Ever since the committee on Capital Account Convertibility (CAC) came out with its recommendations, it appears there is an undue haste to implement them without giving due attention to the essential issues relating to the preparedness of the financial system. The major conditionalities in this regard included setting up of uniform regulatory framework for banks and non-banking finance companies, strengthening risk-management systems and procedures, imposition of stricter capital adequacy norms, according greater degree of autonomy to state-owned banks, enforcement of comprehensive banking legislation & enforcement machinery, and targeted reduction in the level of non-performing assets. An appraisal of the present scenario in the financial services market as well as of the balance sheet of Indian banks reveals that several of these conditions have not yet been met.The recently announced guidelines of the RBI for NBFCs are an extreme case of over-reaction and may eventually result into closure of a numberof them. There is every possibility of amendment in respect of many of them and it would definitely need a lot more time before the clear situation emerges. Even for banks, the regulatory mechanism needs to be strengthened particularly in the area of off-site supervision. For instance, we need to develop suitable Management Information System that can identify the asset liability mismatches and bring to fore the potential liquidity and interest-rate risks. As pointed out by the committee on :CAC, with gradual internationalisation of the Indian banking and deregulation of interest rates, two risks that are going to assume serious dimension are liquidity and interest-rate risks. Even the basic tools for managing such risks like, drawing maturity profile, or interest-rate ladder are not in vogue in domestic banks. The more advanced techniques like Gap or Duration are more of text-book concepts as far as Indian banks are concerned.It is quite unfortunate that the central bank has chosen to deregulate totally theinterest -rate structure before implementing these advanced mechanisms of risk management.
The situation is no better with reference to capital adequacy ratio. In the recommendations of the committee on CAC, it has been observed that the RBI should consider imposition of even stringent capital adequacy standards than the Basle norms, as risk faced by the financial sector are much higher in developing countries. The committee also recommended that there could be steeper capital adequacy norms for banks with higher level of non-performing advances (NPAs). Though capital adequacy ratio (CAR) of public sector banks showed an improvement from 8.7 per cent in 1995-96 to 10.0 per cent in 1996-97, there were two banks that had CAR below 4 per cent as at March, 1997. Similarly, 3 private sector banks had a CAR of less than 4 per cent during the same period. The apparent improvement in the CAR of the public sector banks during 1996-97 was, to a large extent, due to recapitalisation of six banks by the government tothe tune of Rs 1,500 crore. The other important issue is that it is sometimes possible to attain the target of 8 per cent; it is quite difficult to sustain. In the present scenario of turmoil in the capital market, many banks would find it increasingly difficult to raise capital, either through equity or debt , rendering the task of sustaining the CAR even more painful as it is practically impossible to attain the CAR solely through the route of internal generation of capital. It may be added that the concept of CAR in banks in India today takes into account only the credit risk of the counter-party meaning thereby it does not include other balance-sheet risks like market risk that will require to be included in terms of Basle guidelines.
The most serious issue is that relating to non-performing advances. As per the recommendations of the committee on CAC, gross NPAs of the banking sector as a percentage of the total advances has been projected to gradually reduce from the level of 12 per cent to 5 percent by 1999-2000. However, this target appears to be an ambitious one. Though net NPAs as a proportion of total advances have shown marginal improvement from 10.14 per cent in 1995-96 to 10.07 per cent in 1996-97, the ratio for the public sector banking has a whole has, during the corresponding period, deteriorated from 8.90 to 9.18 per cent. The concept of narrow bank, a laudable one recommended by the committee has not been given a serious thought as yet. As such, it is doubtful whether the targeted level of achievement with reference to NPAs for banks in India is at all feasible. In conclusion, it may be reiterated that many of the pre-conditions envisaged by the committee on CAC in respect of banking system are neither pragmatic nor feasible. In such an eventuality, going in for capital account convertibility could be a historic blunder result of which could be disastrous.
(The author is a professor with SP Jain Institute of Management and Research, Mumbai)
Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
