Home >opinion >online views >RBI’s misplaced agenda in J&K

For the second time in as many years, the Reserve Bank of India (RBI) has taken financial sector initiatives vis-à-vis Jammu and Kashmir (J&K) that have serious implications for that state.

First, of course, was RBI’s replacement of the J&K Bank as the lender of last resort for the state government. This eroded the financial underpinning of the unique position of political autonomy that the state enjoys.

Last week, RBI governor D. Subbarao, on his second visit to the state, apparently influenced the state government to operationalize the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI) of 2002 in J&K. The chief minister has promptly committed to bring in an ordinance to make it applicable in the state.

The current position is that extension of SARFAESI Act to the state is sub judice. It has been stayed on the grounds that it conflicts with existing provisions of providing the right to ownership of property in the state only to state subjects.

The reason for RBI seeking its application is rather simple and borders on being innocent: the inapplicability of SARFAESI hampers lending by commercial banks in the state. Ergo, the credit deposit ratio (CDR) is abysmally low.

This is at best a partial truth. SARFAESI is neither a necessary nor a sufficient condition for bank lending. At worst, inapplicability of SARFAESI should increase the risk of lending in J&K which, in turn, should have an impact on the pricing of loans and not the volume of lending.

Be that as it may, Subbarao will do well to look at RBI’s own annual publication, Basic Statistical Returns of Scheduled Commercial Banks, which shows that in 2008, the credit deposit ratio in J&K was 62.5%.

As such, the question that needs to be asked is how did the credit deposit ratio reach a level of 62.5% in 2008 and how did it plummet to 38% four years later?

This can be phrased more constructively: how was the credit deposit ratio raised from 37.4% in 2004 to 62% in 2008? What was done right then and what has gone wrong now? Clearly, the CDR was high even though the SARFAESI was not in force.

The real reason for the low level of lending in J&K is that the lending methodology adopted by commercial banks is unsuited for the structure of business enterprises in J&K.

The process and principles of lending in economies such as those of J&K cannot be generic; it has to be highly granular. Banks are stuck with only one form of lending: term loans. They need to move away from financial statement-based lending, or asset-based lending. Most businesses don’t own physical assets. For example, in the crafts economy, skill of the artisan is a knowledge asset. Or in horticulture, land is an asset which is not readily collateralized. In such a situation, the presence or absence of SARFAESI will not make a material difference.

Thus, a practical solution is required to provide commercial banks greater power for recovery of bad assets. For this, instead of bringing in SARFAESI through an ordinance and jeopardizing the special status of J&K, what the state government needs to do as a majority shareholder in J&K Bank is to get the bank to set up an asset reconstruction company (ARC). It should be a company incorporated in J&K as a “state subject". All commercial banks can have an equity stake in it as long as the majority stake is held by the state government and the J&K Bank.

The mandate of this local ARC should be to buy all the impaired assets in the state. These may include some assets of commercial banks but more importantly of other financial institutions such as the State Finance Corporation.

A special-situations fund should be created, within or outside the ARC structure that focuses on constructive investing in distressed assets for restructuring and turnaround of “orphaned" businesses, including those of the state government. Or provide transitioning from losses to operating efficiencies.

The business viability of the ARC is not in doubt as most of these impaired assets have substantial collateral. Indeed, these are hugely over collateralized.

On average, small and medium enterprises (SMEs) in J&K have less than 5% of their annual turnover as working capital and a mere 20% of their assets as tenured loans. When these ratios fall in line with the borrowers outside J&K, should RBI or the government talk about constraining effect of inapplicability of SARFAESI?

It is developmental initiatives such as these that are needed to increase lending and “lendability" to SMEs in J&K rather than the strengthening of the legal framework.

If RBI is really interested in ramping up credit deposit ratio, it should make all lending in the state as qualifying for priority sector lending. The impact of this will be instant.

Disclaimer: The author is a former chairman of the J&K Bank.

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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