Home >opinion >online views >The RBI clutches at straws

The Reserve Bank of India (RBI) is now clutching at straws to further financial inclusion.

It has recently made the priority sector norms stiffer for foreign banks by bringing them on a par with local banks. It has been stipulated that all foreign banks with more than 20 branches will have to lend 40% to any sector defined as a priority sector by RBI.

After nearly five decades of regulation over 50 banks with nearly 100,000 bank branches enforced with penalty and policy coercion (banks that don’t meet targets are not given new branch licences) the status of the priority sector is pathetic. A case in point being the 26 million small enterprises. These contribute 17% of the gross domestic product, 45% of manufactured output and employ 60 million people. Yet, credit availability to these enterprises is meagre. In fact, it is less than 10% of aggregate net bank credit.

In addition to this abysmal credit availability, the terms at which this credit is made available to these enterprises is at 350 to 400 basis points higher than “established" firms. That is the “priority" that the banking sector accords them.

In such a situation, how will the addition of 41 foreign banks, all of which put together have just 323 branches, make a difference? Of the 41 foreign banks, only four—Royal Bank of Scotland, Citi, HSBC and Standard Chartered Bank—have more than 20 branches.

By extending the priority sector target to these banks, RBI has shown its lack of understanding of how to ramp up priority sector lending and promote financial inclusion. All that it will succeed in doing is to slow the expansion of foreign banks and change their business strategy and focus.

Instead of such moves of doubtful use, RBI will do well to restructure the institutional framework of priority sector lending at the operational level. The ideal way to do this is to revive, resurrect and reform the State Level Bankers’ Committee (SLBC).

Like the concept of priority sector lending, SLBC is an anachronism of the socialist era when the ideology of “social control over banking" was gaining momentum. A year after National Credit Council was set up in 1967, it commissioned R. Gadgil to develop an institutional framework for priority sector lending. This along with the Narasimham report was the basis of the Lead Bank Scheme. Since then, the basic structure has remained the same.

In 2009, RBI did set up a group under Usha Thorat but that didn’t seek to restructure the lead bank scheme. It just tinkered around the margins.

What needs to be done is to make SLBC the hub of the financial inclusion infrastructure and intermediation. It has to be the forum for devising, designing and delivering the concept of financial inclusion within defined geographical areas.

If this is done, it will link the real side with the financial side as well as merge the developmental agenda reflected in the public expenditure policy of the state government with priorities of the regulator (RBI) and the business strategies of commercial banks.

As of now, the problem with the approach is that it is a top-down approach which is inflexible with no consideration for regional differences. There are far too many schemes with overlapping target groups and objectives and wastage of resources.

In terms of methodology, it is casual and highly partisan. There are no horizontal linkages among sponsoring agencies. And often one finds double/multiple sponsoring. This, along with cumbersome appraisal and documentation processes, delayed sanctions and under-financing makes the priority sector, as a concept, inadequate and lending to it unviable.

As such, there are four sets of changes that need to be made to SLBC: structural, organizational, changes in the approach and methodology. At present, SLBC lacks stakeholder ownership. It has authority and enforceability powers and as a consequence no accountability. In terms of organizational design, SLBC is too large, unwieldy, dispersed and bureaucratized. Even its mandate draws from the 1960s mindset of lending and is too steeped in pre-reform banking structures. It is too peripheral.

SLBC needs to follow a cascading committee approach with the top level apex committee working on the agenda and issues raised and filtered by a credit committee, a monitoring and implementing committee and an administrative and regulatory committee.

The apex committee should comprise the convener bank, public sector banks, private banks, regional rural banks, financial institutions, cooperative banks, regulator and government representatives. In fact, it might be worthwhile to corporatize SLBC.

If that is done, it can be the responsibility of this corporate body to work out a comprehensive annual year programme for financial inclusion spread across all owners rather than participants. It will change the way banks think about priority sector lending and financial inclusion.

Haseeb A. Drabu is an economist, and writes on monetary and macroeconomic matters from the perspective of policy and practice. Comments are welcome at haseeb@livemint.com

To read Haseeb A. Drabu’s earlier columns, go to www.livemint.com/methodandmanner-

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