From Business World of 17 September 2004.
Neighbourhood banks
The finance minister has held his customary pow-wow with
banks. Even government hands find it difficult to visualize a more boring
ritual. Bankers come in their Chirag Din suits and arrange themselves around
the table. They stand up and grin sheepishly when the minister comes in. The
minister gives them a predictable homily, serves them tea, biscuits and cashew
nuts. And they disperse.
This time the minister is rather
subdued. His political escapades in the past eight years have left him rather
exhausted; and then there is the burden of dour leftists to carry. But there
was a time when the same Mr Chidambaram had a fire in his belly. There were
things he wanted to get done, and he did not brook procrastination.
One of the things he wanted done
was opening up banking to many new players. He was impatient with the ponderous
public sector banks, and horrified at their sense of irresponsibility. They
lent out without a care to doubtful borrowers as long as they were big and had
contacts in Delhi, and would not look at small, local businessmen. So many
banks were local banks before nationalization. They specialized in lending to,
say, the spice gardens in southern India or the sari makers of Benares. They
had old, local roots, they knew everyone in their neighbourhood, they could
tell good eggs from bad, and they backed the good borrowers through thick and
thin.
The same banks, when they were
nationalized, were combined into elephantine national banks whose central
offices micromanaged local lending. The local managers’ lending powers were so
modest that they had no chance of underwriting and nurturing strong local
businesses. They were given loan quotas; of those, a quarter had to go to
farmers, whether they had any loan servicing capacity or not; another quarter
had to go to small businesses – and that meant lending out little loans of a
lac. Every once in a while a minister or an MLA came along and got loans for
his favourites, whose contacts made them immune to repayment. No wonder bad
debts escalated; and since they were created by instructions, the finance
ministry and Reserve Bank found ways of financing or doctoring them. It was to
remedy this mindless, dysfunctional centralism that Mr Chidambaram, when he was finance minister last time, favoured small, new banks. Reserve Bank was dead against
them; but in response to a minister who would not take no for an answer, it
finally allowed something called Local Area Banks. They could start business,
but each would be given a small area, such as a district, and was not allowed
to stray outside it. Today, seven years later, none is heard of. When
Chidambaram departed early, Reserve Bank also buried his pet idea.
Chidambaram identified a real
problem; but Reserve Bank had a problem too. There are actually thousands of
small, local banks; instead of Local Area Banks, they are called cooperative
banks, cooperative credit societies and regional rural banks. And their
management stinks. They have been mostly captured by local politicians of one
hue or another, they give loans to a small group of their favourites, and their
loan recovery is abysmal. The politicians in Gujarat are more entrepreneurial;
many of them clean out the bank. Madhavpura Bank was a memorable scandal even
by the standards of Gujarat.
And what happened to it?
Kesbhubhai Patel, then chief minister of Gujarat, came running to Delhi and
asked Yashwant Sinha to bale his friends out. Sinha asked him to go to Prime
Minister Vajpayee. Keshubhai touched Vajpayee’s feet, and Vajpayee gave Sinha
the order: save our best man’s bacon.
If he still cares for
neighbourhood banks, Chidambaram has to give thought to this problem: how to
prevent them from falling into the clutches of local frauds who take political
cover? Reserve Bank will tell him, do not let anyone take control of the bank;
restrict everyone’s shareholding to 10 per cent or less. But this is no answer;
if no one is allowed to run a bank, no one will. No serious entrepreneur will
start a bank on those terms; and those who do will find a way to usurp power.
The answer lies in removing the
insurance cover the government has given to fraudsters. Today, anyone can rob a
bank and be sure that the government will bale it out. Chidambaram himself gave
that implicit assurance when he asked Oriental Bank of Commerce to bale out
Global Trust Bank. It is a guarantee he will have to publicly, deliberately,
remove before he can persuade Reserve Bank to relax on its bank licensing
policy. And the guarantee has to go, not just for future banks, but all existing
banks – and especially for cooperative banks and regional rural banks. Before
Chidambaram can construct a new local banking network, he has to excise the
present diseased one.
