Unlike the west, the global financial melt down has mercifully not crippled India's banking sector. Over 40 banks in the United States were wiped out in the last one year including a big multinational bank where its top executives spent sleepless nights pondering over the future. Viewed against this backdrop, the changes that the Indian electoral process has thrown up is reassuring in terms of the strong mandate for the ruling UPA led coalition. Economic reforms can now be implemented more easily without fear of left parties' opposition. The gloomy atmosphere at Dalal Street has been replaced with hopes pushing up the Sensex.

There are signs of economic revival now with FY2009 results of public sector banks showing positive indicators. All state-owned banks have shored up their bottomlines with higher dividends for the year. While many private sector banks are yet to come out with their balance sheets, PSU banks have performed better. The atmosphere is just right enough to push through with the pending reforms in the financial sector.

Need for reforms

The cap on voting rights of the shareholders of the private sector banks is an issue that needs to be looked into urgently. Enlarging the capital base of these banks is imperative in the context of adherence to the capital adequacy norms. With the existing cap of 10 per cent of voting rights, it is futile to expect the promoters of private sector banks to bring in additional capital. Voting rights should be related to the pro-rata shareholding.

Insurance sector in India is growing. As gestation period is long in this sector, there is a need to enhance their capital, as they would be in the red in the initial years of operation. The current limits of 26 per cent holding for foreign holdings in insurance companies' need to be relaxed and any pending legislation needs to be pushed through.

Exploitation of the poor by some of the micro-finance institutions needs to be ended. Picture the proverbial village money lender exploiting the rural poor as portrayed brilliantly by film makers in award-winning films such Mother India. Exploitation today is however in a very sophisticated manner, with the regulators' seemingly tacit approval. The interest rates are abnormally high.

When banks are slashing interest rates on advances like housing loans to 8 per cent, the micro-credit borrowers are still borrowing at high cost. Recently, the Reserve Bank governor indicated enough scope for banks to reduce the rates of interest on their lending.

But the need for reducing the rate of interest of micro-finance institutions does not receive official recognition in any form. Without imposing any populist schemes for poverty alleviation, government may consider the creation of a regulatory authority to regulate the micro-finance business in its totality.

Thrust on inclusive growth

As the banking sector has not touched a sizeable rural populace, the thrust on inclusive growth becomes important. The websites of state level bankers' committees are replete with announcements detailing the attainment of financial inclusion in an ever growing number of lead districts. After evaluating the achievements, RBI has advised banks to make a realistic assessment, because merely opening 'no-frills accounts' in large numbers does not achieve the desired objectives.

What could not be achieved in over 35 years of public sector banking cannot be achieved in a year or two. We may have to wait for the glossy annual reports of banks for the year 2008-09, which incorporate the Directors' Report; to know how far the banks have actually gone ahead in reaching out to the unreached in different parts of the country.

Rural branch expansion has virtually come to a standstill in recent years. With the advent of financial sector reforms, the number of rural branches has come down from 35,206 in 1991 to 30,551 in 2007 - a reduction of the order of 4645 branches. Part of this reduction is on account of the reclassification of rural branches based on the 2001 Census data, resulting in the upgradation of their classification, without a decline in the number of branches situated in rural areas. Secondly, part of the decline in number is due to shifting of many rural branches to semi-urban areas, in search of better business.

Hardly any new rural branch has opened during the last decade. Most banks have shown their disinterest in rural branches and gramin banks too have had their own constraints in expanding their network. The shortage of experienced staff resulting from the earlier embargo on recruitment is a major hurdle The net result is the wide spatial gaps still prevailing in the dispersion of branches in rural areas.

Cost-conscious banks are experimenting with branchless banking which could be welcome. Instead of opening 'no frills accounts' in the branches situated far away from villages, it would be better to provide smart cards to the villagers and to appoint business correspondents in centrally located unbanked villages. The performance of banks in enhancing financial inclusion may be better judged by the number of villages covered by business correspondents and the number of smart cards provided to the villagers, than by the number of 'no-frills accounts' opened in their branches. It is high time that the focus is shifted from opening 'no frills accounts' to enlarging the domain of branchless banking.

