Double mint

Do not devalue the central bank as an institution

Next week the Reserve Bank of India (RBI) will come forward with its quarterly review of the economy and of monetary policy. In less than two months, the tenure of the incumbent RBI Governor, Duvvuri Subbarao, comes to an end. Those who have built India’s great institutions have believed for a long time that decisions pertaining to appointment to high offices should always be taken several months ahead of the actual appointment. But the Indian government has become habituated to last-minute announcements. Hopefully, in this case, Prime Minister Manmohan Singh will take a view and make an announcement about Dr Subbarao’s tenure within this week so that the RBI can take a view about the economy and monetary policy with a greater degree of certainty in the week after. There has been an avoidable and ill-informed public debate on the merits and demerits of giving an incumbent Governor an extension. Rather than depending on political whim and ministerial discretion alone, it would be helpful, both for the RBI as an institution and for policy making in the country, if government’s prerogative on such matters is combined with some professional criteria. In fact, such criteria have emerged in the process of selecting RBI Governors over the past two decades. With few exceptions, most central bank Governors have come from the limited pool of Deputy Governors or Secretaries in the Union Finance Ministry and have been given a five-year tenure. It is understandable that the government should regard experience on Mint Road or in North Block as the minimum qualification for the job, and would seek policy stability through fixed-term appointments. At this time, the question is a more limited one of whether the incumbent should get an extension of term or not, rather than who should constitute the pool of potential candidates. On this question, history offers an answer. In the past half century most Governors, with few exceptions, have served a five-year term. Indeed, some of the best-known Governors who were able to leave their mark on the institution and policy were given five-year appointments. In the more recent past, with the singular exception of S Venkitaramanan, every other Governor has been given either a five-year term or an extension of two or three years after an initial three-year term. Against this background, and in the current context, it is only to be expected that Dr Subbarao would get an extension and be allowed to serve a five-year term. It has been reported that three former RBI Governors have taken the view that a central bank Governor should have a five-year term. If so, the die is cast. There is no reason the government should ignore such sage advice. The point has been made in the media that the Union Finance Ministry has opted for single-term appointments for financial sector regulators like the chairman of the Securities and Exchange Board of India (Sebi) and so on. It is useful to reiterate the point this newspaper has repeatedly made that the RBI Governor is not just another financial sector regulator like the Sebi chief. Indeed, the central bank Governor in all modern economies occupies a unique position in the policy apparatus and that uniqueness should continue; more so at a time when India needs to preserve and protect institutions of governance against the rising tide of arbitrariness and declining quality of available manpower. The government must do nothing that devalues the institution of the central bank.

BS

One-day strike by Bank staff on Aug 5

As part of their protest over the Banking Law (Amendment) Bill, which 'focused' on industries in issuing loans by 'neglecting' other sectors like education and agriculture, United Forum of Bank Unions has decided to go on a one-day nationwide strike on August five. There should be proper prioritisation in setting up interest rates as the country's future lies equally in agriculture and education, as it does in industries", C H Venkatachalam, General Secretary, All India Bank Employees Association, told reporters yesterday. Alleging that people from poorer sections of the society, including farmers, who were in need of urgent financial assistance, were being neglected by banks, Venkatachalam said loans upto Rs 70,000 crore were being given to Micro-Financing Companies. Moreover, interest rate for agriculture sector was nine per cent and that of education 12 per cent, while industrial units were also being charged the same rate, he accused. More than half of the Bank branches were in villages and smaller towns and aiding in development of the village economy and increase in employment opportunities as also agricultural growth should be among the main responsibilities of the Banks, he said.

IE

For inclusive banking

The goal of financial inclusion through new entrants would be better served if the RBI were to facilitate the entry of ‘brownfield' NBFCs into banking

The banking sector today has 170 regular banks (and over 2,000 Cooperative banks with close to 80,000 branches. In spite of this, according to a World Bank report, more than 87 per cent of India's poor cannot access credit from a formal source and have to depend on moneylenders. The key stated goal of the RBI in considering granting new private sector banking licences is promoting financial inclusion as well as increasing competition. While this is a positive step for the sector as a whole as it reduces barriers to entry, it is important to understand the reasons for lack of financial inclusion to assess how this measure should be implemented in conjunction with other measures to further the cause of financial inclusion.

