Respected
Soedradjad Djiwandono, Governor Abdullah, fellow Governors and distinguished participants,
I
am thankful to Governor Burhanuddin Abdullah for inviting me to participate in
the Annual International Seminar 2007. We deeply appreciate the excellent arrangements,
warmth and hospitality of Bank Indonesia. In particular, special thanks are due
to Deputy Governor, Ms. Miranda Goeltom. I also sincerely appreciate the thoughtful
selection of the topics for discussion during this Seminar, which are of significant
contemporary relevance to all of us.
The
role of financial sector policies in growth and employment would naturally have
significant relationship with the institutional arrangements for overall public
policy of the country concerned. The framework and conduct of policy would also
be specific to the country or society concerned and would vary, over time, in
response to changing economic developments, in general, and financial sector developments,
in particular. My comments today would, therefore, be confined to the Indian experience
and capture the changing role of financial sector policies of Reserve Bank of
India (RBI) in the context of ongoing economic reforms.
Monetary
Policy
In
India, the objectives of monetary policy have been clearly enunciated as price
stability along with provision of adequate credit for productive purposes. Thus,
growth as one of the two objectives is part of our mandate, but the relative emphasis
in policy operations would depend upon the circumstances and is articulated from
time to time. It is often said that the best anti poverty programme in India is
maintenance of price stability since a large part of the work force is in the
unorganised sector, with little or no hedge against inflation. In recent years,
the strong growth environment coupled with increases in prices of oil and food
items have required added emphasis on price stability, especially inflation expectations.
As
articulated in the recent monetary policy statements of the RBI, the poor tend
to reap the benefits of high growth with a time lag while rises in prices affect
them instantly. In the short term, the impacts of high growth and price rises
are asymmetrical between the non-poor and the poor, warranting a greater emphasis
on price stability at this juncture of high growth for maintaining social accord
as well as securing popular mandate for the reform process itself. In his welcome
address, Governor Abdullah mentioned about the issue of inequalities in the context
of globalisation and importance of central banks' commitment to stability and
conducive environment for business.
Similarly,
in regard to financial stability also, we note that most of the active participants
in financial markets are non-poor. To the extent there are externalities in terms
of financial sector - both positive and, on occasions, negative - the weight for
stability in our policies has been higher in view of limited capacity of the poor
to bear risks that may occur in the real sector by virtue of developments in the
financial sector. The lack of social security mechanisms and public safety nets
in India are also relevant. The design and pace of liberalisation of financial
sector in India thus takes into account the due weight for stability.
Regulation
and development of financial markets,
institutions, technology etc.
To
enhance efficiency and stability of the financial system and thus contribute to
growth and employment, several steps have been undertaken for widening, deepening
and integrating financial markets although it is ‘work in progress’. Simultaneously,
new processes and institutional arrangements have been put in place in regard
to the banking sector, deposit-taking non-banking financial companies and systemically
important non-deposit-taking non-banking financial companies. By and large, these
initiatives, in particular supervisory systems, are in alignment with the global
best practices, but there are dynamic trade offs between public ownership of financial
institutions, regulation, financial innovation, etc. Similarly, several steps
have been taken to enhance use of technology and market micro-structures in the
financial sector. The financial sector policies are continuously evolving, essentially
in a proactive manner. Medium term frameworks or vision documents have been formulated
in each of these areas since 2004 and are being implemented through a continuous
process of consultations with market participants and industry associations (some
of which were established with encouragement from RBI). The thinking as well as
the progress in actions in this regard are articulated through RBI’s Annual Policies
and Mid Term Reviews.
Cost
of credit
In
the past, as part of the pervasive regime of administered interest rates, banking
and financial institutions were providing loans on concessional terms to certain
sectors and also certain categories of borrowers, leading to significant cross-subsidisation.
The credit allocation by banks was also directed to many such sectors/borrowers
through various prescriptions. The RBI had also been contributing regularly to
Long-Term Operations (LTO) Funds to refinance industrial or agricultural development,
generally on concessional terms. Combined with automatic monetisation of budget
deficits of the Central Government, such contributions also caused significant
increases in primary or reserve money. This practice has been gradually phased-out
in the recent years as part of economic reform, on the ground that, in a liberalised
environment, refinance institutions should expand the avenues of raising resources
from the market. However, if any of their activities result in cross-subsidisation,
we believe that the Government of India should rightfully bear the primary responsibility
of providing the support. Hence, RBI support, if any, for such worthy causes should
be through the Government of India by way of transfer of profits. Thus, while
discontinuing contributions to the LTO Funds, net transfer of profits of the RBI
as dividend has increased from about Rs.200 crore (Rs.2 billion) in 1992 to Rs.11,400
crore (Rs.114 billion) in 2007.
