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Monday, May 4, 1998
Unbankable system
The RBI's former deputy governor SS Tarapore has, in this year's Sir Purshottamdas Thakurdas Memorial Lecture, termed the Indian banking system as the "vulnerable under-belly of the Indian economy." He has said that, "unless concerted attempts are made to bring about a quantum jump in the efficiency of the system, users would legitimately ask the question "why banks" and it is conceivable that vast tracts of the banking system will be sidetracked by the rest of the economy. "Banks are relatively inefficient financial intermediaries, even in developed countries. Financial markets embody the knowledge and information-processing powers of thousands of players, unlike banks, where decisions are taken on the basis of inputs by only a few credit analysts. Transaction costs in developed markets too are a fraction of the costs of the banks. In this country, banks are notoriously inefficient both as regards credit decisions as well as the costs of intermediation. High levels of non-performing assets are the result,which in turn translates into the necessity for high spreads. One of the reasons why real rates of interest are high in this country is because of the inefficiency of the banking system. The other factor is that the rate of development of financial markets in the country has been relatively rapid. In the stockmarket, change has already resulted in transaction costs plummeting, and although the market for corporate debt is still not developed, there has been a move towards the securitisation of credit, as witnessed by the increasing volumes of corporate paper being subscribed to by banks. An additional option for corporates is also to access the overseas markets. Clearly, if the pace of change in the banking system does not keep pace with changes in financial markets, the result will be disintermediation and a shift away from banks.The problems can be addressed in two ways -- by banks following their customers into the financial markets, and by making banks more efficient. The former course has already beentaken, with banks setting up their own merchant and investment banking outfits. But these activities cannot be a substitute for traditional banking business, whose inefficiencies add to the high costs of capital for corporates. While competition can be relied upon to force the pace of change, as in any other business, banking reform is complicated by the fact that bank failures can rock the entire financial system. The operation of the Darwinian principle of the survival of the fittest, accordingly, may not be feasible in banking. There are no easy solutions to the problem, and there may be no alternative to a pre-emptive closure of unviable banks. Copyright © 1998 Indian Express Newspapers (Bombay) Ltd.
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