|The architecture of the financial system has to be recast to ensure the growth of the economy along with adequate availability of credit to the fastest growing sectors of the economy. The aims of the Reserve Bank of India’s monetary policy can be achieved if and only if the role of non-banking financial institutions, including the unincorporated bodies, are recognised, encouraged and integrated in the financial system, says R. Vaidyanathan.|
THE last 15 years have witnessed significant growth in the national income, more particularly in the service sectors. The share of the non-corporate sector (Proprietorship and partnership — P&P — firms) is more than 35 per cent. We note that the services sector constituted nearly 60 per cent of the economy in 2002-03. In activities such as construction, P&P firms accounted for over 60 per cent of the value addition in 2001-02 and in Trade, Hotels and Restaurant more than 75 per cent. In the case of non-railway transport the share of the P&P sector is 81 per cent and in real-estate and business services 76 per cent.
Table 1 gives the real growth rate of the services sector between 1993-94 and 2002-03 and all activities have grown above the national income growth rate of5.89percent.Hotels and Restaurant grew by 10.5 per cent and Trade 7.9 per cent and non-railway transport 7.6 per cent.
Financing of the non-corporate sector
The banking sector has been investing 45-50 per cent of its resources in government securities the last couple of years. The lending pattern of banks reveals an interesting picture, wherein the share of the P&P sector has come down though this sector (predominantly in services) is the fastest growing.
Table 2 gives the share of the P&P sector along with private corporate and government sectors in the credit outstanding of scheduled commercial banks. The share of the P&P sector has come down to 43 per cent from 58 per cent in the 1990s when the P&P sector in trade, transport, construction, restaurants, and other business services has been growing at a CAGR of 8 per cent-plus. Here, households include agricultural households and to that extent the fall is significant. The share of the private corporate sector in the national income is 12-15 per cent but it absorbs nearly 40 per cent of the credit provided by the banking sector. The fastest growing P&P sector gets lesser share of the bank credit, which reveals that the non-banking financial sector is playing increasingly important role in the credit delivery mechanisms of the growth of the economy. This is desispite the household preference for bank deposits as a savings medium.
Table 3 gives the outstanding credit of loan accounts with Rs 25,000 (earlier Rs 10,000) from Scheduled Commercial Banks for selected period.
The number of accounts has shown a dramatic decline in the late 1990s and the share of this segment has fallen to nearly 6 per cent in 2002 from a high of 15 per cent in the early 1980s.
Even the absolute amount outstanding for these accounts has come down from Rs 41,000 crore to Rs 36,409 crore in 2000 to rise marginally in 2002 to Rs 38,501 crore. Something appears problematic with the banking sector particularly in providing credit to the sections that not only require it most, but also which are fastest growing.
For instance, the share of trade in 2000-01 at factor cost at current prices in national income was 12.8 per cent at Rs 2.4 lakh crore (out of Rs 19 lakh crore). Of this the share of non-corporate sector was 82 per cent or approximately Rs 2 lakh crore. If 75 per cent needs to be financed (which could be under estimation since we are looking at value addition and not sale) by the outside institutions then Rs 1.5 lakh crore is the credit need of the trade sector.
The bank financing of trade (non-food credit plus food credit) is Rs 57,836 crore (17845 + 39991) which is around 38 per cent of the credit got by the sector (Handbook of Statistics, pp62, RBI 2001). In other words more than 60 per cent of the financial requirement of non-corporate sector in trade is met by non-banking sources.
The financing of the activities undertaken by the non-corporate sectors particularly in such areas as trade (wholesale and retail), hotels and restaurants is mainly from private money markets where the rates of interest are much higher.
These are cash-flow-based lending, rather than based on asset and are undertaken mostly by the unincorporated financing agencies. Also, funds need to be available to these players without much paperwork and based on personal assessment. Hence, the NBFCs mostly finance these activities.