The challenges

The primary reasons for poor financial inclusion in India are economic in nature. The ticket sizes (both saving and borrowing) are low and the geographical spread of the rural customer makes it uneconomical for banks to set up branches close to them to serve them profitably. As a result, the majority of bank branches in India are concentrated in urban areas and large towns and last mile access remains a hurdle in regular use of banking services. While the regulator has been trying to promote financial inclusion through regulations mandating banks to have a certain number of branches in under-banked areas, lending a minimum of 40 per cent to the priority sector (32 per cent for foreign banks), opening no-frills accounts and allowing business correspondents amongst others, banks view these as obligations and make limited effort to bring about inclusion in the true sense and promote usage of financial products amongst the underbanked. It is unlikely that a ‘generic' greenfield entrant will be able to develop a profitable business model to facilitate financial inclusion given the smaller revenue pool, initial high set-up cost and the lack of a large asset book to spread these costs over. Furtherbuilding a branch network takes time and there will be a long gestation period before any significant scale is achieved by a greenfield bank. The goal of financial inclusion through new entrants would be better served if the regulator were to facilitate the entry of ‘brownfield' NBFCs that already have a strong physical network and meet certain ‘fit and proper' criteria, into banking. Several NBFCs have built a low-cost operating model and provide loans profitably to the lower income segment which banks do not want to serve. They have historically focussed on this segment and will align themselves to banking them profitably.

Last mile access

To improve last mile access, the regulator would also need to take various other steps with appropriate safeguards. The RBI may look at allowing all NBFCs to become Business Correspondents and raise deposits on behalf of banks. The regulator should aencourage more corporates that have strong procurement, payment and distribution links with the rural sector to become Business Correspondents for banks viz. milk, egg, agri-produce, handicraft procurers and FMCG companies. The business correspondent technology platform across the banking sector should be simple and standardised. Mobile phones can be used as the standardised platform across the banking sector as this channel is much cheaper than card-based technology and mobile penetration is already significant. The UID (unique identification number) should be leveraged as a standard tool for identification to facilitate Know Your Customer and lending. The regulator may also look at reforms aimed at co-operative, regional rural and old private sector banks. Some of these banks have strong presence in certain rural pockets and these reforms could help in achieving the goal of financial inclusion through an already existing network.

HBL

Tax googly stumps Axis on Enam deal

RBI asks bank to revise accounting scheme, deal structure. Tax clouds have gathered over Axis Bank’s proposed acquisition of Enam Securities’ equities and investment banking businesses. The Reserve Bank of India (RBI) has directed the bank to revise the accounting scheme and the deal structure. The regulatory diktat has forced the country's third-largest private sector bank to miss the first date to close the deal. In November 2010, while announcing the deal, Axis Bank’s Managing Director and Chief Executive Officer, Shikha Sharma, had said the transaction was expected to be completed in four to six months. “The process of obtaining regulatory approvals for the transaction is under way and the combined revenues will thus not be reflected in the earnings of Q1 (first quarter ended June 30),” Axis Bank spokesperson told Business Standard in an emailed response last week.

PROBLEM POINT

RBI asks why Axis Bank shares have been offered to Enam shareholders when Axis Securities and Sales, a wholly-owned subsidiary of the bank, is acquiring the businesses

IMPACT

The diktat has forced the country's third-largest private sector bank to miss the first date to close the deal

THE WAY OUT

The bank is exploring different options to revise the deal structure without attracting any additional tax burden