Financial
sector reform has several dimensions and of particular relevance to the issue
of output and employment is the cost of credit and its availability. Interest
rates have been deregulated to a significant degree not only to aid movement of
monetary policy to the use of more effective indirect instruments, but also because
administered interest rate regime proved to be inefficient and costly, without
necessarily ensuring flow of credit to the needy. The RBI’s recommended approach,
however, does not preclude subsidisation by the Government but, it disfavours
excessive use of banking system to cross subsidise, especially if it were to favour
non-poor. RBI favours a financial system that provides incentives to encourage
flow of credit at justifiable terms and conditions and for purposes that ensure
servicing of interest and principal, i.e., bankability of schemes.
There
has been broad agreement between the Government and the RBI on the above approach,
and accordingly, subsidies on interest rates through the banking system to small
farmers and small exporters are currently provided for a limited period. There
are several Government-sponsored programmes intended for the vulnerable sections
and these are small-sized loans for which Government provides subsidy, particularly
for employment generation. Thus, the financial sector, in particular the banking
system, is utilised as a conduit by the Government’s fiscal policy, to subsidise
select activities or vulnerable sections, and RBI plays a supporting role in enabling
such measures while emphasising the longer term goals of a conducive credit culture.
The overall objective remains growth with stability, but with elements of selective
fiscal support for ensuring inclusive and equitable growth. Currently, the aggregate
annual fiscal burden of subsidisation on account of the above measures, through
the financial sector, is estimated to be about a quarter per cent of GDP.
Availability
and allocation of credit
The
pre-reform period was characterised by high pre-emptions, aggregating to well
over fifty per cent of bank deposits, through the prescription of cash reserve
ratios and statutory liquidity ratios for banks. As part of the reform process,
these rates have been progressively brought down and are currently close to thirty
per cent – partly reflecting the current policy of liquidity management. Accordingly,
the proportion of resources available for credit to non-governmental purposes
from the banking system have thus increased substantially since the commencement
of the reform process. Further, with planned improvement in revenue accounts of
Centre and States and more normal liquidity conditions in money markets, there
should be significant further enhancement in the proportion of bank funds that
are made available for financing growth and employment in private sector.
Selective
credit controls, as a means of encouraging or discouraging credit flow to select
sectors, was pervasive during the pre-reform period. These have since been dismantled.
However, recently, it became necessary to enhance the risk weights and provisioning
requirements for bank’s exposure to capital market, real estate, housing and consumer
loans in order to enhance the sensitivity of banks to the potential risks arising
out of rapidly escalating asset prices. The measures, which are temporary, appear
to be having desirable impact on credit allocation to these sensitive sectors.
The
most important instrument for influencing allocation of credit in the banking
system, keeping in view the compulsion of growth and employment, has been the
stipulation regarding bank’s lending to priority sector. The stipulation is that
forty per cent of advances in the case of domestic banks (and thirty two per cent,
inclusive of export advances, in the case of foreign banks) be lent to specified
priority sectors such as agriculture, small industries etc. As a result of financial
sector reforms, there has been expansion in lendable resources. However, during
the reform process, the list of eligible sectors for treatment as ‘priority sector’
was expanded to include investments in specified bonds and also activities such
as venture capital. Several dilutions and distortions in computation of the stipulation
occurred in the process. As a result, there had been a growing perception of inadequate
flow of credit to the traditionally preferred sub-sectors of priority sector,
namely agriculture and small industries. In order to address these concerns, a
consultative and comprehensive exercise of review was undertaken and new guidelines
on priority sector were issued in April 2007. Consequently, priority sector is
now restricted to advances to highly employment intensive sectors such as agriculture,
small industry, educational loans for students and low cost housing. The shortfalls
in lending to the priority sectors will have to be, as in the past, deposited
with refinance institutions dealing with agriculture and small industries. Thus,
sectoral focus in credit flow, with emphasis on employment, is ensured through
stipulations relating to priority sector without necessarily undermining commercial
considerations in banking activities.
