anand sinha : striking a balance – credit penetration and npa management – role of information sharing address by mr anand sinha, deputy governor of the reserve bank of india, at the fourth annual credit information conference, mumbai, 7 march 2012. * * * inputs provided by mr manoj sharma, smt rachna dikshit and smt jayanthi n are gratefully acknowledged. mr. nair, chairman, credit information bureau ( india ) limited ( cibil ) and cmd, union bank of india ; mr. mallya, cmd, bank of baroda ; mr. siddharth mehta, president and ceo, transunion ; mr. thukral, md, cibil and other distinguished guests. it is indeed an honour for me to address you all here during the fourth annual credit information conference. banking is a risky business. banks, or more generally the credit institutions, in their role as intermediaries take upon themselves significant credit risks, while interposing between lenders ( depositors ) and borrowers. credit risk is, by far, the largest risk faced by banks. the risk transformation, where they become borrowers to lenders and lenders to borrowers, leads to warehousing of risks in credit institutions. in fact, this risk transformation offered by credit intermediaries is the cornerstone of credit intermediation which facilitates pooling of savings for being lent for various economic activities. in credit markets, the lenders ’ knowledge of a borrower ’ s likelihood to repay ( risk profile ) is imprecise and has to be estimated based on available information. borrowers, obviously, would have superior information than lenders about their own past actions and future intentions although it is the lender who bears the negative consequences of the risk. moreover, borrowers have incentive to misrepresent their risk profile. in any case, lenders cannot rely solely on the information provided by the applicant but must evaluate borrowers ’ claims even when borrowers are truthful. this entails significant cost and time. such information asymmetry has consequences for lending as it results in misallocation of credit. let me explain. before the advent of credit information models, traditional neoclassical economics assumed that markets were “ informationally efficient ”. this implied that one cannot consistently achieve returns in excess of the average market returns on a risk adjusted basis, given the information available. more recent work by stiglitz and others has shown that only

manages large private pools of capital, there is a need to have additional capital requirements to take care of reputation, concentration and other risks not captured in the traditional framework. this is the reason why we are looking at bringing out guidance on banks managing large private pools of capital. derivatives – risks in leveraged and complex structures 10. one of the important needs of a growing and increasingly globalizing economy is for businesses to be able to focus on their main business and have efficient ways of hedging forex and interest rate risks. over more than a decade, new products in the derivatives market have been gradually introduced, to begin with mostly in otc markets and more recently on the exchanges. while many corporates and businesses have used these products for hedging, the aggressive marketing of these, especially leveraged products, and their use by businesses to ostensibly lower the cost of funding or cost of hedging have led to grief to many – banks and businesses alike. the lessons from this experience underline the need for both banks and customers to understand such products and the associated risks especially in those with leveraged and complex structures, having proper risk management policies, accounting standards and disclosures with adequate guidance to users and auditors alike for appropriate valuation and mtm practices. lending to the millions 11. a major challenge of the next decade is going to be financing the millions in the unorganized sector, self - employed in the micro and small business sector, the small and marginal farmers as also oral share - croppers in the agricultural sector ; other challenges include financing affordable housing and education needs of low income households. these households and businesses do not maintain proper books of account, have irregular cash flows and hardly any documents of property or other collateral. drawing these households into the formal banking system through opening of bank accounts is only one and albeit a very first step. the number of borrowers who had borrowed rs. 25, 000 and below from the banking system rose from 36. 8 million 2004 to 39. 2 million in 2009 – an increase of just 2. 4 million over five years. the number of borrowers who borrowed less than rs. 2, 00, 000 increased from 61. 9 million in 2004 to 95. 8 million in 2009 – although there is an increase of nearly 34 million, a vast majority of the population still remain unserved. if the coverage of those borrowing less than rs. 2, 00, 000 has to increase to at least 50 per cent of the adult population in