Merger of banks

Discussions on the bank mergers are still on and the chairmen of a few public sector banks are eyeing take over some smaller banks. The North Block mandarins are no so much enthused by the mergers, though occasionally some hints were given about the necessity of adopting the merger route for strengthening the banking sector. In the private sector, however, mergers have been taking place, reducing the number of small banks every year, particularly in the south. One more bank takeover is imminent in the south.

State Bank of India is the only Indian bank with international standing; it has 1 1148 branches. The merger of one of its associate banks, State Bank of Saurashtra, with itself last year, faced resistance from the staff. It is not clear as to whether there is any further move of merger of the associate banks.

If the objective of bank mergers is to create internationally competent banks, some of the inherent structural peculiarities of the public sector banks have to be taken into account, as they are likely to emerge as speed-breakers in the process. Take the case of one of the big banks, Bank of Baroda, which claims legitimately as India's International Bank. It has 2956 branches as on May 2009, of which 72 branches are operating in different foreign countries.

According to its financial results for FY2009, foreign branches of BOB contributed 22.5 per cent of its total business and 21.2 per cent of the gross profit. On the domestic front, out of 2884 branches, as many as 1092 branches are in rural areas and those in the urban and metropolitan centres are 1150. Rural branches constitute 37 per cent of the bank's total branches. In all probability, less than 10 per cent of its total domestic business is originating from these branches.

The merger of any other bank with Bank of Baroda would not drastically reduce the share of rural branches in the combined branch network; nor is it likely to raise the rural branches' contribution to the total profit.

In the Indian context, the share of rural branches in the gross profit generated is inversely proportional to the share of rural branches in the total branch network. With 37 per cent of its branches operating in rural areas, it would be unrealistic to expect the BOB to compete with the foreign banks on equal terms. One is not belittling the role of rural branches but one is asking for a level playing field, as the foreign banks are not weighed down by rural branches.

For enhancing Indian banks' competitive edge vis-à-vis the foreign banks, there is a need for hiving off the rural branches into a separate, professionally managed rural bank amalgamating the rural branches of all public sector banks.

It is time that a Banking Commission is appointed to formulate a road map for the banking sector, instead of making any ad hoc amalgamation of banks. It may be recalled that the Narasimham Committee, which went into the whole gamut of financial sector reform, has suggested the appointment of a Banking Commission to suggest the suitable pattern of consolidation of the banking sector. The suggestion of appointing the Banking Commission still remains to be considered. If the Commission is appointed now, its recommendations could be implemented before the end of the five year tenure of the new government.

Capitalisation of banks

Two of the public sector banks - Punjab and Sind Bank and United Bank of India remain wholly owned by the Government of India. It is evident from the experience of the 17 public sector banks that their partial privatisation has opened up a new vista of progress for them since the late 1990s. They have changed their work culture, adopted IT and compete with the aggressive new generation banks. Steps may be initiated by these two banks to access the capital market at an early date.

There is a need for exploring the feasibility of introducing the Employees' Stock Option Plan (ESOP) in the public sector banks, when the recapitalisation process is pursued by the major stake-holder. In the past, when the banks were in the private sector, whenever the new public offers were made, many banks used to earmark a small percentage of the shares for subscription by staff members. Even after bank nationalisation, some banks have extended this offer to their staff. A beginning in introducing the ESOP could be made by discussing the subject with the union representatives in the bank boards. Decision at the appropriate level in the finance ministry may have to be taken in this regard.

Social concerns...

Banks have been participating in many of the schemes sponsored by the state governments having an accent on social concern. Besides extending credit support to unemployed youth to take up some self-employment vocations, banks have been on their own arranging for imparting training to them. This process began in South Kanara district in Karnataka state, the cradle of banking, in 1982.

Two of the public sector banks, Syndicate Bank and Canara Bank in association with Shree Dharmasthala Manjunatheswara Education Trust, set up Rural Development and Self Employment Training Institutes (RUDSETI) initially in Karnataka which spread to other states following its success.

Recognizing the effectiveness of this model, the Eleventh Five Year Plan of the Government of India has fixed a target of about 600 such institutes to be established by all the public sector banks, preferably in their lead districts, before the end of the plan period, March 2012. A grant of Rs.1 crore would be available to each institute for developing the infrastructure. The bank promoting the institute has to meet the recurring expenditure.

Due care should be taken by the banks in selecting the right type of candidates for manning the new institutes. Government may have to constitute a high level supervisory board to monitor their functioning in association with the sponsoring banks.