Sub-targets
under priority sector, along with other guidelines including those relating to
Government sponsored programmes, are used to encourage flow of credit to the identified
vulnerable sections of population such as scheduled castes, religious minorities
and scheduled tribes.
The
accelerated growth in the Indian economy has benefited several States, but there
are a few where credit deposit ratios of the banking system are observed to be
low. It has become necessary to identify unique problems for each State for expanding
banking facilities to such lagging States and formulate area specific action plans
for accelerated financial deepening. These plans are drawn up with full participation
of State Governments, banks and other local developmental agencies. Such plans
have already been drawn up for Uttaranchal, North Eastern States, Himachal, Jharkhand,
Andaman & Nicobar and Bihar. There is enthusiasm among banks in view of expanding
business opportunities and significant support from State Governments which see
a synergy. RBI plays a catalyst, as well as a coordinating role, in these initiatives
of growing co-operation between the States and the banking system. In fact, the
RBI has played active role in States’ debt management, treasury management, management
of Consolidated Sinking Fund, transparency in budget, computerisation of Government
accounts and enactment of legislation on fiscal responsibility. The relationship
between the RBI and the States is based on mutual trust and is in recognition
of the credibility of the RBI.
An
important component of these state-specific action plans, in some cases, have
been the scope for expanded role of non-governmental organisations and other microfinance
agencies. Banks, under the overall guidance of NABARD, play an active role in
promoting micro-finance, especially in view of the recently approved innovative
approaches, such as business correspondence models.
An
area of concern has been the concentration of bank branches in metropolitan areas
to the detriment of semi urban and rural areas. To mitigate this problem, since
2006, opening of new branches for any bank is approved by RBI only on condition
that at least half of such new branches are opened in under-banked areas as notified
by RBI. Many banks now find that the branches in semi-urban and rural areas are
also commercially viable.
It
is useful to note that the policy preferences of RBI in the banking sector, which
are aimed to address issues of targeted allocation of credit and penetration of
banking services have not adversely affected the improvements in accounting practices,
reduction in non-performing assets and improvements in profitability as well as
capital adequacy. It is useful to note that the valuation of bank stocks, of both
public and private sector, are improving while foreign banks gather a fast increasing
proportion of their global profits from Indian operations.
Beyond
credit : Financial inclusion
In
the reform process that commenced in 1992, the reform of financial sector was
early in the cycle. The first stage of the process concentrated on elimination
of financial repression which was followed by greater marketisation of financial
sector and changes in regulatory regime, consistent with global standards. The
process strengthened financial sector, improved efficiency, imparted stability
and facilitated impressive growth, withstanding several global and domestic shocks.
The next phase clearly was to ensure what may be termed as democratisation of
financial sector. The process which was commenced two years ago aimed at ensuring
hundred per cent financial inclusion. The process of financial inclusion consists
of seeking each household and offering their inclusion in the banking system.
The main features of the approach involve ‘connecting’ people with the banking
system and not just credit dispensation; and using multiple channels such as civil
service organisations, NGOs, post offices, farmers’ clubs, panchayats, MFIs (other
than NBFCs), etc. as Business Facilitators / Correspondents to expand the outreach
of banks. Further, a decentralised approach is adopted which is state / region
specific, and has close involvement and cooperation between the respective State
Governments and banks.
Information
technology is critical to minimising transaction costs. The Government’s on-going
massive programme of rural employment and pension payments etc. can be implemented
with minimal transaction costs by recourse to financial inclusion through I.T.
Several districts have already been covered under total financial inclusion and
a process of evaluation and feedback is underway. RBI is encouraging and aiding
the process.
The
importance of financial inclusion for Emerging Market Economies (EMEs) was expressed
eloquently by Governor Tito Mboweni in the 13th C.D. Deshmukh Memorial
Lecture on 2nd November 2007 in the following words :
"Then,
there is the added concern that the unequal distribution of wealth brings with
it a tension between the haves and the have-nots. Under these circumstances, the
broadening of access to financial services becomes an important policy objective.
It is well recognised that the financial inclusion of the lower echelons of society
into the financial sector is a powerful contributory factor to poverty alleviation
through, for example, the provision of microfinance. As the demand for consumer
finance increased, a greater range of financial instruments are needed and the
financial sector will need to adapt."
