In this phase of uncertainty where the banking sector is witnessing a world of chaos and big names are found to be tumbling like a pack of cards, the Indian Banking sector has shown a remarkable resilience. This throws certain lessons that the world may well catch up. An attempt has been made to trace the evolution of banking sector in India and analyze the reasons for this resilience as also to pinpoint the challenges that lie ahead.
Historical Perspective:
The history of banking in India is probably as old as the civilization itself. The practice of money lending can be traced to the Vedic period i.e. 2000 to 1400 BC. While references to professional banking can be traced to as early as 500 B.C. Kautilya in his famous work “Arthashastra” has given thought provoking ideas in relation to creditors, lenders and lending rates. Interestingly, the work also documents the norms for banks going into liquidation. In that early age where information and communication was a scarce commodity, an extensive network of Indian Banking Houses existed connecting all commercial cities/towns. They had their own inland Bills of exchange (commonly called Hundis) which were significant forms of transactions. The system was founded purely on mutual trust without any securitization whatsoever. The dishonoring of Hundis was almost unheard of and was a crime second to none.
With such a rich cultural heritage, it does not seem strange that a certain semblance of that heritage continues right from executive decisions to grass root banking.
However, the credit for introducing a formal banking architecture, as the world knows it today, goes to the British. The beginning was made with the establishment of The Bank of Bengal, The Bank of Bombay and The Bank of Madras (collectively referred to as the Presidency Banks). The pre independence era was entirely dominated by the private players. The central Bank of the country was established in 1935 which was subsequently nationalized in 1948. Another step forward was the enactment of The Banking Regulation Act in 1949.
With the dawn of Independence, the focus of the policymakers shifted from “Class Banking” to “Mass Banking”. This is evident from the nationalization of 14 banks in 1969 while another 6 banks were further nationalized in 1980. Till the late 90s, the sector witnessed a reasonable growth but the expansion was invariably dictated by a socialistic bent of mind with little or no concern for profitability or quality services.
The decade of 90s witnessed the ushering in of pro liberalization policies in an attempt to integrate the economy with the so-called global village and unlock the depressed purchasing power of a large populace. In the last part of the decade the government allowed the private players to set up shop in this sector at a fast pace which was meager in the pre-liberalization era. The sector today spans 82 commercial banks, 92 Regional Rural Banks, 4 Local Area Banks, 1813 Urban Cooperative Banks and 107497 rural cooperative credit institutions. In spite of the tremendous growth clocked in by the private sector and the foreign banks, 75% of the total banking assets continues to be in the domain of public sector banks.
Financial Crisis:
At a time, when two words, namely “Sub prime” and “Bailout” have become the buzzwords of the economic world, the Indian Banking sector has stood its ground with minimum Governmental intervention, except for elevating the public sentiment. Barring one private sector Bank, the exposure to US crisis has been minimal, with majority of the Banks reporting strong balance sheets growth. The reasons are not far to seek and are a combination of our psychological mind set and strong economic realities. As has oft been repeated to the point of boredom, the US crisis has been a result of indiscretion on the part of the bankers who presumed that home prices can only increase. This upbeat sentiment got transferred right from Banks to Securities firms and there from to the Investment Banks, who sold their complex collaterized Debt Obligations to Hedge funds and Private equity players. However, while more and more sophisticated instruments were brought in vogue, the original lenders had conveniently transferred their risk to others so that they had no stake in performance or otherwise of the borrowers. In this context, the words of former Fed Chairman, Alan Greenspan in his memoir “The Age of Turbulence: Adventures in a New World” are worth mentioning. He writes, “I was aware that the loosening of mortgage credit terms for sub prime borrowers increases financial risk…..but I believed that the benefits of broadened home ownership are worth the risk”. In short, the crisis was primarily due to misplaced conceptions and overly optimistic notions. While the governments the world over were busy doling out gargantuan bail out packages and desperately trying to put the financial system in shape, there is one economy where the policy makers have only one job to do and that is to hold press conferences to lift public sentiment while not worrying about the crash of the Banking sector. That economy is India: often touted as a Tortoise, but as the old story goes, the rabbits usually lose out.
