Modi makes banks toe the line

Modi’s government has presented a development-friendly budget. Despite being sympathetic to the subsidy system, the 2015 Budget focus is on growth with investments channeled to capital investments and infrastructure.

Finance Minister Arun Jaitley aims to maintain the annual growth rate at 7%. Subsidies have been pruned and continuing pragmatic economics, underperforming banks will now come under the scanner.

They will get a lower share of capital. The Government is offering only Rs 7,490 crores in 2015 to public sector banks. The budgeted amount can only cover 50% of the banks requirements. Most of this funding will go to the big banks like State Bank of India. The government will also reduce its capital holding in banks by up to 52%.

It will adversely affect the smaller banks who are already burdened with bad loans and interlinked low growth.

Looking at the right perspective one should not forget that in a vast country like India it is the smaller banks which are the conduits for flow of funds to government projects. In addition, they are often forced to fund Central and State government projects.

The cache of bad debts (approximately 13% of total bank loans as against 4.5% in the private sector) is largely due to loan waivers which all governments employ as political popular measures especially in the agriculture sector.

Small and underperforming banks can expect no easy finance from the Government after this budget. They will have to opt for private financing (difficult since private financial institutions are vary of financing bad investments) or merge with larger banks. Banks will also have to pull up their socks and minimize their bad debts. The 2015 budget seems to have landed them in a catch 22 situation.

In stark contrast, Government has increased the loan target for banks for ‘Farm Loans’ to Rs 8.5 lakh crores amounting to about 14% of total bank credit. Bankers are dismayed and despair when they cannot even maintain the funds required for meeting RBI requirements for providing for restructured and bad loans and BASEL III norms of 6% of common equity, how can they fund these loans.

What is the role envisaged by Modi for banks?
Banks are largely funded by the Government and have to toe the line. They are not in a mess due to inefficiency rather, they do not have the freedom to practice good fiscal methods.

However, Modi is throwing them a few lifelines to stay afloat.

One, he is giving them a larger degree of autonomy. Setting up an autonomous Bank Board Bureau will ensure merit appointments to key positions in ,anks. It is hoped this will increase efficiency and make the smaller banks viable.

A Holding and Investment company is to be formed that can raise funds privately and in turn finance banks. Or else banks will have to scale down their operations to profitable levels. In the long run profitable downsizing is good for the economy. Failing which merger with larger banks will be the last best alternative. Taking a positive view of mergers the network built up by the smaller banks across the country will not go to waste. Merger will also bring in healthier economic criteria and improve banks fiscal position.

But will larger banks be interested in merging with less profitable banks. A readymade set up can always be utilized and reshaped to make it a sound investment.

Reserve Bank of India reforms
The role of Reserve Bank of India and its discretionary and other powers are proposed to be reduced or brought under Government ambit.
RBI had earlier mooted that instead of ‘ad hoc anti inflationary measures’ a definite target for inflation could be set by Parliament. It also recommended forming a Monetary Policy Committee to control interest rates.

Finance Minister Jaitley has taken these recommendations into account and announced a ‘Monetary Policy Framework Agreement’ with the Reserve Bank of India to keep inflation below 6%.

The Government is also proposing to set up a ‘Monetary Policy Committee’ and a ‘Public Debt Management Agency’.

Lop off the dead wood and the tree will flourish, perhaps is what Modi and Jaitley hope to achieve.