Download Reform strategies in the Indian financial sector

ROLE OF STATE-OWNED FINANCIAL INSTITUTIONS IN
INDIA:
SHOULD THE GOVERNMENT “DO” OR “LEAD”?
Urjit R. Patel
Infrastructure Development Finance Company Ltd.
World Bank – IMF – Brookings Institution Conference on
Role of State-Owned Financial Institutions
Washington, D.C., April 26-27, 2004
World Bank - IMF - Brookings Conference, April 26-27, 2004
MUSINGS
“The crucial issue … is whether Corporate Governance is compatible with
public ownership, which makes the system accountable to political
institutions and not to the economic institutions or even regulators. Could we
have public ownership without Government or political control …? ”
- Governor, RBI, Pune, Jan 2002.
“The Agricultural Infrastructure and Credit Fund, the Small and Medium
Enterprise Fund, and the Industrial Infrastructure Fund will be operational
shortly. All the three funds will, without compromising the norms of financial
prudence, provide credit at highly competitive rates, which is expected to be 2
percentage points below the Prime Lending Rate (PLR)”
- Union Interim Budget, 2004-05.
World Bank - IMF - Brookings Conference, April 26-27, 2004
1
STRUCTURE OF PRESENTATION
 Status and changing profile of the financial sector
 Involvement of govt. and other public institutions in
intermediation
 Consequences of continued govt. presence in intermediation

The incentives story
 An examination of government’s role in the current financial
sector environment
 The way forward and conclusions
World Bank - IMF - Brookings Conference, April 26-27, 2004
2
STATUS OF INTERMEDIATION IN INDIA
 Financial markets have deepened

M3/GDP ratio is now 70%; bank branches increased eightfold
 Banks are the largest intermediaries


Deposits have been 40% of financial savings p.a. on average
Other deposit taking institutions (DTIs) are much smaller
 The role of Development Financial Institutions (DFIs) is
diminishing …

ICICI is now a bank, IDBI is in the process of becoming one, IFCI is
being merged
 … but some Systemically Important Financial Institutions (SIFIs)
are becoming a cause for concern

Investible funds of LIC were 11.9% of GDP in 2002-03; of the Employee
Provident Fund Organisation (EPFO), 5.6% of GDP
World Bank - IMF - Brookings Conference, April 26-27, 2004
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GOVT. INVOLVEMENT IN INTERMEDIATION
 Dominance of government owned institutions in most segments
of intermediation

Banking, mutual funds, insurance
 Central bank performs multiple tasks besides oversight of
intermediaries


Owner of some intermediaries, investment banker for government’s
borrowing program
Impedes its interest rate management function
 Govt. involvement is, furthermore, larger than mere ownership



Pre-emption of resources
Directed credit
Implicit guarantee of bailouts
World Bank - IMF - Brookings Conference, April 26-27, 2004
4
INDEX OF GOVT. INVOLVEMENT IN FINANCIAL
INTERMEDIATION (IDGI-F)
140
130
120
110
100
90
80
1990-91 1991-92 1992-93 1993-94 1994-95 1995-96 1996-97 1997-98 1998-99 1999-00 2000-01 2001-02
Political forbearance lead to distorted incentives!
World Bank - IMF - Brookings Conference, April 26-27, 2004
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DISTORTIVE EFFECTS ON INCENTIVES
 Implicit “comfort and support” engenders moral hazard for both
depositors and lenders


Vitiates commercial discipline
Declining investment efficiency of non-commercially oriented loan
portfolios
 Regulatory forbearance


Non closure of unviable intermediaries and lax enforcement of project
completion norms
Risk weighting of govt. securities kept low
 Extra-commercial oversight by government agencies

Accountability to agencies like CVC, CAG, etc. deter “good” risks by
Public Sector Bank (PSB) loan officers
Result: “Bad risk” pushes out “good risk”
World Bank - IMF - Brookings Conference, April 26-27, 2004
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OUTCOME: “LAZY BANKING”!
Credit creation role of banks is squeezed
80%
70%
60%
50%
40%
Q1
Q2
2001-02
Q3
2002-03
Q4
2003-04
Quarter-wise cumulative investment (SLR securities) – deposit ratio
World Bank - IMF - Brookings Conference, April 26-27, 2004
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IS GOVT. NEEDED IN INTERMEDIATION?
 Indian banks now have performance standards that are prima
facie comparable to world yardsticks
 Systems and regulatory frameworks, to a large extent, in place

