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End practices of socialist era: Economic Survey's advice to revive banking sector

Revival of the state-run banking system should be on a case-to-case basis instead of a 'one-size-fits-all' approach, it said.

ET Bureau|
Last Updated: Feb 28, 2015, 03.08 AM IST
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Revival of the state-run banking system should be on a case-to-case basis instead of a 'one-size-fits-all' approach, it said.
Revival of the state-run banking system should be on a case-to-case basis instead of a 'one-size-fits-all' approach, it said.
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MUMBAI: End the banking practices of the socialist era by slashing the mandatory holding of government bonds, reducing directed lending to the so called 'priority sector', and even sell off some poorly managed state-run banks, said the Economic Survey.

Revival of the state-run banking system should be on a case-to-case basis instead of a 'one-size-fits-all' approach and the banks should be using the profits from rising bond prices to provide for bad loans and improve their capital adequacy, it said. "The policy implication is that a one-size-fits-all approaches to governance reforms, public ownership, exit and recapitalisation should cede to a more selective approach," said the Economic Survey. The document also questions whether the private sector banks have played their role in the past two decades effectively in nation building as their share of overall market share seems to have been stagnant, it said.

"The right sequence would be to gradually reduce statutory liquidity ratio (SLR) and then provide incentives for a deeper bond market," the document said. "Second, priority sector lending (PSL) norms can be re-assessed. There are two options: one is indirect reform, bringing more sectors into the ambit of PSL, until in the limit every sector is a priority sector; the other is to redefine the norms to slowly make priority sector more targeted, smaller, and need-driven."

SLR and the PSL have been thorns on the bankers' side with them arguing that it distorts the demand-supply forces in the industry. State-run banks with a strict government monitoring, with Herculean efforts, meet their 40% lending to priority sector. But private sector and foreign banks take an easier route by investing in the NABARD run rural infrastructure development fund.

Although the statutory liquidity ratio is being reduced gradually by Reserve Bank governor Raghuram Rajan to 21.5%, there has been little progress on the PSL. Reducing the priority sector lending, or adding more sectors, could benefit the emerging sectors of the economy. For state-run banks which forever have been looking to the government for capital investment are being told that take profits from bond holdings as rates fall, and improve your financial strength amid less participation by the government in businesses.

"SLR reductions could allow them to offload G-secs and reap the capital gains which could help recapitalise them, reducing the need for government resources, and helping them raise private resources," said the Survey. "This is a better and cleaner way of recapitalizing the banks than to allow banks to mark their G-secs to market and realize the accounting profits. To avoid any moral hazard issues, gains from recapitalization should go first towards provisioning against NPAs, and only the surplus should go towards being counted as capital."

It questioned how much private lenders helped in funding the economic growth of the past few years. "Indeed, one of the paradoxes of recent banking history is that the share of the private sector in overall banking aggregates barely increased at a time when the country witnessed its most rapid growth and one that was fuelled by the private sector," it said. "It was an anomalous case of private sector growth without private sector bank financing. Even allowing for the irrational exuberance of the public sector banks that financed this growth phase, the reticence of the private sector was striking."

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