A
beginning has been made to enhance financial literacy and impart financial education
to enable vast numbers of new entrants into employment and higher incomes to better
manage their finances in a rapidly marketising fincancial sector. Informed choices
are preferred in the interests of the individual customers as also the financial
system as a whole. In view of the surge in retail loans, especially consumer durables,
and attendant debt-servicing problems for many, a beginning has been made in the
establishment of credit counselling centres as a non-profit activity, by some
banks.
Institutional
Reforms
There
was no banking crisis or currency crisis since reforms commenced in 1992. However,
it was observed that some scheduled commercial banks had inadequate capital; several
urban cooperative banks were bankrupted and rural cooperative credit system deteriorated
significantly. Corrective steps have been taken in recent years. The institutional
reform of scheduled commercial banks reinforced governance standards and witnessed
the disappearance of all who could not meet the capital adequacy standards. But,
the credit needs of vast section of population, especially of unorganised sector,
traders, rural areas are best met by revival, restructuring and revamping of what
may be termed as community based banks. Rural areas, particularly in backward
regions, are sought to be better served by restructuring an institutional mechanism,
namely Regional Rural Banks (RRBs). A special programme for the revival of rural
cooperatives has been launched with close involvement of RBI, NABARD, Government
of India and State Governments with a possible fiscal support to the tune of about
0.50 per cent of GDP. These reforms are considered essential to cater to the gaps
in services by scheduled commercial banks, not only in banking but in other related
services including forex for current account, insurance products, etc.
Innovative
mechanisms through Memorandum of Understanding between the RBI and the State Governments
to overcome issues of dual control and ensure better co-ordination, which were
found to be successful when adopted for re-vamping the urban co-operative banks,
have also been adopted in the ongoing programme of revival of the rural cooperative
system.
Beyond
deregulation and competition
As
the reform progressed, it was assumed that deregulation and competition would
enhance efficiency and ensure better than before quality of service at reasonable
but competitive cost to the customers. However, while many improvements have taken
place, entirely as expected, several adverse features in regard to retail customers
were noticed particularly in respect of a few banks. Apart from issues of appropriate
pricing, instances of unequal contracts, unfair trade practices, non-transparent
fees, intrusion into privacy, excessive penalties, delays in cheque-clearing,
arbitrary revision of interest rates or equated monthly instalments, usurious
interest charges in some cases and excesses by loan recovery agents have been
noticed warranting several institutional, policy and procedural interventions
by RBI. A delicate balance between competing considerations is needed but to the
extent banks have special privileges, the regulator who has granted such privileges
has a responsibility to ensure financial deepening and widening in an efficient,
fair and equitable manner. RBI considers delicate balances of these considerations
to be critical for both growth of financial sector and a meaningful contribution
of financial sector to growth and employment.
Latest
initiatives
The
RBI’s Mid-Term Review of Annual Policy Statement, October 30, 2007, refers to
some new initiatives that are worth noting. First, an internal working group has
been constituted to consider recommendations made by a Committee on Agricultural
Indebtedness (Chairman : Dr. R. Radhakrishna). Second, recommendations of a Technical
Group (Chairman : S.C. Gupta) on improving the legal and enforcement framework
relating to money lenders was forwarded to State Governments for appropriate consideration.
Third, the National Commission for Enterprises in the unorganised sector (Chairman
: Dr. Arjun K. Sengupta) submitted a comprehensive report to the Central Government.
A working group is being constituted to study those recommendations which relate
to the Indian financial system. Fourth, it is proposed to review the working of
lead bank scheme and related arrangements of coordination between RBI, banks,
NABARD, State Government at the state and district levels. The review of these
institutional arrangements for development oriented banking would help design
a new framework reflecting not only the new orientation such as financial inclusion,
financial literacy and credit counselling, but also increasing demands of rapidly
growing economy led by domestic investment, domestic consumption and export demand.
Concluding
Remarks
To
conclude, our experience shows that financial sector policies and instruments
need to be constantly rebalanced to respond not only to financial markets, prices
and overall stability considerations but also to developments in real sector,
in particular trends in growth across sectors, regions and sections of population.
Such a comprehensive but dynamic approach to development of the financial sector
enhances contribution of financial policies to growth and employment while maintaining
stability.
Thank
you.
Speech delivered
by Dr. Y V Reddy, Governor, Reserve Bank of India at Bali, Indonesia on November
8, 2007