Sources said the tax liability due to the change in the accounting scheme and the deal structure could be a potential deal breaker and the bank was exploring different options to minimise the hit. While RBI has given approval in principle to the deal, it has questioned why Axis Bank shares have been offered to Enam shareholders when Axis Securities and Sales, a wholly-owned subsidiary of the bank, is acquiring the businesses. Sources said the bank was exploring different options to revise the deal structure without attracting any additional tax burden. The recent high-profile legal battle between mobile phone service provider Vodafone and the Income Tax Department had made the bank more cautious, sources said. Tax experts said one way to revise the deal structure was Axis Bank acquiring Enam’s businesses and then transferring these to its wholly-owned subsidiary. “Transfer of businesses to wholly-owned subsidiaries is exempted from capital gains tax,” said a partner of one of the country’s top law firms. However, another tax expert said if the transaction involved transfer of tangible assets, it might attract higher stamp duties. Axis Bank did not comment on this issue. The bank had earlier said Enam would de-merge its equities and investment banking businesses into a wholly-owned subsidiary of Axis Bank. The bank will also de-merge its investment banking business into this subsidiary. Shareholders of Enam will get 5.7 shares of Axis Bank for every one share in the broking company. In other words, Enam shareholders will get a 3.3 per cent stake in the bank on enlarged capital. Earlier, RBI had stalled Axis Bank's plan to induct Vallabh Bhansali, co-founder and chairman of Enam, as an independent director on the bank's board. RBI had said “no shareholder of Enam acquiring shares of Axis Bank under the scheme of arrangement would be eligible for being a director on the board of the bank.” Axis Bank is currently exploring ways of working with Bhansali since he cannot be a part of the bank's board.

BS

Bankers’ dilemma on India, Bharat

Census 2011 shows one in three Indians now lives in an urban habitat. The urbanization trend will throw new challenges to those Indian banks which want to take larger exposure to retail loans, but have not been able to do so.....

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Liquidity may tighten a week ahead of RBI policy

Liquidity conditions are expected to tighten, due to government borrowing and increased demand for funds from banks as the new reporting fortnight begins this week. Banks borrowed around Rs 21,000 crore on a daily average from the Reserve Bank of India (RBI) under the liquidity adjustment facility last fortnight. Market participants expect bank borrowings from the repo window to increase to Rs 50,000-60,000 crore daily in the coming week. “Banks may step up repo borrowings from RBI to cover the fortnightly reserve needs ahead of the expected rate hike in the following week,” said a bond dealer of a public sector bank. Economists expect RBI to raise the repo rate (at which it lends to banks) by 25 basis points in the first quarter review of monetary and credit policy on July 26. “From a policy perspective, despite signs of slowing growth, we expect RBI to continue to focus on inflation to bring down still-high inflation expectations,” said economists Sonal Varma and Aman Mohunta of Nomura Securities. Presently, the repo rate is 7.5 per cent. The Wholesale Price Index rose to 9.4 per cent in June as compared to the same period last year. The WPI was at 9.06 per cent in May and 8.66 per cent in April. Adding stress to liquidity will be high government borrowing. RBI is scheduled to auction Rs 12,000 crore of dated government securities this week. In addition, the government has already announced auction of 56-day cash management bills of Rs 8,000 crore for tomorrow. State Development Loans worth Rs 5,250 crore, maturing in 10 years, will be auctioned on Tuesday. Also, 91-day Treasury bills worth Rs 7,000 crore and 182-day Treasury bills worth Rs 3,000 crore will be auctioned on Wednesday. Reflecting the need for funds, the interbank call money rate is also expected to inch up. On Friday, the weighted average call money rate closed at 7.53 per cent and the Collateralised Lending and Borrowing Obligation closed at 7.44 per cent, according to Clearing Corporation of India.

BS

What Can Monetary Policy Do for the Common Person? - S S Tarapore

India has one of the highest rates of growth in the world but among the Emerging Market Economies (EMEs), India has one of the highest rates of inflation. The present inflation rate of 9 per cent, based on the Wholesale Price Index, is just not acceptable.

