent, continuing the strong
rebound from the crisis, was eventually recorded at 6.5 per cent. The slowdown of the
economy in 2011-12 compared to the previous year was a phenomenon common to all
major economies.
Undoubtedly, there has been a decline in growth, which cannot be solely attributed to the
global slowdown. A part of it can be traced to domestic infrastructural and governance
issues. The twin deficits, inflation and the supply side bottlenecks are some concerns that
need to be quickly tackled to spur growth. The poser before India at this juncture is whether
we can afford to relapse to the Hindu rate of growth and be content with being considered an
emerging nation forever, or should we make efforts to take our due position among the
leaders in the world arena? We cannot and must not revert to the Hindu rate of growth.
In order to overcome these challenges, we need to focus on the key areas of productivity,
innovation and reforms, both at the level of the macro economy and at the individual
firm / enterprise level. These will help us overcome the various bottlenecks currently
shackling our growth and put us firmly on the path of sustained high economic growth. It will
ensure that we are able to leverage our strengths, some of which I would be alluding to
subsequently, in order to create a conducive growth environment. These reforms need to
involve all stakeholders and should, necessarily, leverage on technology, which has the
potential to act as a force multiplier in our efforts towards productivity, innovation and
reforms. I see that some of these topics would be the focus of the technical sessions slated
for later in the day. I am sure these sessions will deliberate on how the various measures
could be implemented in an effective and time bound manner.
The role of the financial sector in any economy is to subserve the needs of the real economy.
Consequently, if the Indian economy has to fully realize its optimum potential, the financial
sector would have to play a pivotal part. As we all know, our financial sector is predominantly
bank-centric and therefore, the performance of the banking sector is crucial to the fate of the
economy. The Indian banking system has come a long way since the Financial Sector
Reforms, with the banks having served the economy remarkably well over the last two
decades. Liberalization has resulted in greater autonomy for banks in business decisions, but
with the concomitant responsibility of conducting business in line with the highest standards
of corporate governance, customer service and a commitment to nation building, which
encompasses financial inclusion.
There is no doubt in my mind that if the economic growth engine has to churn out a powerful
performance, banks would, necessarily, have to be the prime mover. The domestic credit
provided by the banking sector in India stands at an abysmally low level compared to many
of our emerging Asian peers, let alone the advanced economies. There is enormous scope
for the banks to expand their business to areas/sectors hitherto lacking formal credit.
10. Banks have to develop the ability to maintain high growth levels over a sustained period
of time. They also need to develop strong linkages with the real sector. These linkages
should critically determine all aspects of banking operations including the kind of products
and services offered, the pricing strategies, delivery channels adopted, sectors/ sub-sectors
receiving focused attention, technology platforms adopted, etc. This linkage with the real
sector will ensure relevance of banks as a key pillar in the economic system and enable
them to fully meet their crucial role in nation building. Besides, by ensuring that the financial
system grows in tandem with the real sector, build up of systemic risk through creation of
asset price bubbles can be avoided. This lack of linkage between the financial system and
the real sector was one of the critical factors contributing to the global financial crisis and
hence, the importance of this linkage has been one of our important learnings from the crisis.
What are our strengths?
Demographic dividend
Sometimes, like the mythological Hanuman, we need to be reminded of our strengths, first
and foremost of which is the great demographic dividend that the country enjoys. India has a
young population not only in comparison to advanced economies but also in relation to the
large developing countries. According to the Approach Document to the Twelfth Five Year
Plan, the labour force in India is expected to increase by 32 per cent over the next 20 years,
while it will decline by 4 per cent in industrialized countries and by nearly 5 per cent in China.
This "demographic dividend" can lead to sustainable long term growth, provided two
conditions are fulfilled. One, higher levels of health, education and skill development must be
achieved. Two, an environment must be created in which the economy not just grows rapidly,
but also promotes inclusion by generating good quality employment/ livelihood opportunities
to meet the needs and aspirations of the youth. The demographic dividend has payoffs in
creating a skilled, technology savvy work force, strong customer base and higher savings
rates, thereby increasing the resources available for productive investments. The progress
made in the field of education and literacy is leading our transformation from being the
world's back office to being a knowledge partner.
