MUMBAI, Oct 6: The Reserve Bank of India governor, C Rangarajan, has categorically ruled out the possibility of setting up an asset reconstruction fund (ARF) to rid bank balance-sheets of bad debt.

"The creation of ARF may not be an ideal solution for the recovery of bad loans. Since individual banks are responsible for giving the loans to their clients, they should be responsible for their recovery," Rangarajan told bank executives after delivering the keynote address at the 20th Bank Economists' Conference in Mumbai on Monday.

Rangarajan's statement assumes significance in the context of higher non-performing assets (NPAs) in Indian banks. The Narasimham committee recommendations-which formed the basis on which financial sector reforms were undertaken-focussed on the creation of ARF to clean the balance-sheets of weak banks. The Tarapore panel on capital account convertibility, however, said that ARF was not a workable proposition and instead advocated the concept of "narrow banks". Narrow banks, Tarapore said, should not be allowed to increase either their advances or their liabilities till they strengthened their balance-sheets.

Rangarajan dubbed the concept of "narrow banking" as a "temporary solution. This is an answer to a particular situation. Banks should lend in those areas (government securities) where the risk is not very high till their capital adequacy ratio is improved. The focus should be on risk-free assets," Rangarajan said.

NK Thingalaya, chairman of the Indian Banks' Association's committee of economists and CMD of Syndicate Bank, flayed the idea of converting weak banks into narrow banks while delivering his introductory remarks in the inaugural session of the conference. Theme of the conference was Indian banking's "Second Phase of Reforms-Issues and Imperatives."

The governor also ruled out any hike in interest rates on banks' cash reserve ratio (CRR)-a long standing demand of bankers. "Between November 1995 and January 1997, the CRR was reduced by five percentage points. The effective CRR is now pegged at below 10 per cent. The increase in lendable resources will add to banks' profitability. We cannot increase theinterest rates on CRR," Rangarajan said emphatically, demolishing the traditional argument that the effective rate of return on CRR, at less than three per cent, tended to put a heavy strain on the profitability of the system.

Rangarajan reiterated the need to offer functional autonomy to profit-making banks to prop up organisational effectiveness.

"The finance ministry and the Reserve Bank are actively looking into the issues. The public sector banks need to be given greater autonomy with respect to recruitment and promotion of personnel and in general management of staff and in determining the organisational structure," he said.

He also hinted at further deregulation on the deposit front. "Bankers have been asking for freedom in offering higher interest rates on large deposits as the transaction costs are lower in large deposits. We have already given them some kind of freedom to offer differential deposit rates on non-resident deposits. May be once the system stabilises, we may look into the aspect of allowing banks to offer higher rates on big deposits," he said.

Answering a question on whether mergers can be solution to public sector banks' problems, Rangarajan said: "Mergers are possible in the private sector. In the public sector we analyse whether a particular bank has the minimum economic size to stand alone. Till now, the size is adequate for survival," he said.

The RBI governor outlined four major challenges faced by banks in the second phase of reforms:

* Greater specialisation in niche markets like retail, agriculture, export, small-scale and corporate lending;

* Greater reliance on non-fund business;

* Greater overlaps between banks and NBFCs in offering products; and* Greater financial disintermediation with large corporates accessing domestic and overseas debt markets.

Calling on banks to formulate five-year corporate plans to expand their businesses, Rangarajan said: "Banks shold not expect customers to walk in. They should seek customers."

Copyright © 1997 Indian Express Newspapers (Bombay) Ltd.