Dr.C.Rangarajan, the Prime Minister’s topmost policy adviser, has categorically indicated that the inflation rate in July 2011 could be 10 per cent. Monetary tightening is always criticized by those who benefit the most from inflation, but it is the Common Person who suffers the most. Inflation control is the Dharma of the Reserve Bank of India (RBI). At the present time, the government has conceded that inflation control must be given priority over growth and that in the process some growth would need to be given up. Thus, there can be no better time to tighten monetary policy. What should the RBI do? The RBI should raise the repo rate ( the rate at which the RBI provides accommodation to banks against the collateral of securities) by 0.50 per cent from 7.5 per cent to 8.0 per cent. There would no doubt be protests that this measure would hurt growth. The window of opportunity for monetary tightening is invariably short and it is best that RBI takes action while it can. Why is it necessary for the RBI to raise its repo policy rate of 7.5 per cent? At present, banks pay 9 per cent for one year deposits while the inflation rate is 9 per cent. As such, access to the RBI by banks is a first resort rather than a last resort. Furthermore, an increase in the RBI policy rate would be a signal to banks to increase lending and deposit rates. Given the high inflation rate, an increase in the deposit rate would only be fair. The Savings Bank Deposit Rate is the only rate regulated by the RBI and, since 2003, it has been kept fixed at 3.5 per cent ( in May 2011 RBI raised this rate to 4.0 per cent). The RBI provided signal service by releasing an excellent Discussion Paper in April 2011 on deregulation of the Savings Bank Deposit Rate. The All India Bank Depositors’ Association ( AIBDA) arranged an Interactive Session on July 7, 2011 at which the Discussants were Ms. Usha Thorat, Director of the recently set up Centre for Advanced Financial Research and Learning (CAFRAL), Ms.Kishori Udeshi, Chairman, Banking Codes and Standards Board of India (BCSBI) and the present columnist. All the three Discussants were of the unanimous view that the time had come to deregulate the Savings Bank Deposit Rate. It is argued, by those opposed to deregulation, that with high inflation and interest rates on the uptrend it would not be appropriate to deregulate the Savings Bank Rate. Be sure that when inflation is low and interest rates are on the downtrend it will be argued that it would not be desirable to deregulate this rate! Ms. Thorat forcefully argued that the real issue is not the deregulation of the Savings Bank Deposit Rate, but the timing of the measure. She asserted that it is best to deregulate the rate when inflation is high and she preferred a one stroke full deregulation of the rate. While the present Savings Bank rate could fall, she marshaled data to show that after the freeing of the term deposit rates for short durations, these rates fell only very occasionally and for very short periods. If the Savings Bank rate went up, the amount of term deposits for short maturities could come down and hence the overall cost of funds of banks would be unaffected. As regards concerns that asset- liability maturity mismatches would increase, she said that 80- 90 per cent of Savings Bank deposits are stable and as such this should not be a problem. On the issue of service charges she said that service charges for individuals should be lower than for non- individuals. As regards fears that there would be unhealthy competition, she felt that the system would adjust on its own and that competition would be good for the system. According to Ms. Kishori Udeshi, deregulation of the Savings Bank rate would encourage the savings habit and provide protection to depositors. In the absence of widespread financial literacy she felt that the RBI should regulate the introduction of new financial products. Demolishing the argument prevailing in influential policy- making circles that savers prefer low interest rates provided they were fixed, Ms. Udeshi said that this was akin to saying that if the Common Person’s daily requirement was three chapatties, he would be satisfied with half a chapatti per day, provided it was guaranteed, rather than getting none on some days and two or even six on some days in this context she recalled that the Savings Bank rate was 6 per cent in 1992. Ms. Udeshi stressed that with deregulation, the regulator should make known to depositors the financial soundness of banks. In this context she called for a proactive role for the deposit insurance agency which should be empowered to safeguard the interests of the depositor. This is an important suggestion and it is time that the deposit insurance agency is given precedence over other regulators on matters relating to depositors’ interest. The present columnist felt that the Savings Bank rate should be deregulated in baby steps, starting with the July 26, 2011 policy review, but the process should be completed speedily by March 2012. In the first stage, the rate should be prescribed as a range, say, 4.0- 5.0 per cent and banks should be advised to set their rates in a manner that their net interest margins are not affected. After a few months the ceiling could be removed but the floor should be maintained. The AIBDA can no longer be a low profile organization. It should actively canvass for voluntary contributions to a fund to safeguard depositors’ interest. Given that there are 550 million savings bank accounts, raising funds to enable it to be more active should not be a problem but the AIBDA should make it widely known that it is open to receiving voluntary contributions for this worthy cause.