Potential for inclusive growth
A recent internal study conducted by the Reserve Bank on the profile of customers of banks
has heartening indicators. With increasing number of bank branches, the average population
per bank branch has improved from 15,583 in 2001 to 12601 in 2012. As per latest census,
58.7 percent households were availing of banking services in 2011 as compared to
35.5 percent in 2001. With liberalization of the branch licensing policy and drive towards
financial inclusion, the share of rural and semi urban branches in total new branches opened
reached 69.8 percent during 2011-12 from a mere 23.2 percent in 2004-05.The share of
hitherto unbanked centres in newly opened branches has been around 20 percent during
2011-12. Further efforts are required and are being made in view of the large number of
unbanked centres in the country. The Reserve Bank has been encouraging banks to improve
banking penetration through the Business Correspondent (BC) model, allowing "for-profit
organizations" to work as BCs, leveraging technology, including mobile technology, to deliver
banking services as part of the drive to enhance financial inclusion. While there has been
some progress, more ground needs to be covered before we achieve the goal of meaningful
financial inclusion. The extent of financial exclusion is high when compared to some of the
advanced as well as developing countries. In a cross country analysis of financial inclusion,
we compare poorly at 10.64 branches and 8.90 ATMs per 0.1 million adults, say, as against
Brazil, which has 46.15 branches and 119.63 ATMs per 0.1 million of the population. In this
vast financially excluded populace lies our opportunity!
Growth, merely in terms of numbers, would not carry any meaning unless it reaches every
section of society - the vulnerable, underprivileged and the marginalized. Public sector
banks as well as RRBs have played a key role in expanding the branch network to rural
India. However, since it has been observed that the benefits of Government schemes often
do not reach the intended beneficiaries, Reserve Bank has been encouraging banks to
implement Electronic Benefits Transfer (EBT). Since many such social security beneficiaries
reside in villages with population of less than 2000, RBI has been giving thrust on expanding
the benefits of EBT to all villages. SLBC convenor banks have, therefore, been advised to
prepare a roadmap covering all unbanked villages with population of less than 2000 and
allocate these villages to various banks for providing banking services in a time bound
manner. Besides, banks also need to provide a BC touch point in each village, where brick
and mortar branches are not available, for extending the provision of EBT services at the
earliest. BCs could also provide door step services to EBT beneficiaries through regular visits
to villages, thereby ensuring that all kinds of banking facilities are available in the long run
through a mix of brick and mortar branches and BC networks. We have also recommended
the one district-many banks-one leader bank model in our "Operational Guidelines for
Implementation of EBT and its Convergence with Financial Inclusion Plan", which would
expedite implementation of EBT in a simple and scalable manner. Banks need to
wholeheartedly work towards achieving these goals, not as a CSR activity, but rather by
seeing this as a viable and profitable business opportunity. Likewise, banks should also
pursue extending banking services like opening of Basic Savings Bank Deposit Accounts,
etc. as a potential business proposition and not as a regulatory burden. It is in banks' own
interest to realize early that the population mass concentrated in financially excluded centers
has the potential to drive their future growth and profitability and help place the economy in
the fast track mode!
Infrastructure financing - huge potential
Stimulating growth puts the spotlight on developing infrastructure - an efficient public
transport system, roads, public utility services, housing, educational institutions, locomotive
plants, ports, container terminals, etc. - the entire gamut, which forms the backbone of any
developing country. The increasing infrastructure requirements to support a growing
economy call for enormous investment. A McKinsey estimate suggests that each year we
may have to build about 700 - 900 million square meters of residential and commercial
space, 350-400 km of metros and subways and 19000-25000 km of roads - a massive task
and an equally massive opportunity for banks. The Approach Paper to the 12th Plan
estimates that infrastructure investment will need to increase from about 8.0 per cent of GDP
in the base year (2011-12) of the Plan to about 10.0 per cent of GDP in 2016-17. The total
investment in infrastructure would have to be over Rs. 45 lakh crore or $ 1 trillion during the
Twelfth Plan period.
