70 years of banking: When will the financial repression end?

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W.E. Preston, a member of the Royal Commission on Indian Currency and Finance, set up in 1926, once said: “… it may be accepted that a system of banking that was eminently suited to India’s then requirements were in force in that country many centuries before the science of banking became an accomplished fact in England.”

Most banking activities in India (transactions based on inland bills of exchange or hundis) worked on mutual trust, sans securities, the bedrock of British banking. Kautilya’s ‘Arthashastra’ (400 BC), a Sanskrit treatise on statecraft and economic policy, contained references to creditors, lenders, and lending rates; it even laid down norms for banks going into liquidation—something which we now have in the form of the Insolvency and Bankruptcy Code.

Despite such deep roots and rich history, only one Indian bank is among the top 50 banks globally in terms of assets. This, too, happened recently after associate banks of State Bank of India (SBI), the nation’s largest lender, merged with the parent.

A large segment of the population is still financially excluded. Following recent government efforts, millions of Indians have been able to open bank accounts, but their access to loans, insurance and mutual fund products is still very limited.

The high street banks are still not forthcoming to lend to the poor because of high transaction costs and credit costs. In the absence of intense competition, financial repression still continues despite expansion of the branch network and use of modern technology. Unlike some developed markets, the financial sector in India has not led the real sector; it followed it. Building societies in the UK tell a different story.

In 1947, there were 97 scheduled banks (including Imperial Bank, 81 ‘A1’ banks with more than Rs5 lakh capital and reserves, 15 exchange banks—those dealing with foreign exchange—and 557 non-scheduled banks. These 654 banks collectively had Rs1,179 crore of deposits and over 5,000 branches.

Today, we have more than 300 scheduled commercial banks (including regional rural banks, small finance banks and payment banks, but excluding cooperative banks) with a branch network of 143,890 (roughly 60% of which are in rural and semi-urban India) and a deposit base of Rs106 trillion. Still they are not enough because most state-owned banks, buried under a pile of bad assets and strapped for capital, have almost stopped lending even as most private banks are reluctant to go beyond the city limits.

In 1947, 38 banks failed of which 17 were in West Bengal, with a collective paid-up capital of Rs18 lakh. The next year was far worse. In 1948, 45 banks with paid-up capital of Rs1.8 crore went belly-up.

The Banking Companies Act 1949 (later rechristened as the Banking Regulation Act) tried to address the bank failures in a limited way but the Act was not adequately equipped to deal with the abuse of power by bank management and promoters.

The Reserve Bank of India (RBI) finally got the powers to deal with them in 1960. Six years before that (1954 to 1960), 83 banks were merged; the speed picked up later, leading to mergers of 217 banks by 1966. During this period, at least 100 banks were liquidated, too; many opted for liquidation voluntarily.

In 1969, when 14 private banks with deposits more than Rs50 crore each were nationalized to better serve the development needs of the economy, India had 9,007 bank branches, each covering around 65,000 people. Today, less than 10,000 people are served by a bank branch. In 1969, the Indian banking system had a deposit portfolio of Rs5,173 crore and a credit portfolio of Rs3,729 crore. This translated to a credit-deposit ratio of 72.1. Now, the banking system’s deposit base is around Rs106 trillion and credit portfolio is close to Rs79 trillion; so, the credit-deposit ratio has only marginally risen to 74.76.

Bank nationalization in 1969 (the second phase of nationalization happened in April 1980) brought in structural changes; there was rapid branch expansion in rural India and massive deposit mobilization. By 1991, when India embraced economic liberalization, the country had 61,724 bank branches.

Post-economic liberalization, the government ceased to be the sole owner of public sector banks; new private banks were allowed to come in, interest rates were gradually freed, reserve requirements in the form of statutory liquidity ratio (compulsory buying of government bonds) and cash reserve ratio (the portion of bank deposits kept with RBI) came down in phases and the wall between commercial banks and development financial institutions was razed. The savings bank interest rate, the last bastion of administered rates, was freed in 2011. Banking has never been the same again.

Now we have at least eight more than 100-year-old state-owned banks—Allahabad Bank, Punjab National Bank, Bank of India, Canara Bank, Corporation Bank, Indian Bank, Bank of Baroda and Punjab and Sind Bank. Allahabad Bank is 152 years old and SBI has been there for more than two centuries in various avatars.

However, unlike wine, commercial banks do not necessarily mature with age. Collectively, 21 state-owned banks in the June FY18 quarter posted a net loss of Rs307.49 crore, with nine making losses, in contrast with 17 private banks’ collective net profit of Rs11,445 crore. Money set aside to cover the risk of default on bad loans has eroded their profits. The set of state-owned banks have set aside Rs36,697 crore as provisions, four times what the private banks have done.

By August 2022, when India will celebrate 75 years of Independence, we will probably see fewer public sector banks with consolidation under way and newer private banks in place. A few successful non-banking financial companies may also become banks even as a few small finance banks may migrate to universal banking and a few others are likely to be taken over by other banks.

The banking regulator is withdrawing the protective ring around state-owned banks and is ready to welcome new banks of different shapes and sizes. Even if a few of them fail, that will not shake the financial system. There is a radical change in RBI’s philosophy. The traditionally conservative Indian central bank is ready to experiment and face failures.

We will have a new banking landscape but the question is: Will the financial repression end? Will the banks care for their customers and financial inclusion? Without that, inclusive growth will remain a chimera.

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