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Hardly bankable

THE MOVE TO link bank exposures to advances rather than incremental deposits of the previous year can expand substantially the money the banking sector can deploy in the capital market. While the corporate sector and the broking community have been seeki ng higher funds flow from banks to the market, it may not be the best thing for the banking sector. The fundamentals of most banks, in terms of asset quality, earnings and capital adequacy, suggest the need for consolidation and strengthening the balance -sheet, rather than enhancing equity exposure. The equity exposure of the banking system -- not even of the public sector banks, including the SBI -- has not reached even the current limit of 5 per cent of incremental deposits. So, unless there is subtle suasion (perhaps this latest recommendation is of this genre) from the RBI, it is unlikely that the banks would pump more funds into equity.

The `Standing Committee of the RBI and SEBI on Bank Financing of Equity' has recommended that up to two-thirds of the permitted limit may be channelled through mutual funds and the rest deployed directly. The mutual fund option is to enable banks overcom e any deficiency in in-house expertise in the capital market. No doubt, most if not all public sector banks and most private sector banks are deficient on this score. While the latter may have the freedom to choose fund managers based on performance, th e public sector banks may feel constrained on this count, given the possibility of fingers being pointed later on if the bank makes losses by parking funds with private sector funds. The PSUs may have no choice other than the UTI, whose track record is n ot very comforting. So, unless banks have genuine freedom and there is a signal that commercial judgment would be respected, their managements may only show inertia in the choice of the mutual fund, and this could prove damaging.

While the Committee has rightly observed that banks have a role in deepening the capital market, its reasoning for a relaxed framework for equity investments appears flawed. For, if an increase in the number of institutional investors is what leads to st ability and lowers volatility, then the US market should score on this count. But there too, volatility is pervasive. In the Indian context, the entry of more funds from the banking system is unlikely to touch this aspect. Volatility is a reality of the market and the Committee's thinking appears naive. The problem of volatility must also be seen in the context of a small number of quality stocks available in the Indian market unlike the US. With most of these already valued at high levels, a sharp rise in funds flow from the banking system may help market operators, short-term traders and brokers but not necessarily the banks themselves.

What could be encouraged is a higher level of financing of the market intermediaries with margins appropriate for the higher risks. But this has to be alongside a more transparent system that gives a complete picture of a broker's exposures, so that bank s are not caught out and with more stress on the cash component in the margin than securities. In this context, the Committee's suggestion of a uniform minimum margin of 25 per cent for issue of guarantees on behalf of brokers is welcome. But the same ca nnot be said of its recommendation on lending to NBFCs for on-lending to individuals for IPOs and to the corporate sector. It is not going to be easy to monitor the end-use as suggested by the Committee. For the health of the banking system and the marke t, of greater importance is the need to ensure better disclosures of banks' equity exposure to prevent any incipient crisis.