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October 22, 2001
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There's more to life than mere rate cuts

BS City Editor

CREDIT
POLICY
An interest rate cut is the collective obsession of India Inc.

Give them free money, the corporates are unlikely to touch it as no company has any investment plan up its sleeves. And yet they want a rate cut as this will prop up the sentiment.

Besides, over 75 per cent of the companies raise bank loans at rates linked to banks' prime lending rate and they will get the benefit if the PLR comes down.

Bankers are opposing any move to cut the benchmark bank rate tooth and nail as they can't afford to bring down their lending rates without cutting the deposit rates which are already at their historic lows.

Reserve Bank of India Governor Bimal Jalan may or may not cut rates. If he chooses to wait and watch the uncertain times, the absence of any monetary measure may steal the thunder from his eighth monetary policy but there is life beyond interest rate cuts.

As the shadow of uncertainties loom large over the economic fabric, it's time to do a soul-searching and address the structural issues. Since the efficacy of bank rate as a monetary tool has already lost its relevance, the RBI must use this opportunity to take financial sector reforms a big step forward instead of adopting a status quoist approach.

On the top of the list of its priorities could be rationalising the cash reserve ratio. At 7.5 per cent, Indian banks are subjected to the highest cash reserve requirement in the global banking community.

The RBI must cut the CRR and also announce a roadmap for bring it down to the mandated 3 per cent level at the earliest. The central bank must also take steps to bring it down further by amending the RBI 1934.

The banks earn only an average 2.7 per cent on the money impounded by the RBI (currently banks do not earn any interest on up to 3 per cent of the CRR. Beyond that -- up to 7.5 per cent -- they earn 6 per cent interest) which otherwise would have fetched them a modest 8-9 per cent if they invest in government securities and at least 7 per cent if perked in overnight call market.

Bankers have been demanding a higher interest rate on CRR. But that will not solve the problem. The RBI must bring down the level of CRR without further delay. This is important as the pressure on banks' spread is mounting every day.

The RBI should also initiate the process of amending the Banking Regulation Act, 1949, to bring down the minimum statutory liquidity ratio requirement below 25 per cent. In the absence of corporate demand for credit, some of the banks have already turned "narrow banks" by investing in government securities alone.

The banking system's present excess SLR holding is over Rs 1,200 billion -- higher than the annual gross borrowing of the central government.

The right-sizing of the reserve requirement will give the banks greater maneuverability in liquidity management and add to their profitability immensely.

This will also smoothen the rough edges of the road to universal banking for the financial institutions.

The RBI should also take a close look at the savings bank rate -- the last relic of administered interest rate regime. The ideal step should be deregulating the savings bank rate. If that is politically too sensitive an issue, the central bank can fix a cap for the savings rate and allow banks to offer even lower than the stipulated rate. This will help banks to pare the cost of deposits.

The other structural issue that the RBI may like to address at this juncture is the abysmally low net worth of some of the old private sector banks.

The promoters must be asked to pump in fresh money and if they fail to do so within a given time frame, these banks should either be liquidated or merged with stronger private banks or the state-run banks as in they can pose a threat to the system.

Alternatively, the RBI can toy with the idea of amalgamating some of the old private banks operating in the same region. For instance, United Western Bank, Satara Bank and Sangli Bank together can form a relatively stable bank in western Maharashtra.

Another critical area is the banking industry's investment in unrated corporate bonds. A time bomb is ticking away there as most of the investments in this segment are "accommodation" investments. A blanket ban on investment in unrated securities may save the industry from a huge embarrassment later.

Finally, it's time to evaluate banks' role in the capital markets. Should RBI continue with its fragmented approach? Or, should it allow banks to play a greater role in pumping in liquidity in the markets? The central bank's policy to allow banks finance margin trading has miserably failed. It is high time RBI lifted the cap on banks' capital market exposure and left it to the individual bank boards' discretion.

The system should not be penalised for a few rogue bankers who played in the market throwing all prudential norms to the winds. The long shadows of investigative agencies have brought the capital markets to a grinding halt. The RBI can play an important role to lift the morale of the markets.

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