Budget: indirect implications on banks

GENERALLY SPEAKING, the annual budgets of the Central Government have indirect implications for banks' operations in terms of resource mobilisation, liquidity, interest rates, investment in government securities, foreign exchange operations and the overall lending activity in the economy. However, since 1992-93 when banking reforms were introduced as part of economic reforms, the budget has become a direct and important instrument for setting the pace as well as direction of banking reforms. This process has been ably implemented and carried forward by the Reserve Bank of India which provides the guidelines and the requisite policy environment.

The budget for 2001-02 has to be considered in the context of banking developments during 2000-01. The credit offtake by industry was low due to the decline in industrial growth. The non-performing assets (NPAs) of banks remained high, notwithstanding the efforts at speedier recovery. Real interest rates remained high and there was some upward movement in inflation rate. Banks invested more in government securities than what was required in terms of statutory liquidity ratio.

The banking system remained sufficiently liquid. The foreign exchange market remained relatively more stable after severe bouts of depreciation. The banking sector reforms, after making steady progress till 1996-97, slowed down thereafter; and in the last three years there was little progress, giving rise to the impression that the Government was not inclined to carry forward the reforms. To what extent these concerns are reflected in the budget proposals relating to the banking sector is the key question.

Some general aspects

The budget proposal to reduce interest rates on small savings under various schemes is of considerable significance for banks in the medium to long term. This move ushers in a low interest rate regime. Though the reduction in interest rates proposed in the budget relates to contractual savings, it is bound to percolate into the entire economy over the next 6-12 months. A declining interest rate environment will prove positive and flexible for the banks in terms of lower deposit and lending rates.

The question is how soon will the low interest rate regime become a reality. First, there could be no automatic lowering of lending rates unless NPAs of banks are brought down substantially. Given the level of NPAs, banks build the cost of NPAs into their lending rates. Second, banks will have to reduce their spread if deposit and lending rates are to be aligned. Third, it also depends on how soon the Government will reduce the cost of its borrowing from the market. Fourth, the impact of interest rate reduction on deposit growth needs to be watched. There may be fear of competition from private banks, both Indian and foreign, as they offer better rates to parties with high net worth. But the public sector banks may continue to attract deposits for reasons of safety and liquidity. The recent stock market crisis has already contributed to a spurt in deposit growth.

The budget proposal to lower the exemption limit for purposes of TDS (tax deducted at source) may pose some problems for banks. The move to lower the exemption limit from Rs. 10,000 to Rs. 2,500 (later revised to Rs. 5,000) is intended to prevent splitting of deposits by individual account holders, but it would increase the workload of banks especially at a time when there is exodus of staff under the voluntary retirement scheme (VRS). The proposal for lowering the (TDS) limit is totally against what banks have been asking for (abolition of TDS) and against what financial institutions were lobbying for, that is, raising TDS limit to Rs. 10,000 from Rs. 2,500 applicable to them at present. Banks which have computerised 75 per cent of their branches can cope with the additional workload arising from the lowering of the TDS limit. It may be difficult for other banks.

The budget has introduced a new Section 14A in the Income-tax Act, 1961, which will affect banks adversely. The new section says that no deduction shall be made in respect of expenditure incurred by the assessee in relation to income which does not form part of total income. Thus, if a corporate has taken a loan to invest in a Relief Bond or an open-ended mutual fund where it earns a dividend, the interest payable on the loan will be tax deductible only on a net basis, that is, only when interest payable on the loan exceeds the tax exempt income. This provision will hit banks and financial institutions as they are engaged in borrowing and lending business. This provision is very much prone to litigation as they will need to prove that their investments are not out of borrowed money but out of their own share capital, reserves and surplus.

Service tax

The budget has proposed to bring banking services into the service tax net. The Government is yet to notify the date from which service tax will be levied. Unlike in the past, banks now offer a number of services and with the emergence of technology and concepts such as universal banking, additions to services become inevitable. Till now the banking sector was not liable to pay service tax and though specific services are to be taxed banks may have to face problems in implementation, in terms of systems and procedures. There may also be doubts and conflicts, that is, double taxation, levy of service tax on ongoing contracts and credit card services. The important aspect is whether the increased cost on account of service tax is borne by the bank or the customer. This is where banks will face competition.

In order to strengthen the management of public sector banks and enable them to face competition, the budget proposes to give greater autonomy to bank managements. It also proposes to abolish the BSRBs in order to give banks greater independence in recruitment. The talk of giving autonomy to public sector banks (PSBs) has been going on for several years without any encouraging results. If the Government is sincere, it should draw a roadmap for genuine autonomy of PSBs and implement it. The Government should give up its mindset that it is the owner of PSBs and for that reason it should have a say in everything concerning banks.