Concentric circle of banking institutions
There is need to integrate domestic financial markets through a system of making NBFCs the channel partners to large banks. The reforms have focused only on the liability side of NBFCs and failures therein, but the asset side is equally important in terms of credit delivery to large segments of our economy. The focus is more on failure of some institutions.
There are two types of failures. One due to malfeasance on the part of promoters in terms of running these institutions, which has resulted in the loss to the depositors. This is related to the operational and supervisory mechanism. The other relates to the riskiness of the underlying assets invested in by these entities and that is part of business risk phenomena.
There is a need to understand the return-risk paradigm of any financial operation and these entities are into cash flow based lending as in activities such as trade, hotels, and construction. They do not have the benefit of sovereign guarantee provided to public sector banks nor have they any insurance facility as given to bank deposits. They also do not have the ” comfort letters” provided to the MNC bankers in India by their parent’s abroad.
In such a situation, some failures are to be expected when we are dealing with thousands of institutions. In the case of failure of commercial banks, particularly those in the public sector, it is explained as “systemic” failure and the government pumps more funds to re-capitalise these institutions Protecting the depositor interest should go hand-in-hand with enhancing the credit delivery mechanism to the largest sections of the economy, which are not currently bank-dependent for their activities.
In a sense the NBFC sector is the best route to finance these activities in the service sectors. This is because in their area they are market savvy and have the ability to rate the P&P groups, monitor them and recover the money lent to them.
Already in truck financing the large domestic and foreign banks are using the NBFCs as channel partners. Hence, the public sector banks could finance the the NBFCs on a wholesale basis and they, in turn, could fund the non-corporate sectors in a chain of retailing credit and recovery functions.
If the banks finance the NBFCs after rating them even at 4 -5 per cent above Prime Lending Rate (PLR) then these institutions could fund the non-corporate sector at perhaps 8-10 per cent over and above the PLR. This would still be lower than the open market rates of two and half to three times the PLR at which this sector, in many of these activities, is financed.
The financing of non-bank organisations (both corporate and unincorporated) by the commercial banks should be treated on a par with priority sector lending.
The commercial banker could be given the powers to licence these entities and provide credit to them to reach the larger market. It can also be specified that only licensed non-corporate bodies will be permitted to operate in the credit market in terms of collecting deposits and also getting loans from the banking institutions.
This would provide opportunities to banks to enlarge their scope of operations and also allow the un-incorporated bodies (UIBs) to carry on their business with loans from the banking system. It will also introduce orderliness in terms of banks rating these entities for licensing them and reviewing this process annually. The depositors are also protected to some extent in the context of assessment by the commercial banks for licensing them.
This concentric circle of banking will end the current inverse relationship between the size and the cost of borrowings without much application of credit rating of the borrower. It would also facilitate creation of proper database in these activities for credit rating of these entities.
Integrating the financial markets
There are efforts by governments both at the Centre and in the States to allow global companies into such activities as retail trade, transportation and construction and restaurants. If the competition from the international giants has to be effectively met, then cost effective and efficient credit delivery mechanism is important for the local institutions.
Globalising the financial sector without domestic integration of the financial markets may lead to a situation of cherry picking by the global players and/or linkages created only at the “creamy layer” level without adequate strengthening of the base. The paradigm of taking the UIBs as channel partners by the commercial banks on a large scale would facilitate the players in these fastest growing activities to compete effectively with global players in the emerging scenario.
Suggested are certain steps that will facilitate
- Reduction in interest cost and hence benefits the ultimate consumer;
- Enhancing the credit delivery mechanisms;
- Introduction of rating processes at retail level;
- Creating level playing field when global players enter retail;
- Reversing the inverse relationship between the size of borrowing and the cost of borrowing;
- Strengthening the professionalism of the NBFC sector through education and training, and
- Integrating the financial markets.
It is required for us to recast the architecture of the Indian financial system if it has to ensure growth of the economy along with adequate availability of credit to the fastest growing sectors of the economy. The aggregate monetary policy of the RBI can be achieved if and only if the role of NBFCs, including the UIBs, are recognised, encouraged and integrated in the financial system.