FPJ

Financial Stability Report: stress free for now

Indian financial system remains stable in the face of some fragilities in the global environment financial scene

The Reserve Bank of India (RBI) released its Financial Stability Report (FSR) recently. The third in a series, the recent FSR follows the tradition of the two preceding reports (March and December 2010) and represents the central bank's “continuing endeavour to communicate its assessment of the incipient risks to financial stability”.  The FSR's approach is holistic and focusses on risks to the system arising out of an interplay of the disparate elements of the financial sector infrastructure — the macroeconomic setting, policies markets and institutions. Like its counterparts in the developed world, the RBI says it relies on the latest techniques of risk assessments involving stress tests and so on.  Though technical in nature, the FSR has plenty of messages even for the common man. An important conclusion is that the Indian financial system remains stable in the face of “some fragilities being observed in the global macro-financial environment”. Major economies around the world are slowing down even as the risks from global imbalances and sovereign debt crises remain. India's growth momentum too has slackened mainly due to the uncertainties in the global environment characterised by high energy and commodity prices. However, despite high inflation and fiscal concerns, India's fundamentals remain strong.

Findings

Two of the most significant findings of the FSR are (a) that the banking sector in India — by far the most dominant portion of the Indian financial sector — continues to be stable and (b) the domestic financial markets have remained stress free recently. However, a few caveats are in order. Indian firms are relying increasingly on external sources of finance, mostly euro-commercial borrowings. That has resulted in currency mismatches. The well-known problem in the derivatives segment in which uninformed companies, many of them from the SME segment, sold unhedged products (loans in Swiss francs or other currencies with low interest rates but without a forward cover) has had disastrous consequences. The aggressive selling of an essentially speculative product has also cost the banks dear. According to many that development would not have happened if the RBI had been more gradual in relaxing foreign exchange controls. It has been one of the cardinal rules of exchange control that there should be an underlying commercial transaction behind any forward cover. Sans the commercial it becomes pure speculative trading.  Although the above has not been highlighted in the FSR, it does mention the other great risk arising out of an unbridled access to foreign currency borrowings by Indian companies.  Many of them who issued foreign currency convertible bonds (FCCB) may face refunding risks at the time of conversion by March 2013. The conversion price of these FCCBs is said to be substantially higher than the prevailing market price and the differential is unlikely to narrow. The RBI recently announced some concessions and extended the date of conversion, but the basic problems with FCCBs remain. Despite giving a clean chit to the banks — at least for now — the FSR does voice some concerns. Banks have aggressively expanded their credit portfolio to accommodate their borrowers. In the process they have come to rely on high cost funds such as those mobilised through certificates of deposits (CDs). Resource mobilisation on those terms is generally for shorter periods and hence contributes to the risk of asset-liability mismatch.

High cost funds

In effect, banks have relied on the higher cost funds to fuel credit booms. How far such practices impair their balance sheets may not be clear now but one has to look at a related factor as well. Incremental credit has tended to concentrate on a few sectors such as retail lending (including home loans), commercial real estate and infrastructure. Although, on the face of it, banks are not over-exposed to these sectors, the fact remains that lending to some of these sectors has become a fashion even among public sector banks. Commercial real estate has been subjected to higher provisioning by the RBI to prevent “overheating”. Individual home loans are highly sensitive to interest rate movements. There is strong possibility that the level of non-performing assets (NPAs) will increase.  The share of public sector banks (PSBs) in these sectors is high. In one obvious sense that might be understandable: after all they remain the dominant players. Yet retail lending — home loans, personal loans including credit cards — has never been part of the ethos of public sector banking. Part of their new enthusiasm might have been prompted by their desire to match the foreign and the new generation private banks. The crucial question is whether the PSBs are equipped to cope with failures such as in credit cards.  There is much more to the Financial Stability Report. Like any RBI report, it is a mine of credible, well researched information that are of immense benefit to many sections.

HBL

Inflation at 9.44% adds pressure on RBI to hike rate

Real inflation rate may already have crossed the 10% mark, believe analysts........

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Measures to rein in inflation will hurt growth: Tata

...Fiscal and monetary measures being taken to combat inflation would impact growth in the Indian economy's key areas, particularly infrastructure, as rising input costs and costlier borrowing would delay critical projects....

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Revealing growth numbers

..The concerns expressed by the RBI Governor on the “quality of data supplied” need to be taken seriously and addressed quickly. Ipso facto, one may not be entirely incorrect in arguing for a course correction with a redoubled focus on the supply side for an economy which has still influential unorganised pockets. .......

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