Commentators never run short of adjectives to describe bankers. Quite a few years back, then Reserve Bank of India (RBI) deputy governor Rakesh Mohan called Indian bankers “lazy” when they stopped lending and were buying only government securities. After that phase, our bankers turned “crazy” and started giving out loans with aggression as if there was no tomorrow. As a result of this, bank credit grew at around 30% for three years in a row. Now, as the global financial system crawls back to normalcy after being hit by an unprecedented credit crunch in the wake of the collapse of US investment bank Lehman Brothers Holdings Inc. in September 2008, a debate is on: Should banking be boring or exciting?
Also Read Tamal Bandyopadhyay’s earlier columns
At a recent banking and finance seminar in Mumbai, RBI governor D. Subbarao went all out to contest the noted economist and Nobel laureate Paul Krugman’s argument that banking must be made boring. The New York Times columnist has argued that there is a negative correlation between the business model of banking and economic stability. Whenever banking got exciting, it went out of hand and jeopardized the stability of the real sector. But dull and boring banking always ensured economic progress.
Krugman has divided American banking into three phases. Before the Great Depression in 1930, banking was exciting. The industry attracted talent as the bankers were paid handsomely and there were innovations. In the second phase, banking was tightly regulated and boring, coinciding with spectacular economic progress. In the third phase, beginning in the 1980s, innovations came back as regulations were loose and, once again, banking became exciting. But it threatened the stability of the real sector and, hence, according to Krugman, banking as a business should be dull to ensure that economic stability is not compromised. Krugman had written this piece in April. Why did Subbarao react to this in November end? This is because quite a few others have meanwhile joined Krugman in advocating boring banking. Bank of England governor Mervyn King is one of them and another is Y.V. Reddy, Subbarao’s immediate predecessor at RBI, widely seen as the saviour of the Indian financial system from the meltdown.
On 20 October, at a function in Edinburgh, King argued for restricting banking to its traditional “utility” function—performing basic retail financial intermediation of deposit taking and lending, and providing payment and settlement services. He is in favour of hiving off the riskier financial services such as proprietary trading into a separate entity.
Closer home, Reddy, in a 22 October speech in Chennai, called for “back to basics” in banking. According to him, banks must use their deposits to lend to real sectors of the economy, particularly agriculture and small and medium industries that cannot access the capital markets easily.
Subbarao thinks banking can never lack excitement in India, particularly when bankers need to reach out to the non-banking pockets for financial inclusion and fund infrastructure projects that will play a key role in sustaining economic growth.
According to Shankar Sharma, director and chief global trading strategist of brokerage firm First Global, banking is a “dumb” business. Why? A bank borrows cheap, lends dear, and makes a spread. But if a certain percentage of its assets go bad in an economic downturn, then a portion of its equity is wiped out. Since banking is a commodity business, in order to increase return on assets, banks need to go higher up the risk spectrum and lend to lower-rated firms but the higher asset and credit growth at some point of an economic cycle comes back to haunt the bank. So the traditional or “boring” banking should always be a state-owned business, where there is no incentive to shoot for higher return on assets and, hence, no trading in exotic derivatives. It’s all about safety and serving a social purpose since banks are taking public deposits. Private banks, however, will chase growth and keep climbing the risk spectrum and, at some point, almost inevitably, blow up. But since India is still an under-banked country, there is some time before our private banks become blow-up candidates, though we do see them once in a while. “It’s when we hit maturity, growth becomes difficult to achieve, the intrinsic dumbness and poor economics of this business will become apparent,” Sharma told me. In his view, banks should either be state-owned or be niche banks, serving a small footprint. “Growth” banks will blow up, almost inevitably.
Barring a few exceptions (Ramesh Gelli, founder promoter of erstwhile Global Trust Bank Ltd, is one of them—he was too adventurous), Indian bankers are a smart lot. (I’m not very sure though whether smart is an appropriate antonym of boring. The thesaurus throws up three—exciting, fascinating and interesting—while synonyms range from uninteresting and tedious to dull, dreary, unexciting, monotonous, uninspiring, insipid, routine and even stupid.) Our public sector bankers don’t wear expensive Armani and Gucci suits (they can’t afford them) and seldom play golf, but the way most of them run their banks is remarkable. They offer cheap money to farmers, cater to the whims of the bureaucrats of the banking division of the finance ministry, learn the art of giving loans to women entrepreneurs and how to conduct business in Hindi from teams of parliamentarians round the year among others, and yet make huge profits. Private sector bankers are not always happy about tight regulations, but they accelerate growth and shrink balance sheets with equal ease. Banking in India is never boring.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Please email your comments to email@example.com