Financing this level of investment will require larger outlays from the public sector, but this
has to be coupled with a more than proportionate rise in private investment. Private and PPP
investments are estimated to have accounted for a little over 30.0 per cent of total investment
in infrastructure in the Eleventh Plan. Their share may have to rise to 50.0 per cent in the
Twelfth Plan. Government's proposal for modification in investment norms for pension and
provident funds to channelize their large cash inflows into Infrastructure Debt Funds would
also provide infrastructure projects with reliable sources of long term funding. The funding for
infrastructure has not been a major constraint thus far and credit to infrastructure has
continued to account for almost one third of bank credit to industry. There have, however,
been other conspicuous stumbling blocks, viz. delay in policy promulgations, environmental
clearances, land acquisitions, permissions, etc. which have contributed to delays and project
over-runs. While Central and State Governments would have to deliver on easing these
roadblocks and facilitating investments in the infrastructure sector, banks would also need to
hone their credit appraisal, monitoring and risk management skills, keeping in view the long
gestation period of infrastructure projects. This would ensure that the sector's funding needs
are met, while keeping the position of NPAs under stringent control.
Challenges for banks
Need for enhancing productivity
The performance of banks in 2011 and 2012 have been somewhat muted due to the general
slowdown in the economy and the higher interest rate environment. The balance sheet of
Scheduled Commercial Banks (SCBs) reflected slower growth at 15.5 percent in 2011-12 as
compared to 19.2 percent in 2010-11, with deceleration in credit growth. The increased cost
of deposits impacted net profit of banks, which increased at a slower rate of 16.1 percent as
compared to 23.2 percent during the previous year. Interest expended on deposits, along
with increase in proportion of high cost term deposits, led to acceleration in the interest cost
of banks. Net Interest Margins of banks dipped marginally compared to the previous year. An
analysis of profitability of banks, however, reveals that profitability of foreign banks is higher
than that of other bank groups. Though their share of total assets of the banking system
stands around 7 percent, foreign banks account for close to 12 percent of profits of SCBs. A
Du Pont analysis showed that foreign banks registered highest Return on Assets amongst
bank groups due to better asset utilization, although their operating expenses to assets ratio
was higher compared to other bank groups. Their higher profitability could be attributed to
better fund management practices. This is an area where Indian banks would need to
improve.
The profitability of SCBs would be under increased strain during 2012-13 due to higher level
of NPAs. The gross NPAs of the banking system has increased from 2.36 percent in March
2011 to 3.25 percent in June 2012. Restructured standard accounts as a percent of gross
advances have doubled from 2.7 percent in 2009 to 5.4 percent as at June 2012 with
substantial increase in restructuring in certain sectors. Data indicates that restructuring is
largely resorted to in case of industrial sector accounts, particularly, large industries, as
against smaller borrowal accounts such as agriculture, micro and small enterprises. The
persistently high level of NPAs and increase in restructured accounts continues to pose a
significant constraint on banks' abilities to reduce lending rates, thereby, in a sense,
penalizing the honest borrowers. Corporates need to innovate and embrace technology to
improve their productivity and efficiency so that their costs can come down, they remain
competitive and continue to service their obligation as borrowers. Banks on their part must
look to arrest the deterioration in asset quality by adopting better risk management practices
like better credit appraisal, closer monitoring of borrowal accounts, greater information
sharing among banks and by carrying out elaborate viability studies before restructuring.
While NPAs/ restructuring of assets cannot be wished away, they need to be effectively
curtailed so as to ensure that the lendable resources of banks are maximized. On its part,
RBI has mandated banks to put in place an effective mechanism for information sharing by
December 2012 and to sanction ad hoc loans/renewal of loans to new or existing borrowers
only after obtaining/ sharing the information.
Lack of enabling environment
According to the Doing Business Rankings 2013, India ranks way down at 132 out of
185 countries in the global index of countries in "Ease of doing business"; 41 places below
China, 51 places below Sri Lanka and 116 places below Taiwan. Explosive growth can only
be achieved if there is an enabling economic environment. This requires Governmental
policies for quicker clearances, which encourage business and long term investment.
Recently, some steps have also been announced to stabilize the Government finances and
contain fiscal deficits within manageable levels.
Government has also taken steps to encourage public investment as well as public private
partnerships in infrastructure and to tap into available technology and capital from around the
world. I firmly believe that for achieving explosive growth, it is imperative that macroeconomic
environment stabilizes, inflation and inflation expectations come down to comfortable levels
and the twin deficits are contained. The steps initiated by the Government need to fructify
into effective change.
