Home / Opinion / Views /  More banks won’t solve problem of credit supply

The reason that globally rules on who can set up a bank and what regulatory hoops they need to constantly jump through are much tougher than for a biscuit or a car company or even a telecom service provider has to do with the nature of banking itself. If a non-bank fails, the problem is only for the employees, the shareholders, the raw material and parts sellers and for those who liked the biscuit or car and now can’t have it. But when a bank fails, it takes down the savings and deposits of average households who trusted the bank. Worse, a too-big-to-fail entity can take down the whole system.

The report released by the Reserve Bank of India’s (RBI) Internal Working Group last week has generated a flood of opinions on why manufacturing firms should not be given a bank licence. But the issue is deeper than just that. There is a premise that expanding the number of banks and a supply of credit will fix India’s problem of being credit starved. But banks have turned risk-averse and even the existing flow of liquidity from RBI is deposited right back through the reverse repo window rather than being lent out to the non-triple-A-plus rated entities. Just expanding the supply of banks is not going to improve the flow of credit to the corporates, including the small and medium scale firms.

Banks are not lending because of the fear factor as the clean-up in banking is opening up past decisions on loans. Bankers don’t want to be pulled out of retirement to go to jail for judgements they made that went wrong. Of course, the political mis-use of public sector banks as ATMs for cronies is the overhang from the past that is making banking as a whole risk-averse. And that leads to the problem that needs to be resolved. Was it a loan that went wrong due to a bad judgement or was it a favour for profit of a few individuals? If we can answer this question through a process, we can solve a part of the credit freeze issue.

We need three changes in the system. One, banks need better oversight of the firm and corporate houses they lend to. A tight reading of old rules to prevent a full reading of the story of a corporate house and its structures needs to change. Banks need to use technology and go beyond just profit and loss statements to triangulate data points using AI, big data and the other digital exhaust that individuals and firms throw out. The skill level and risk management within banking, and specially PSU banking, needs a quick, sharp and dramatic upgrade.

Two, the role of the regulator needs to be to put in metrics, incentives and oversight so that this question “business loan or favour?" can be answered much better. And that brings the crying need for a re-haul in the supervisory and regulatory capacity of RBI. The banking regulator can see what the capital market regulator is doing in terms of effective regulation, capacity building and new ideas to better regulate the market. The teams lead by Sebi chairman Ajay Tyagi and the four whole-time members have experimented with several new ideas including far greater inter-departmental co-operation than ever before. Select existing staff cadres have been trained in big data analytics to piece together stories that a tick-box regulatory process will never tell. From what I have myself seen through my work in Sebi’s mutual fund committee, there is far more regulatory confidence when it is backed by hard evidence from the stories that data analytics tell. RBI needs a rethink in how it views its supervision and what tools it equips its cadres with. RBI has restricted supply as a means of regulation for far too long. It needs to remember that it is easy to police a city under curfew—there will be no murders, robberies or other crime. But we can’t shut life down. Then why have we shackled innovation and enterprise in banking for so long?

Three, banks pose systemic risk to the economy and we need an early warning system to point out distress in a bank far ahead of it eroding its capital. The Financial Resolution and Deposit Insurance (FRDI) Bill was attempting to put in place such a system but was killed by the Leftist cabal in 2018. You can read more about the Bill and what it was trying to do. We need to bring back the bill and put in place a system of tight monitoring of the bank’s own financials so that even rogue promoters who evergreen their balance sheets are unable to pull wool over the regulator for so long. The PM and FM need to put their weight behind this Bill for a safer financial sector.

Credit expansion in India will not happen by just increasing the supply of banks and money. Unless the other parts of the system are changed simultaneously, it will be more money chasing the same old markets or going right back to the RBI through reverse repo.

Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation

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