Delivering the keynote address at ``Money Talks,'' a seminar organised by Tata Consultancy Services, Reddy said a credit sqeeze could be unsettling for small companies which are not in a position to access alternate sources of finance. Hence the pace of operationalising debt-recovery systems needs to be carefully modulated, he said.

``Sharp tightening of norms will pose an unbearable burden on banks and will serve no substantive purpose unless corresponding changes are made in credit appraisal systems and debt recovery mechanisms,'' he said. Tighter income recognition norms had to be introduced gradually so that both banks and borrowers had time to adjust their operations, he said. Otherwise this will cause a seriousdisruption in the normal banking activity and erosion in public confidence in the banking system due to balance sheet impact, Reddy underscored.

The deputy governor announced that the central bank will soon mount the second phase of reforms on prudential requirements. These requirements will warrant significant additions to the capital of the banking system as a whole, he said. Further progress will depend on resolution of issues in government relating to budgetary support, permitting access to capital markets, strategy for weak banks, mergers among banks and possible changes in the percentage of public ownership, he added.

Elaborating on RBI's unfinished agenda Reddy said interest rates will be further deregulated and an enabling environment created for reduction in interest spreads. ``This would depend on the progress in reduction of fiscal deficit, reduction in non-performing assets and improvement in credit appraisal systems,'' he said.

RBI will pursue vigorously, improvements in transparency,disclosure standards and accounting standards to attain the best international practices, he elaborated. Compliance with core principles was also being expedited, he stressed.

Dwelling on the direction of impending reforms Reddy said, RBI will endeavour to foster competition between banks and in due course between banks and other financial intermediaries. ``The issue of competition with other financial intermediaries has to recognise the level playing field argument warranting special treatment to banks as long as they have large pre-emptions linked to fiscal deficit,'' he stressed.

The central bank will endeavour to ensure smooth credit flow but this could be facilitated only when legal systems and judicial processes were reviewed to replace cumbersome and time consuming procedures, Reddy added. ``In addition to laws relating to debt recovery, changes in bankruptcy law, tenancy laws and urban land ceiling laws would be needed to ensure that the collateral offered is in reality a realisable collateral,''he stressed.

INSIGHT
Limits to prudence

Deputy governor Reddy's comments reflect a welcome introspection on prudential norms. These have already frightened banks into becoming risk-averse. They are tight-fisted lenders. Further tightening of asset recognition norms would only result in a credit squeeze. This, in turn, would retard recovery from recession and, thus, worsen banks' balance sheets. The inevitable erosion of public confidence in banks would follow. So long as the business cycle does not bottom out, stiffer prudential norms would only strengthen the investment slack. And hastening debt recovery would prolong the down turn of the business cycle. So Reddy's point about the vulnerability of the small companies is correct. But he should have explained why banks consider small companies to be high risk borrowers and whether the small in a supplier relationship with the big are pushed to the wall by the latter because they, in turn, are under pressure from the banks.