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Friday, 04 May 2012 00:00
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Govt has to rethink its ownership levels of banks
RBI’s new Basel III guidelines, notified on Wednesday, pose a challenge not just in terms of how banks are going to find the R1.5-2 lakh crore of fresh capital, but also in terms of their ownership structure. Indeed, since the focus is more on Tier 1 capital which has been redefined to include mainly common equity-equity capital and reserves, this implies that banks will be further challenged going ahead. The issue of where the capital is going to come from is more pertinent for the public sector banks which have so far been dependent on the Budget for funding. Since the government doesn’t always have the money to fund these banks—think of why India’s premier bank, SBI, was downgraded—it needs to seriously consider letting these banks raise more money from the public. Since that will work for the better functioning banks, it may be a good idea to look at getting local private partners or foreign banks to take stakes? This sounds good prima facie, but we have to be clear about how much leeway we are willing to give banks here. The issue of getting in foreign funds to bring in capital for banking and insurance has been a matter of debate with strong votaries on both sides.
The second question relates to how economic growth will be affected? If banks do not have capital, they have to perforce cut back on credit. In other words, India’s 8-9% growth target cannot be funded. Indeed, SMEs will be hit even harder than others since the risk provisioning on loans to them will rise. In fact, banks may just be tempted to go in for narrow banking as investment in GSecs helps in preserving capital. This can lead to supply constraints for the system that can come in the way of growth. The government, however, may ironically find more takers for its paper on this score.
While we have six years to build up the necessary capital base, we need to start working on it now. Allowing more new private banks will help as they can start on a clean slate and grow in a disciplined manner. M&A activity has to be encouraged so that banks become stronger in terms of capital. We should look outwards for foreign capital to support this effort, for given the requirement for funding and the present sources of funds, there is a large enough gap that needs to be filled. This is probably the best time to bring in our banking reforms to address these issues at one go.

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