The abolition of BSRBs is of theoretical interest apart from saving a few lakhs of rupees for banks. The BSRBs were created to relieve the PSBs of the administrative burden of recruiting clerical staff. Even this limited activity of BSRBs declined because of the ceiling of 1 per cent imposed by the Government on the expansion of staff of PSBs. Also BSRBs were never utilised for recruiting higher level staff. If the PSBs could not recruit quality staff for higher levels, it is because of Government's interference, nepotism and corruption. The abolition of BSRBs is going to create problems for human resources management as it would give a free hand for political influence and the losers would be candidates belonging to scheduled castes, scheduled tribes and other backward classes.

Banking reforms

This is one area which raised high expectations from the budget based on frequent statements made by the Finance Minister (before budget presentation) about the Government's commitment to carry forward the reforms. During 2000-01, a number of measures were taken to consolidate the reform effort. Financially sound banks have been permitted to enter insurance business to mobilise resources for investment. Revised norms were announced for the entry of new banks in the private sector. Moves were made towards consolidated supervision of banks by incorporating the balance sheets of subsidiaries into the balance sheets of parent banks. In-house management was introduced to collate and collect information required for the Credit Information Bureau.

Steps to lower NPAs

Though banking reforms have proceeded in a phased manner over the past decade, the continuing high level of NPAs poses a serious problem for pushing through the reforms. Therefore, the budget focuses attention on this issue. In order to bring down the level of NPAs and also to curtail the growth of fresh NPAs, the budget has proposed the following measures:

First, in addition to the existing 22 debt recovery tribunals (DRTs) and five appellate tribunals, seven more DRTs will be added in 2001-02. Second, legislation is proposed for new foreclosure norms as also enforcement of securities, which will prevent borrowers from defaulting. Third, the repealing of the Sick Industrial Companies Act (and also the abolition of Board for Industrial and Financial Reconstruction (BIFR)) will prevent defaulting companies from taking refuge in BIFR. These measures should result in a substantial decline in NPAs but the crucial question is one of implementation. Given the lethargic movement of government and the manner in which Parliament is functioning, one cannot be too optimistic about the outcome of the proposed measures.

A major reform proposed in the budget is the dilution of government holding in the banking sector from 51 per cent to 33 per cent. To achieve this, the Banking Bill was introduced in December 2000. Earlier, in 1994, government equity was brought down by the Congress government from 100 per cent to 51 per cent. The proposed dilution to 33 per cent has already drawn loud protests from major opposition parties and trade unions on the ground that the measures would affect the flow of credit to the priority sector and to poverty alleviation schemes. The Government has, however, assured that the banking sector would continue to retain the public sector characteristic and image. It is only legitimate to question the urgency for dilution when there are more important problems (for example, NPAs) requiring attention.

Missing items

There are certain areas which have not received the attention of the budget. First, the budget seems to assume that a low interest rate regime together with incentives to industry would automatically increase credit offtake. There is no specific proposal to enable banks to be more outgoing in credit extension and to change their mindset concerning strictures from vigilance. Though the RBI and the government repeat, parrot-like, their concern for efficient credit delivery to small scale industries (SSIs), there is little improvement, notwithstanding the fact that unlike the bigger corporates, SS1s, are a more stable source of demand for credit.

Second, the budget does not contain any specific measures for the three weak PSBs - Indian Bank, United Bank and UCO Bank - though the Verma Committee recommendations were accepted by the Government. The Talwar subcommittee on weak banks has suggested a two-stage recapitalisation of the three banks. Estimates made earlier indicate that the three weak PSBs would require a capital support of Rs. 2,300 crores to shore up their capital adequacy ratios. Of this Indian Bank alone would require Rs. 1,750 crores. However, the total amount involved in restructuring the three weak banks is expected to be Rs. 5,000 crores, if funds required for voluntary retirement scheme and technology upgradation are included. The budget does not show any awareness of this situation.

Third, the budget seems to be blissfully indifferent to the problems of implementation of VRS by PSBs and its impact on their bottomlines. The cost of VRS for the entire banking industry is estimated at Rs. 7,500 crores. Where will the money come from, given the level of NPAs, low credit offtake, low interest rate regime and competition from private sector banks.

Last, the budget does not say anything about universal banking though it is a much debated subject. There is need to diversify financial intermediation, which is now heavily concentrated in banks rather than non-banks. Initiatives for further reforms in the banking sector should come from the Government.

T. K. Velayudham

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