Banking
initiatives
The Finance Minister announced major
banking initiatives in his budget speech. They relate to two problems.
First, India’s exchange reserves continue
to grow; they are so large that they now exceed the supply of money (excluding
bank deposits). If money supply exceeds what the public wants to hold, it will
spend the money. If there is surplus capacity, this will lead the economy to
grow. If there is not, it will lead to rising prices and worsening balance of
payments; both phenomena are now evident. The government can withdraw money out
of the economy by issuing bonds, and our government is a chronic borrower; but
two years ago, the growth in money supply looked likely to exceed the
government’s borrowing requirements.
So Reserve Bank and the finance ministry
worked out a solution: Reserve Bank would borrow money for the government even
though the government did not need it – it would issue the so-called Market
Stabilization Bonds (MSBs) up to a limit of Rs 550 billion. Now that limit is
nearing exhaustion. But the finance ministry resented having to pay interest on
money it did not need. Also, there were no buyers, so Reserve Bank was
unloading MSBs on hapless government banks. But demand for commercial loans was
reviving, banks earned much more on them, and they were demanding higher
interest on MSBs.
Now Reserve Bank and the finance ministry
have devised a new way of forcing banks to disgorge or immobilize money. The
Reserve Bank of India Act of 1934 will be amended, and Reserve Bank will be
given powers to force banks to buy government securities without limit. Since
they will have to take the bonds, banks will not be able to complain about
interest; or rather, they will complain, but to no avail. Further, Reserve Bank
will be authorized to make banks hold any proportion of their assets in cash.
Cash by definition is a perpetual interest-free government loan. Reserve Bank
pays bank a small interest on their cash reserves; but this is more in the form
of a baksheesh.
Second, bank
loans grow every year by about 15 per cent. Few countries have sufficiently
large supplies of risk capital; banks end up giving loans which are in effect
risk capital, and keep losing some of the money in bad debts. If they are not
to go bankrupt, they need a continuous infusion of risk capital. Hence the Bank
for International Settlements (BIS) in Basel requires that banks in its member
countries must always have equity equal to 12 per cent of their assets. This is
no problem for foreign banks; their Indian operations are a minute part of
their world business, and they can easily bring in the required capital from
abroad. But it poses a problem for government banks as well as private banks.
Government banks
are by definition owned by the government, which must bring in capital. But the
central government does not like to sink capital into its second-rate banks.
They could go to the capital market. But it will give capital only to the few
prosperous banks; and even they cannot raise more than a certain limit because
otherwise the government would lose majority in their equity capital and lose
control. Reserve Bank could always bend rules and deprive private investors of
control; but that would make them even less willing to invest. For second-rate banks,
the government has devised the solution of merger with stronger banks. This is
passed off as consolidation to face competition, but it is really only a
baleout and copout. As for stronger banks, it would be nice if they could
borrow equity capital, but the BIS does not recognize borrowings as equity. So
the government’s solution is that they will be allowed to issue preference
shares, which are considered equity but give fixed returns like loans. Nothing
has been said about voting rights, but I bet they will be restricted.
And for private
banks, the best solution is takeover by foreign banks. Mr Chidambaram sees
this, but Reserve Bank has opposed it tooth and nail. Now a compromise has been
worked out: Reserve Bank will entertain applications from foreign banks to take
over private banks. It says very clearly that it does not have to approve such
take-overs. My bet is that Reserve Bank will use this power to scuttle entry of
foreign banks, just as it did the setting up of new private banks ten years ago.
Mr Chidambaram cannot win – at least for now.