The Story of the Tortoise
As with the tortoise, Indians by nature, dispel things sophisticated and are comfortable with chaos and disorder, two things that are a part of every Indian’s ordinary life. When tongue twisters like collateralized Debt Obligations were being lapped up by the savvy Bankers and Fund Managers the world over, we continued to revel in our immature securities market. The net result is that the lenders maintain the risks on their books and so remain prudent and continue to be the stakeholders in the performance of their assets. In India the relationship between the lender and the borrower is like a marriage made in heaven-till death do us apart, while the US relationship remained to be under silos. The first moral of the story – complexity does not always breed efficiency and liquidity rather adds up to the confusion and then results in profound suspicion.
The existence of black money in the system has often been derided for the ills of the economy but it has proved to be a blessing in disguise for the Banking system. Any one who has transacted a real estate deal would reveal that a majority of such transactions involve an element of black money. This has an interesting repercussion. When any such real estate transaction is proposed to be financed, the Banker would usually have to bolster the claim of the borrower because the income evidenced by the documents would usually be far less than the actual. Further the margin money in such a transaction would be far ahead of what would be insisted upon by the Bank. Consequentially, the borrower has a significantly higher stake in the performance of his part of the contractual obligation. The risk of defaulting on the loan and finding one’s name in the morning newspaper on initiation of legal proceedings carries a moral hazard, which a large proportion of the Indians would be loath to invite upon them.
It would not be misplaced to point out the contribution of the legislature in this regard. The very nature of Indian polity, where a wide range of political forces exist, has ensured that the process of liberalization has been slow with a lot of heated debates interspersed in between. The economic reforms have been undertaken in a gradual and sequential manner. To give credit where it’s due, the successive governments have adopted international best practices with India specific conditions, while stepping up prudential regulations. Instead of plunging head on into the turbulent racecourse, the tortoise has firstly watched the bloodshed caused to the rabbit and then calibrated its response. What it means is that a lot of contentious issues have been resolved after considerable debates and while the economy has opened up, the integration with the world economy has been done with a cautious approach. The moral- Regulations ought not to be enacted in response to a crisis but in anticipation thereof.
At the risk of sounding repetitive, Indians as a class have often resorted to the maternal wisdom of living within their means so that the debt exposure of an average Indian is miniscule when compared to that of an average US citizen. When stock markets the world over were the darling of the masses, the Indians continued to stock up astronomical piles of gold, which today proves to be the best investment that anybody could have ever made. The Moral: It pays to stick to conventional wisdom.
Notwithstanding the immunity to global crisis, the Indian Banking sector faces considerable challenges in the long run and must gear up in seeking out wisdom from this financial bloodshed.
The Road Ahead:
The Indian economy is believed to be poised to become the fourth largest economy by 2025, but as the old saying goes “Finance follows Economics”. A vibrant banking sector has to be ensured to support the growing economy. More than ever, the sector requires new and upgraded skills in relation to sales, marketing, credit and operation. Therein the competition from the foreign banks is going to intensify in the times to come. It is estimated that the sector would require capital infusion to the tune of Rs 600 Billion to fund the growth in advances, non- performing loan write offs and investment in IT and human capital upgradation. The sector ought not to expect windfall treasury gains that decade long secular decline in interest rates provided, which in turn would expose weaker banks.
The biggest challenge probably lies in increasing the penetration of the banking services. It is estimated that only 27% of the rural farming population has access to banking services. There lies a potential to generate huge volumes of deposits simply by geographical expansion.
Although the Reserve Bank of India has taken creditable steps in popularizing no frills accounts yet a lot needs to be done in this regard.
Taking cue from the American fiasco, urgent steps need to be taken in regard to sharing of credit information of potential borrowers. Though such a mechanism does exist, the public sector Banks have been reluctant in sharing such information.
The Management success would largely depend on capability upgradation, adoption of value-creating Mergers & Acquisitions as a growth avenue and development of innovative business models to access the tremendous opportunities that lie ahead.
In Hindsight:
The global recession has thrown up serious challenges for the financial as well as real sector. The fact remains—although financial sector remained buoyant in the course of uncertainty but the world financial crisis has percolated its aftermath into the real sector. Further hindrance in the growth of real sector can have devastating effect again on financial sector. It is still believed that the Indian economy is going to be one of the main drivers of the growth engine. In such an expected scenario, bank boardrooms must gear up to meet the challenges while retaining the competitive edge.
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