Most banks adhere to RBI prudential norms; NPAs under control
 India unlikely to suffer a full-blown financial crisis

SARFAESI Act bestows significant foreclosure powers to banks and
financial institutions
 Institutions needed for market “completion” might, however, have
to be reinforced



Facilitating transactions
Creating specialised markets
Promoting “development” and social objectives
World Bank - IMF - Brookings Conference, April 26-27, 2004
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ROLE OF
GOVT.
FACILITATING TRANSACTIONS
 Efficient capital markets are critical for imposing commercial
discipline on intermediaries
 Speed and complexity of capital markets transactions have
increased

Counterparty risks increase with non-govt. entities
 Three pivots for efficiency of capital markets: Trading, Settlement
and Delivery

Screen based trading introduced by NSE
 Resulting spot benchmarks helped catalyse derivatives markets


STCI, CCIL, etc., have helped deepen govt. securities markets
NSDL has changed equity delivery formats
World Bank - IMF - Brookings Conference, April 26-27, 2004
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ROLE OF
GOVT.
CATALYSING SPECIALISED MARKETS
 Commercially oriented activities in areas hitherto state dominated
entails a new set of risks


Many infrastructure segments continue to retain “public good”
characteristics
Requires a novel approach to financing
 Role of specialised intermediaries (like IDFC) in “leading private
capital to commercially viable projects”

Developing innovative financial products and deepening capital
markets
 Take-out financing, risk participation facilities, “annuity” financing
 Stimulating external trade

Filling trade financing gaps that private intermediaries are unable or
unwilling to assume (Exim Bank)
World Bank - IMF - Brookings Conference, April 26-27, 2004
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ROLE OF
GOVT.
ADVANCING “SOCIAL” OBJECTIVES
 Attempts to mix “development” with commercial objectives


Extending the reach of intermediation into rural areas
Advancing industrial development objectives
 Alternative delivery systems likely to be more cost effective


Specialised lending institutions for rural and small industries exist,
but ineffective in their mandate
Revamping post office network is likely to be more cost effective
 Using intermediaries to provide social security nets


Artificially high rates of interest to maintain pensioners’ purchasing
power
EPFO’s solvency needs to be critically assessed
World Bank - IMF - Brookings Conference, April 26-27, 2004
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WAY FORWARD
 The government should not be directly intermediating resources

Merely aggravates moral hazard
 “Social contract” with intermediaries and depositors

Root cause of persistent unease with the financial system in India
 Need to shift reform focus from individual intermediaries to a
system level

Privatisation of intermediaries is a necessary condition
 Make appropriate deposit insurance the anchor of public
confidence in the banking system


Despite regulatory oversight mechanisms and a degree of
macroeconomic prudence, insurance for bank deposits is relatively
liberal
Introduce co-insurance and risk-based premia
World Bank - IMF - Brookings Conference, April 26-27, 2004
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SUMMING UP
 (Justifiable) reasons for erstwhile govt. presence in intermediation
no longer exist
 Unfortunately, a tendency to confuse outcomes with processes
still persists
Return to a dirigiste mode?
Interim Budget announcement of lending at 2% below PLR
Various funds have been proposed to increase funds flow
 Entire banking sector becoming narrow

Measures earlier proposed for individual weak banks now becoming
an endogenous reality for the sector!
World Bank - IMF - Brookings Conference, April 26-27, 2004
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SHARES OF INTERMEDIARIES
Gross Domestic Savings
Bank deposits outstanding
Small Savings deposit outstanding
Mutual Funds assets
NBFC deposits
1990-91
1998-99
2002-03
1,301
3,932
5,500
(24.3)
(22.3)
(24.0)
2,078
7,140
13,043
(38.2)
(40.5)
(50.1)
1,071
3,333
3,810
(20.0)
(19.1)
(15.4)
253
858
1,093
(4.7)
(4.9)
(4.2)
174
204
178
(2.4)
(1.2)
(0.7)
--
2108
901*
(12.0)
(3.5)
Total borrowings by DFIs
(outstanding)
Figures are in Rupees billions
Numbers in parentheses are percentages of GDP
* Excludes ICICI Bank
World Bank - IMF - Brookings Conference, April 26-27, 2004
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STATE PRESENCE IN FINANCIAL SEGMENTS
Public
(%)
Private
(%)
Total
(Rs. Bn)
Scheduled Commercial
Banks
75.6
24.4
16,989
Mutual Funds
48.2
51.8
1,093
Life Insurance
99.9
Negligible
2,296
Bank and mutual fund data are for 2002-03; Insurance data for 2001-02
Share definitions: Bank assets, net assets of MFs, life insurance liabilities
Sources: RBI, SEBI, IRDA
World Bank - IMF - Brookings Conference, April 26-27, 2004
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GOVT. INVOLVEMENT IN INTERMEDIATION
 Share of public sector banks and financial institutions in total financial
intermediation.




