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Universal banking, for whom?

N. Srinivasan

HARMONISING the roles of banks and development financial institutions (DFI) was the theme of a workshop held at a recent premier academic institution. In the current context, harmonisation implies the introduction of universal banking (in a limited sense ), wherein the DFIs could become banks and inter-mediate in the short-term end of the financial market; and commercial banks could enter the long-term end of the financial market.

Harmonisation also involves placing the DFIs and the banks at two ends of the financial services continuum, allowing the two institutions to move freely to the other end.

Universalisation implies the elimination of the distinction between the DFIs and the banks; and the market segmentation that currently exists between banking and development finance.

At present, the DFIs and the banks operate in different segments of the financial market. The DFIs finance long-term investment requirements, and the banks the short-term investment and production requirements. Both the banks and the DFIs would be lookin g to inter-mediate in a big way at the other end of the market where they are less dominant now. Some of them also may diversify into insurance and other related areas.

The cost of funds differentiates the DFIs from the banks. The DFIs incur higher costs for mobilising long-term finance. Banks, however, do not as of now mobilise substantial deposit resources with maturities in excess of five years (only 11.7 per cent of deposits have maturities of more than five years), limiting their ability to extend long-term loans. This has resulted in consortium arrangements between the DFIs and the banks so they can take care of the total credit needs of any project. However, the re is conflict of interest between the DFIs and the banks over security and apportioning repayments when the borrowing unit is unable to maintain its repayments schedule.

Apart from giving direct loans, the DFIs refinance banks to supplement the latter's long-term resources. Again there is the potential for conflict between DFIs and their client banks. The S. H. Khan Committee recently suggested that the DFIs should eithe r become NBFCs or banks within the next five years. After they become NBFCs, their ability to mobilise long-term funds at the present rates of interest would be affected. If they become banks, they would have to acquire drastically different skills and c ompete with established foreign, private and public sector banks.

With asset-liability management being made compulsory for the banks and the DFIs, there might be a reduction in the flows of long-term loans from the banks. If the DFIs convert into banks, the ALM norms might limit their involvement in long-term loans.

The DFIs are specialist institutions catering to different sectors, appraising projects from technical and financial parameters. Specialisations have been built up in financing industry, exports and imports, small industry, agriculture, infrastructure, venture capital, tourism and the rehabilitation of sick units. This specialisation has given the DFIs, banks and project holders an edge in terms of project appraisal. Now, there is the possibility of this specialisation being lost.

While commercial banking has seen impressive growth even post-reforms, the growth of all India financial institutions (AIFI) was even better. The Table gives the comparative growth rates of financial assets of banks and the AIFIs.

What can be inferred from the AIFIs' higher growth rates is that though they operate in a niche market for long-term funds, there is significant demand for their services. If this is so, is it worthwhile for them to shift focus from long-term project loa ns? And, in what way would the clients be better served by such a shifting is also not clear.

The impact of banking sector reforms has been felt more on the banks' asset portfolios. There is a shift from loans to government securities, small loans to big loans, from start-up enterprises to established industrial houses and from long-term project loans to short-term commercial loans. Banks are keener on short-term exposures to cut risks.

The DFIs offer long-term loans and additional services to induce investments and encourage private enterprise. In a market-oriented financial system, taking their cue from the banks, the future course of the DFIs would be to become commercial and reduce long-term loans and `developmental' activities. Of late, there have been instances of the DFIs refusing to sanction loans for committed projects and refusing to disburse loans already sanctioned. Some DFIs have taken to stockbroking and related activitie s in pursuit of profitable business diversification.

With the liberalised regime for investment flows from abroad, there would be requirements of complementary domestic financing from banks and financial institutions. Project-based lending skills will be necessary in the next five years, going by the spat e of FIPB approvals. One is not sure whether this has been factored into the sequencing of the policy framework to harmonise the financial system.

An anticipated result of the universalisation of banking is the expansion of banks and diversification into new financial and para-banking services. The business focus of the large entities that would emerge would be on profitable lines, such as trade fi nance, credit cards, consumer finance, foreign exchange dealings, treasury and stock market operations, where the payback period is short and risks less compared to the traditional project and working capital financing. With increased growth, there would be a marked reluctance to enter the smaller end of retail banking. The small borrowers, especially in the rural areas, would find it difficult to access the bank's services as they may not be significant to the banks' business volumes or profits.

The paradigm shifts in retail banking over the last year show that even in the urban areas, banks would like to minimise the human interface (and the associated staff costs) with the customer, with the help of technology through ATMs and virtual banking. In the rural areas, such technology-led cost reduction would not be possible because of the high infrastructure costs involved and the level of literacy necessary for customers to use the electronic interface. What this portends for rural banking does n ot seem to be in consonance with the national priorities. The questions that require greater debate are:

While clear separation between investment banking and commercial banking is statutorily mandated in advanced economies such as the US (at least till very recently) and Japan, why are we compelled to harmonise?

When specialised financial institutions exist with state support in developed countries, why do we want to erase their identity in India?

If the DFIs in their present form go out of existence, how will long-term resources be mobilised?

What is the place for refinance facilities in the emerging future for banks ill-equipped to mobilise long-term resources to meet their term-lending commitments, especially considering the new asset-liability management norms?

Can banks develop project-lending skills while carrying on service-intensive retail banking?

Can the DFIs develop banking skills within a short period of five years, that too in a crowded competitive market?

Have the industrial and agricultural sectors come of age, and do they have the maturity to deal with a commercial financial system?

Are satisfactory regulatory and supervisory mechanisms in place to oversee the complex financial supermarkets that would emerge?

Is harmonising an objective in itself, or does it serve any superordinate objective of establishing a national financial structure capable of meeting appropriately differing financial requirements of different sectors?

What would be the shape of the rural financial sector, and what would be the involvement of `universal banks' in it?

Are there still priority sector and social obligations of banks in the harmonisation and universalisation of banking process?

The questions are easy to raise and could be discerned as obstructionist in the context of change-thinking. But the change planned should prove beyond a doubt that its benefits outweigh the costs. At present, the apprehensions are that the fallout of cha nges contemplated would be adverse to certain sectors of economic activity, and the likely economic costs thereof would be more than the gains of the positive impact on the benefiting banks and financial institutions. If reforms with a human face are wha t we want, then universal banking has to make adjustments and ensure that financial services are available to all at affordable costs. Access to financial services should not become an elitist privilege.

(The author is General Manager, Nabard, Mumbai.)