Banks must stick to their core functions

Diversification into long-term financing, insurance, mutual funds and share broking have affected their performance

The recent statement by Finance Minister Nirmala Sitharaman at a private bank’s foundation day event is a marked departure from the usual rhetoric of politicians. The Finance Minister said: “Banks should not engage in unnecessary scaling up of business, and, rather lenders must understand their core strength of business and run operations with consistency, stability and with a sense of ownership.” She added, “The orthodoxy in banks is better, since it is layered with conventional wisdom.”

The above statement is a refreshing one because we have allowed the banks to deviate far away from the principles of sound banking. Whatever problems the banks are undergoing now are on account of such deviation.

Different entities

There is a marked difference between the business of banking and other businesses. Banks operate with others’ money and with a very small capital base. Banks’ failure will affect not only the shareholders but also their clients. Moreover, their operations will have contagion effect. The ability of banks to return depositors’ money is of paramount importance. Year after year, the government is pumping taxpayers’ money to shore up the capital base of public sector banks to maintain their capital adequacy.

Until three or four decades back, Indian banks’ function was mainly to mobilise community savings for the purpose of lending for productive purposes.

Banks were not considered as a ‘super market’ of financial products. Banks have been able to mobilise deposits only because of the trust developed in them over the years. To have the trust of the people, the banks must adopt sound banking principles like liquidity, safety, profitability, secrecy and customer service.

Into non-core areas

When commercial banks ventured into long-term finance after the closure of development finance institutions like IDBI and ICICI, it led to asset-liability mismatches and affected the liquidity of banks.

Banks’ lending without adequate tangible security has led to a rise in non-performing assets (NPAs) and affected the safety of funds with banks and the profitability of the lenders as well. The diversification of banks into non-banking activities such as insurance and mutual funds has forced them to deploy the productive workforce in these activities, affecting thereby the core function of banking.

Paradigm shift required

It is time for the policymakers to introspect and allow banks to function only as banks under sound banking principles. One hopes that the Finance Minister is serious about the concern she expressed. If so, the following steps should be taken forthwith.

Security-based lending should be restored to and loans should be sanctioned only with adequate tangible security. Only credit to the weaker sections should be exempt from this criteria.

Banks’ role should be to focus only on accepting deposits for the purpose of lending. Non-banking activities such as insurance, mutual funds and share broking should be left to dedicated entities other than banks.

Dedicated development financial institutions should be started again and commercial banks should lend only for the short to medium term.

Loan waivers should be stopped and using banks’ funds for politically-driven schemes should be eliminated.

Targets should be fixed more for the quality of operations and not for quantity. When quality is maintained quantity will automatically flow in.

The writer is a retired banker