Opportunities galore
Customer centricity
Banking
Every challenge is also an opportunity. A Boston Consulting Group study "Indian
2020 - Making the Decade's Promise Come True" estimates that the income group below
the middle class with annual household income of Rs 90000 to Rs 2.00 lakh per annum will
constitute the largest group of customers, increasing from an estimated 75 million
households in 2010 to 120 million in 2020, constituting the "Next Billion". This customer
segment would increasingly demand affordable, low cost banking services. The challenge for
banks is to extend the reach of banking services through bank branches/ATMs/BC model to
tap the potential of this customer segment. Banks need to develop customer centric products
and services. The pricing has to be right and affordable. Greater use of technology, including
mobile services, could revolutionize banking. The potential of mobile banking is immense.
The BCG study estimates that even if 25-30 percent of mobile users have GPRS / 3G
activated, there would be 250 million to 300 million customers who would access banking
services over the mobile. The Indian banking industry would have to innovate and build an
efficient and low-cost framework for transaction banking. Going forward, customer
satisfaction would be the buzzword for success and would set the winners apart from the
laggards.
Dream big, think small
If we are to achieve explosive growth, banks would need to increasingly focus on the SME,
agriculture and retail sectors. It is a fact of life that large corporates have easy access to
huge loans across the banking sector, but they also account for a major segment of
NPA/restructured accounts. On the contrary, the small borrowers/MSMEs continue to face
difficulties in accessing bank finance due to perceived higher risk and lower ticket size. It
needs to be appreciated in this context that the delinquencies in this segment are largely
attributable to the inadequacy of finance and lack of support from the banks to the viable
units at an appropriate stage. Banks must realize that through adequate appraisal, fair
pricing and by extending proper handholding support to the MSMEs, the sector can be a
potential game changer in terms of accretions to the banks' bottom line.
Banks need to evolve business models and delivery channels which would bring down the
cost of providing credit to the agriculture/ retail/ SME segments. We can achieve explosive
growth if banks are able to customize and deliver cost effective products and services to this
customer segment while simultaneously guiding and providing handholding support to these
sectors. The fear of increase in NPAs cannot be a ground for depriving these sectors of
timely and adequate credit. Besides translating into increased business opportunities for
banks, these sectors can significantly contribute to employment generation and growth in
savings, and would support GDP growth.
There is also a need to encourage incubation and development of new business ideas and
providing funds to translate these into reality. Facebook would not have been a reality if
angel investors Reid Garrett Hoffman and Peter Thiel had not funded Mark Zuckerberg.
According to a BCG India study, India has 190,000 millionaires but only about 500 angel
investors. The HNIs in India prefer to invest in real estate. While Venture capital funds, to
some extent, do provide funding to start ups, much more needs to be done to develop a
viable ecosystem where new ideas with potential for employment and wealth generation can
flourish. Banks could consider providing funding to such innovations.
Attitudinal changes
Success demands change in the way banks do business, harness the power of innovation,
recognize the huge potential at the bottom of the pyramid and reach out to them. Banks need
to go the extra mile in financial literacy by educating the customers and understanding the
ecosystem in which small businesses and agricultural operations grow and thrive. They need
to learn to work in a partnership to finance sustainable business.
Success is not about financing seemingly safe large corporates by following the herd in a
"me too" manner. It is about changing mindsets, looking at untreaded paths, putting the
customer above all and tapping the power of technology. This demands a committed
workforce with the requisite technology, HR and risk management skills. It calls for re-skilling
the existing workforce and hiring and retaining talent in the public sector, particularly, in view
of the large scale retirements over the next few years. PSBs would have to increasingly look
at performance management, changing mindsets and empowering employees for fast and
effective decision making. It requires a cultural revolution in the banking sector, particularly
for public sector banks if they wish to retain the competitive advantage of size over the
smaller but more nimble footed private sector/ foreign banks.
