Do not reward your banks
The budget season is also the season of supplication.
Hundreds of poor old beggars write to the finance minister asking for favours.
If they are small fry, they end up meeting a flunkey of the revenue department
and leave a memorandum with him which is soon consigned to a dustbin. If they
are important enough, the finance minister himself deigns to meet them.
Amongst the lucky ones are
state-owned banks. Being the finance ministry’s own daughters they get a
privileged hearing. The finance minister himself meets the heads of banks, and
they have all the time to lay our their wish list before him.
This year they had some urgent
requests. They want the finance minister to bring back Section 80L, under which
interest on fixed deposits was exempt from tax up to Rs 12000, and to raise the
limit to Rs 15000, and to exempt interest on savings accounts altogether.
P Chidambaram has been intent on
removing tax rebates and exemptions and simplifying income tax law and
administration. He repealed Section 80L to this end in 2005. How can the banks
go to him and ask him to bring it back?
Their argument is that they are
running short of cash, and that their capacity to lend is being constrained.
The economy is experiencing a wonderful boom, and it is their patriotic duty to
fuel it. To do so, they must have ample liquidity. To have the cash, they have
to be able to retain deposits; tax exemptions will give them an advantage in
the competition for deposits.
Who, then, is luring away the
deposits from banks? Mutual funds. They offer a greater variety of investment
outlets – debt, equity, long-term, short-term. And they do not have to comply
with 2000 pages of Reserve Bank regulations; they do not have to open rural
branches; nor have they to employ thousands like the banks. So the margins they
charge are much narrower than banks’. If the latter earn margins of 4-7 per
cent on their funds, mutual funds charge only 1-2 per cent.
But if the banks are being so
patriotic by lending money, why did Reserve Bank raise the cash reserve ratio
and reduce their ability to lend? It did so because it is worried about
inflation and overheating of the economy. The banks hope that the finance
ministry does not share Reserve Bank’s obsession with stability; they have some
reason to hope that the finance minister is more optimistic and would like the
boom to continue unrestrained.
Such a view can be legitimately
held. After a long while India has got a beautiful boom with not a dark cloud
on the horizon; it is perfectly respectable to wish that it would continue, and
to help its continuation along.
But there is another, hidden
agenda behind the banks’ ploy; they would like to get an advantage against
their competitors, the mutual funds; and what better way than getting a tax
concession for their customers only?
And that is precisely what is
wrong about their request: that the finance ministry should not be favouring
banks against their competitors – especially because it owns the banks.
Taxation should be strictly neutral between different forms of financial
investment. For instance, there is no justification for the tax rebate on
long-term capital gains. Realized capital gains are income just like any other;
as long as they are calculated after indexation of the original investment,
they deserve to be taxed like any other income. The stock market would not like
it, and may even stage a collapse to register its protest. Still, the
discrimination is wrong – unless it is extended to all income from investments.
They are not doing so yet, but if
banks were to argue that the restrictions on their business – that they can
take only deposits of various tenures and use them only to finance loans – are
unreasonable and cramp their ability to compete, there would be some truth in
their complaint. And the remedy for that would be to remove the regulatory
barrier between bank lending and investment in mutual funds. Banks should be
able to offer their depositors the choice of investing in mutual funds.
But that freedom should be
extended to mutual funds as well; they too should be allowed to take deposits,
just like banks. It is time that Reserve Bank removed the embargo it has placed
on new banking licences since 1994, and gave one to every mutual fund asset
management company.