Share in resource mobilisation (as a sum of the following):
Net domestic and time liabilities in banks (as % of financial savings).
Resources mobilised by FIs through bond issues (as % of financial savings).
Premia of LIC / Amounts mobilised by UTI (as % of financial savings).
 Lending practices and use of funds.


Investments in government securities by banks and financial institutions.
Excess deposits deployed by PSBs in priority sectors (relative to minimum
prescribed norms).
 Government’s pre-emption of financial resources.




Share of public investment in overall investment.
Public sector saving – investment gap.
Public sector fiscal / resource gap (a proxy for PSBR).
Outstanding contingent liabilities (guarantees and other off-balance sheet items)
of the (central and state) governments.
World Bank - IMF - Brookings Conference, April 26-27, 2004
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INTERNATIONAL BENCHMARKING
RoA of banking sector (% of assets)
1.4
Parameters (in %)
(March ’03)
SBI
Best
International
Banks
Return On Assets
0.86
>1
Return On Equity
18.05
>18
Capital Adequacy
Ratio
13.50
11-12
Gross NPAs
9.34
<3
Net NPAs
4.50
0
Expense Ratio
50.53
<50
Other Income to
Operating Income
36.52
>40
Net Interest Margin
2.95
>3.5
Transaction Costs
1.80
<1
1.2
1.2
0.9
1
0.8
0.7
0.8
0.6
0.4
0.4
0.2
0.2
0
USA
UK
Australia
France
Germany
Source: BCG presentation, CII summit, 2003
Data pertinent to 2002 or 2003
India
Source: SBI Investor presentation, 2003
World Bank - IMF - Brookings Conference, April 26-27, 2004
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INSTITUTIONS TO ENABLE MARKETS
INSTITUTIONS’
ROLE
OBJECTIVE
TRANSLATION TO THE INDIAN
FINANCIAL CONTEXT
Market creation
Enabling property rights
and contract enforcement
• Facilitating transactions
• Catalysing specialised markets
Market
legitimisation
Social protection; conflict
management; market
access
• Ensuring systemic stability
• Facilitating intermediation in rural
areas
• Designing appropriate social security
nets
Market
completion
“Spanning states of nature”
resulting from non-existent
markets
• Developing institutions to mitigate
(specific) market making risks
• Develop pension safety nets
World Bank - IMF - Brookings Conference, April 26-27, 2004
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GEOGRAPHIC SPREAD OF BANKING
Scheduled Commercial Banks (at end-March 2003)
No. of bank
branches
Deposits
Credit
C-D Ratio
(%)
29%
67%
79%
70%
Metro centres
13%
45%
62%
83%
Top 100 centres
23%
61%
75%
74%
71%
23%
21%
38%
Semi urban centres
22%
19%
11%
35%
Rural centres
49%
14%
10%
42%
Shares
Urban centres
Non-Urban centres
Source: RBI Banking Statistics – Quarterly Handout, March 2003
World Bank - IMF - Brookings Conference, April 26-27, 2004
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DEPOSIT INSURANCE
Coverage Ratio
(Limit / Per Capita GDP)
Coinsurance
Permanent
Fund
Annual Premium
(% insured deposits)
India
6
N
Y
0.05
Argentina
3
N
Y
(Risk-based) 0.4-0.7
Brazil
4
N
Y
0.3
Chile
1
Y
N
0
In full (till 2005)
N
Y
0.3
Indonesia
Blanket Guarantee
N
Y
0
Japan
In full (till March ’01)
N
Y
0.04
Korea
In full
N
Y
0.05
Turkey
In full
N
Y
(Risk-based) 1.0-1.2
UK
1
Y
N
On demand
USA
3
N
Y
(Risk-based) 0.27
Switzerland
1
N
N
On demand
Mexico
Source: Demirguc-Kunt & Kane, World Bank Economic Review, 2001.
World Bank - IMF - Brookings Conference, April 26-27, 2004
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