Regulatory / supervisory environment
One of the essential pre-requisites for attaining sustained growth is financial stability, which
in turn requires a combination of strong regulation and supervision. The regulators and
supervisors need to be abreast of the changing contours of the financial system, be aware of
the changes in the way banks do business, new products and services, the risks and the
mitigants. They need to have their ears to the ground, so to speak, so that they are not
caught unawares by the undercurrents in the financial system, which could turn into a
financial tsunami. Given the tremendous financial and human cost of the recent sub-prime
crisis, we cannot afford a relapse. Hence, the emphasis has to be on developing a strong
supervisory infrastructure for creating a robust financial system and an environment
conducive to growth. We at the RBI have been looking at the supervisory system and the
way we supervise banks. Based on the recommendations of the High Level Steering
Committee set up for the purpose, we have initiated the transition from a CAMELS
transaction based approach to a Risk based approach in supervision of banks. Based on the
interactions that I had as the Chairman of the HLSC and other periodic dialogues that I have
with the bank management, my assessment is that most of the banks do not have a clear
perception of their activity wise costs and profits. It is, indeed, perplexing how these banks
have been managing their risks when they do not have an idea of which activity/business line
has a positive risk-reward skew?
Against this backdrop, as a first step, we have advised banks to re-assess their risk
management architecture, culture, practices and such other related processes and to
benchmark them against certain essential requirements which have been identified as
prerequisites to introduction of risk based supervision. Banks have also been advised to
upgrade their HR capabilities with regard to skill sets required for handling risk management
systems, MIS, etc. to facilitate the switch over to risk based supervision. RBI would also
conduct training programmes/ workshops for banks once the Risk Profile Templates and
guidelines on RBS are finalized. Meanwhile, the challenges for banks would remain in terms
of upgrading their MIS capabilities, fine tuning their transfer pricing policies, measuring
transaction/ activity wise costing, evaluating the risk-return trade off, putting in place an
effective and transparent framework for risk based pricing of products and services and
non-discriminatory pricing of liabilities.
Conclusion
To sum up, let me recapitulate the key ponderables:
•
The first and foremost requirement is to improve the Governance standards in all
spheres - at the centre, state, institutions, individuals, etc. Probity in public life and
in our dealings are key ingredients that can unshackle the chains that bind us. We
need to build public opinion/ awareness about the need for rapid growth as it would
prove to be the main driver for the changes that we seek. Agitation is not and cannot
be a solution.
• The banking sector has to develop strong linkages with the real sector in order to
ensure stable and sustainable growth. This should govern all aspects of banking
operations which would help avoid build up of systemic risk through asset price
bubbles.
•
We have recounted some of our inherent strengths earlier. All we need is to refocus
on our key strengths and to concentrate our energies on overcoming the bottlenecks
currently shackling our growth. Collectively, we need to work hard and improve our
productivity and efficiency. There is no reason why we cannot realize our potential of
being a high growth economy. As stakeholders, let us strive towards attaining a
sustainable high economic growth trajectory and making India a vibrant economy
where the gains of inclusive growth disseminate wide and deep and touch all lives,
especially those at the bottom of the pyramid. Together we can make this happen.
I once again thank ASSOCHAM for inviting me to this Summit and giving me an opportunity
to share my thoughts on the theme of the Summit. I note that the technical sessions to follow
will be focusing on related sub-themes such as financial inclusion, reforms and the emerging
regulatory framework. I am sure that the imperatives of productivity, innovation and reforms,
along with the need for linkages between financial sector and real sector, which I alluded to
earlier, would find resonance in the session discussions.
I hope that today's deliberations would generate new ideas on how to realize the potential of
Indian banking and achieve the explosive growth required to support the needs of the
economy, as it seeks to regain its high growth trajectory. Thank you.
References
Report on Trend and Progress of Banking in India 2011-12
India's Urban Awakening: Building Inclusive Cities, Sustaining Economic Growth-McKinsey
Global Institute April 2010
Doing Business 2013 - IFC & World Bank Report
Faster, Sustainable and More Inclusive Growth - An Approach to the Twelfth Five Year Plan
(2012-17)
Indian Banking 2020 - Making the Decade's Promise Come True - Boston Consulting Group
Business Standard, August 18, 2011 - India to be $5.6 trillion economy by 2020: Dun and
Bradstreet
Business World issue dated Nov 19, 2012 - Where are the angels?