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Credit Delivery: Lazy banking and structural problems

Thursday, Sep 23, 2004

R. Vaidyanathan The growth in the economy the last decade has been facilitated by the non-bank finance sector and this has not been adequately recognised. Contrarily, it has been "Lazy Banking" in the organised sector. The proposed commission for the "unorganised" sector, announced by the UPA Government recently, should focus on the issue of integrating the financial markets by everaging on the strengths of the informal sector, says R. Vaidyanathan.

THE GROWTH in the service sectors in the last decade has been much higher than that of manufacturing and Agriculture. Table1 puts the share of the services sector at nearly 50 per cent of the economy in 2000-01 and it is the fastest growing sector of the economy clocking more than 8 per cent during the period.

Four sectors trade, transport (other than Railways), construction and hotels and restaurant constitute dominant parts of the service sector other than business and professional services. Actually trade constitutes the third largest chunk of the economy (share of 13 per cent in GDP in 2000-01) after Agriculture (26 per cent) and manufacturing (16 per cent).
Non-corporate organisations

These activities are conducted by Proprietorship and Partnership (P&P) type of organisations (non-corporate) with active involvement from members of family and community.

The share of non-corporate organisations in these activities is presented in Table 2. We find that in trade the share of non-corporate sector is more than 80 per cent and in non-railway transport it is above 75 per cent and so is the case in hotels and restaurants. It is important to understand that corresponding proportions in developed market economies are less than 10 per cent. In other words, developed markets are significantly corporatised in such activities as trade, construction, hotels and restaurants, transport, etc. For these sectors credit comes in the form of payables/ receivables or from bank sources or non-bank financial sector (NBFS). The financing of such activities as trade (wholesale and retail), hotels and restaurants is mainly from the Un-incorporated Business (UIBs) that is money lenders. These are, Cash Flow Based lending rather than on "Asset Based" lending. The organised Non-Banking Sector is more in "Asset Based" lending for such items as equipment, trucks (new and second-hand), etc. The levels of risk undertaken by the NBFS are significant as they lend with least paper work. This is one of the major reasons for the large margins seen in trade, both wholesale and retail. For many of the fast moving consumer goods (FMCG) the gap between the company balance-sheet figure and the street prices appears to be more than 35 per cent and one factor in this is the "Open Market" interest paid by the trade channels. In the case of cash crops and vegetables, the gap between producer prices and consumer prices can be as high as 70-80 per cent. Here again the financing cost both for holding and transport plays a major role.

On the other hand, the banking sector has been investing, up to 45-50 per cent of its resources, in government securities in the last couple of years. This is what is called as "Lazy Banking" by Dr Rakesh Mohan, currently Deputy Governor of the Reserve Bank of India (RBI). The lending pattern of Banks reveals an interesting picture , wherein the share of P&P sector has come down though the P&P sector (predominantly in services) is the fastest growing sector in the economy. Table 3 provides the share of P&P sector along with private corporate and government sectors in the credit out standing of scheduled commercial banks
Distortions in the banking system

Table 3 shows that the share of P&P sector has come down to 43 per cent from 58 per cent in the 1990s when the P&P sector in trade, transport, construction, restaurants, and other business services has been growing at more that 8 per cent CAGR. Here, households include agricultural households and to that extent the fall is very significant. Hence, the growth rate of the 1990s of the economy is neither related to economic reforms of the Central Government nor to the credit mechanisms of the banking sector.

It is not only lazy banking but also banking with significant structural distortions. The share of private corporate sector in National Income is 12-15 per cent but it takes away nearly 40 per cent of the credit provided by the Banking sector. The fastest growing P&P sector gets lesser share of bank credit which reveals that the non-banking financial sector is playing increasingly important role in the credit delivery mechanisms of the growth of the economy. This is in spite of the fact that the household preference for bank deposits as a saving medium, has been continuing uninterrupted. Bank deposits as percentages of incremental financial assets have risen from 32.1 per cent in 1995-96 to 37.8 per cent in 2001-2002.Also, the share of term deposits in the total deposits has gone up from 56.6 per cent in March 1990 to 64.6 per cent in March 2002. Of course Finance Ministers often meet the Bankers and " impress upon" them about enhancing credit to " unorganised" sector. There is an implicit belief, among planners, that post nationalisation the banks will meet what is called "Social Obligations" through directed lending. Table 4 provides the outstanding credit of loan accounts with Rs 25,000 (earlier Rs 10,000) from scheduled commercial banks for selected period. The Table shows that the number of accounts has declined dramatically in the late1990s and the share of this segment has come down to nearly 6 per cent in 2002 from a high of 15 per cent in the early 1980s. Even the absolute amount outstanding for these accounts has come down from Rs 41,000 crore to Rs 36,409 crore in 2000 to show some increase in 2002 to Rs 38,501 crore. Something appears really problematic in the banking sector particularly in providing credit to the sections which not only require them most but also which are fastest growing sectors.
Asset-based versus income-based lending

It is to be noted that the market knowledge and information regarding these activities are not fully available with commercial banker on an updated basis. The typical bank manager of a public sector bank has a two to three year tenure in a particular branch and is also shifted across activities like foreign exchange, administration, agricultural finance, personal banking, training, industrial lending etc. By and large the public sector banks have been geared to "Asset Based Lending" rather than lending based on forecast cash flows. Even in asset based lending they are more tuned to lending based on "Paper Financial Ratios". But activities such as trade, transport, hotels and restaurants, construction, etc, where there are significant fluctuations in the cash flows on a daily basis, require totally a different mindset and approach. Also, funds need to be available to these players without much paperwork and based on personal assessment and at odd times. The traditional public sector banker is not geared for such risk management. He is not promoted or given extra incentives for taking risks. His promotion is a function of the number of years of "unblemished" service. Hence, these activities are mostly financed by the non-bank finance sector. Large segments of disparate activities are clubbed together under a single banner called NBFS.

To sum up, the growth in the economy during the last decade has been facilitated by the NBFS and this has not been adequately recognised or appreciated. The story of the saga of excellent credit delivery mechanisms with reliable credit assessment systems and collection mechanisms, of the NBFS sector, tuned to our ethos and cultural roots has not been written about since the Oxbridge Metropolitan Elite is allergic to indigenous institutions and the left intellectuals are struck in their nineteenth century rhetoric of revolution through nationalised banks.

But we will focus on the NBFS and suggest ways to integrate the existing " Lazy Banking" around them for sustainable growth in the economy. We feel that the proposed commission for the "unorganised" sector, announced by the UPA Government recently, should focus on the issue of integrating the financial markets by leveraging on the strengths of NBFS. (The author is Professor of Finance and Control, Indian Institute of ManagementBangalore, and can be contacted at vaidya@iimb.ernet.in. The views are personal and do not reflect that of his organisation.)