Curiously in so far the financial sector reforms process is concerned, the April 4, 2017 RBI proposal for WLTF Banks connotes both continuity and change. Two interrelated questions may crop up in this context: (a) what is the need of these WLTF banks?; and (b) how are these WLTF bank different from the erstwhile pre-merger developments financial institutions (DFIs) like IDBI or ICICI?
While rich in cross-country experience, the present RBI paper is reticent about the Indian context of necessity of such WLTF banks. It may be useful to get a historical perspective here. It is important to note that one of the key outcomes of the financial sector reforms in India has been the demise of the so-called development banks. This was in line with the report of the Narasimham Committee II, which recommended that the IDBI should be corporatized and converted into a Joint Stock Company under the Companies Act on the lines of ICICI, IFCI and IDBI. In some sense, the Narasimham Committee II echoed the spirit reflected in the World Bank’s World Development Report, 1989 which commented, “Nonbank financial intermediaries, such as development finance institutions, insurance companies, and pension funds, are potentially important sources of long-term finance…..most of the existing development banks are insolvent, however” (p. 4). Development banks were winded up in India primarily due to lack of sources of non-concessional finance which in turn emanated from a binding fiscal constraint. Put simply these development banks became unaffordable and their concessional sources of funds dried up. Accordingly in January 2001, the RBI permitted the reverse merger of ICICI with its commercial bank subsidiary. Later on October 1, 2004, IDBI was converted into a banking company and subsequently in April 2005 it merged its banking subsidiary (IDBI Bank Ltd.) with itself. With the demise of the IDBI and the ICICI, the term lending of the country had experienced a distinct transformation.
Who filled up the void of terms-lending / wholesale funding? In an economy with well-developed financial markets, private corporate bonds could have come up. But despite various attempts, corporate bond market in India remained largely a private placement market catering primarily to blue-chap corporates. Thus, commercial banks had to come up to fill-up this void. But commercial banks have typically short term deposits as their main source of funds; hence any exposure to long term lending created a serious asset liability mismatch in their balance sheet. Long-term loan to infrastructure is a major issue here. Such exposure to long-term infrastructure lending has been a key reason behind the accumulation of non-performing assets (NPAs) in commercial banks in India in recent times. The problem is a serious one as the RBI Financial Stability Report of June 2017 noted that the gross NPAs of scheduled commercial banks in India rose from 9.2 per cent in September 2016 to 9.6 per cent in March 2017 – it is anticipated to rise to 10.2 per cent by March 2018. Furthermore, their stress tests indicated that to loans to infrastructure could considerably impact the profitability of banks so much so that a severe shock could completely wipe out the recorded profits of 2016-17. Faced with such a situation WLTF banks seem to be the right answer.
Development of corporate debt market is not the only way to fund longer term financing needs – there are complementary approaches. It is in this context that the RBI Discussion Paper flagged the instances of a number of globally successful WLTF banks – Brazil, South Korea, Japan to name a few. When commercial banks in India are burdened with NPAs and infrastructural needs of the country are huge to reap the full growth potential, the proposal to set up WLTF banks is really opportune at the current juncture. Nevertheless, going forward, the viability of their business model and the extent of involvement of the government in this venture will determine whether both the bottle and wine are new in this proposal for establishment of WLTF banks.
Prof. Partha Ray, Professor of Economics, IIM Calcutta writes this piece for the July edition of Economy Watch.
