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Khan group hints at bank, FI mergers

The working group headed by Industrial Development Bank of India chairman S H Khan today submitted its summary recommendations to Reserve Bank of India Governor Dr Bimal Jalan, recommending the possibility of gainful mergers between banks and between banks and financial institutions under a specific regulatory framework and a risk-based supervisory framework.

The working group also made several recommendations for improving the organisational efficiency and risk management strategies bringing information technology to international standards and development of human resources.

With regard to the reorganisation of state-level institutions (SLI), the group suggested consolidation and professionalising of SLI, allowing them to grow stronger and bringing them under the supervisory ambit of the RBI.

The group, set up by the RBI in December 1997 to review the role and structure of the developing financial institutions and commercial banks in the emerging environment, recommended several interim measures towards achieving coordination and harmonisation of the lending policies of banks and financial institutions before they move towards universal banking.

It has suggested setting up of a standing (coordination) committee with banks, financial institutions, and RBI as members to achieve the coordination.

On structural changes, the working group recommended a progressive move towards universal banking and the development of an enabling regulatory framework for the purpose. In particular, it emphasised that a full banking licence be eventually granted to development financial institutions. In the interim period, development FIs may be permitted to have a banking subsidiary with 100 per cent holding while the development FIs themselves may continue to play their existing role.

While size, expertise and reach are crucial to sustained viability and future survival in the financial sector, the group report said that the gainful mergers should be possible not only between banks, but also between banks and development FIs, and not only between strong and weak though viable entities, but even between two or more strong banks and development FIs. However, such restructuring and mergers should be brought about in a market-oriented fashion and should be led by viability and profitability considerations alone.

If the development FIs are required to assume any developmental obligations, the group suggested that the RBI and the government should provide an appropriate level of financial support to enable them to fulfil these obligations.

A function specific regulatory framework must be developed which aims at targets activities and institution neutral with regard to the regulatory treatment of identical services rendered by any participant in the financial system. This concept of neutrality should be applicable to both foreign and local entities.

In view of the increasing overlap in functions being performed by various participants in the financial system, the Khan group felt that a measure of coordination among regulators was desirable. It suggested for setting up a super-regulator to supervise and coordinate the activities of these multiple regulators to ensure uniformity in regulatory treatment.

The group's view is that at a fundamental level, legal reform is called for, in cases of enforcement of contractual obligations and dissolution of companies. In particular, a speedy implementation of legal reforms in the debt recovery area of banks and financial institutions should be given top priority. It recommended a thorough revamp of the 1993 act on recovery of debts from banks and development FIs on the suggested line in this regard.

On changes in supervisory practices, the report said, the supervisory authority should undertake primarily off-site supervision based on periodic reporting by the banks and development FIs as the case may be. Another essential element of the improved supervisory framework should be the ability of the supervisors to supervise the development FIs and banks on a consolidated basis. It recommended setting up of a risk-based supervisory framework along the lines of the report of the task force on conglomerate supervision, published by the institute of international finance in February last year.

On statutory obligations, the group report said that the application of cash reserve ratio should be confined to cash like instruments and it should be brought down progressively within a time-bound frame to international levels. There is also strong case for phasing out the statutory liquidity ratio in line with international practice.

Rather than imposing the statutory obligations like credit reserve ratio and statutory liquidity ratio norms on the entire banking system, the group's view was that there was a need for an alternate mechanism to be developed for financing the sectors that suffered from a paucity of funds. Such a mechanism will aim to balance the need for funds with the need to bring better suited structures and specialised skills to bear in dealing with the sectors. In the context, the group said that it might be preferable not to include infrastructure lending in the definition of net bank credit used in computing the priority sector obligations.

On state-level institutions, the Khan group said that strong SLIs should be encouraged to go public by making initial public offers and bring down the state government's holding to below 50 per cent. These institutions should be brought under RBI supervision. The group suggested that credit reserve ratio should not be applicable to development FIs under the present structure where they are not permitted to access cash and cash-like instruments.

The group suggested that the banks be permitted to exclude investments in statutory liquidity ratio securities issued by a development FI while calculating the exposure to that institution. In line with interbank deposits, a uniform risk weightage of 20 per cent may be assigned for investment made by commercial banks in bonds of rated development FIs.

The development FIs should be granted full authorised dealers licence. The group was of the view that it would be worthwhile going into the details of the requirements and drawing up a perspective plan and blueprint for a robust automation in the financial sector.

UNI