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In the
period before the nationalisation of banks, key sectors
of the economy including agriculture remained thoroughly
neglected in terms of availability of institutional
credit. Whereas the industrial sector at that
time accounted for about 15 per cent of national output,
it appropriated two-thirds of commercial bank credit,
whereas the agricultural sector contributing about half
of national output was almost completely neglected by
the commercial banks.
One of the most important objectives of government policy
since the nationalisation of 14 commercial banks in
1969, was to extend and expand credit not only to those
sectors which were of crucial importance in terms of
their contribution to national income and employment,
but also to those sectors which had been severely neglected
in terms of access to institutional credit. The
sectors that were initially identified for this purpose
were agriculture, small industry and self-employment.
These sectors were to be accorded priority status in
credit allocation by the banks.
As a consequence, policies such as interest rate controls
and pre-emption of resources through directed credit
programmes aimed at agriculture and the small scale
sector increased in magnitude during this period. There
was also a concerted effort at substantially expanding
the reach of the banking system, especially to the rural
areas. The success of policy in terms of branch expansion,
mobilisation of household savings, diversification of
lending targets and direction of credit to the priority
sector was substantial.
Yet, by the late 1980s, the banking sector in India
was faced with criticism of a completely different kind.
The focus of that criticism was the low profitability,
low capital base, high non-performing assets and the
ostensible "inefficiency" of and lack of transparency
in the banking system. Such criticism constituted the
point of departure of the Committee on the Financial
System (CFS) under the chairmanship of M. Narasimham
established in 1991 to pave the way for the liberalisation
of banking practices.
Among other things, this Committee recommended a reconsideration
of the policy of directed investments and directed credit
programmes, as well as the interest rate structure pertaining
to these. Thus it suggested that priority sector
credit as hitherto defined should be phased out. It
also recommended that the concept of priority sector
itself be re-defined to target only the truly needy,
viz. the small farmer and the tiny sector in industry
and that the credit to this redefined priority sector
should be only 10 per cent of total bank credit.
On interest rates, the Committee suggested that the
complex system of administered interest rates be dismantled
in a phased manner and that there should be greater
reliance on the market mechanism so that interest rates
could be allowed to perform, in a greater measure, their
allocative function.
As the erosion of profitability was not only due to
factors operating on the income side, but also on the
side of expenditure of banks, the committee wished that
without prejudice to the availability of banking facilities
especially in the rural areas there should be a reconsideration
of the future of unremunerative branches. In the
Committee's view, judgement relating to future expansion
of branches should primarily be left to banks themselves
and accordingly branch licensing by the Reserve Bank
should be abolished.
When recommending financial liberalisation as a solution
to the "problem" of low profitability, there
was the immediate problem of dealing with the existing
large element of non-performing assets in banks' portfolio.
Subjecting banks that had hitherto functioned under
a completely different discipline to market-based competition
and the threat of closure would have amounted to discrimination
vis-à-vis new entrants with adequate resources.
The Narasimham Committee coined a new definition of
NPAs that was in conformity with international practice.
From 1991-92, banks had to classify their advances into
four groups such as (i) standard assets; (ii) sub-standard
assets; (iii) doubtful assets and (iv) loss assets,
and indicated that the advances classified under the
last three groups were to be considered as NPAs.
Chart 1 shows the NPAs of public sector banks between
1993 and 2001 , as a proportion of total assets. It
shows that the proportion of total NPAs to total advances
declined from 23.2 per cent in March, 1993 to 12.4 per
cent in March, 2001.
Chart 1 >>
The sharp decline in NPAs of public sector banks during
1996-97 was really due to a definitional change.
RBI introduced a new concept of "net NPAs"
in 1996-97 in place of gross NPAs followed by it earlier.
This was derived by deducting various items, including
"total provisions held", exclusion of which
conceals the gross damage caused by the NPAs on the
banks.
Chart 2 indicates that the share of the priority sector
in total NPAs for public sector banks decreased until
2000, even though the proportion of total NPAs accounted
for by the priority sector was inflated by the new method
of calculating net NPAs. Subsequent increases have been
due to the broader scope of priority sector lending,
as explained below.
Chart 2 >>
Also, NPAs resulting from small advances (i.e. where
outstanding bank loans amounts to Rs. 25,000 or less)
have been declining and that too quite sharply in relative
terms. The recovery performance of direct agricultural
advances had been improving, especially in the first
half of the 1990s. According to the RBI, the recovery
performance of direct agricultural advances had increased
from 54.1 per cent in 1992 to 59.6 per cent in 1995.
The policies initiated by the RBI, which implicitly
treat agricultural advances as prone to result in NPAs
should be viewed against this backdrop. An informal
working group set up by the RBI in 1992-93 to consider
any required relaxation in the implementation of new
prudential norms had recommended that in the case of
advances granted for agricultural purposes, banks should
adopt the agricultural season as the basis for treatment
of NPAs. Accordingly, it was decided that any agricultural
advance should be treated as NPA only when interest/instalment
is not paid continuously for 2 half-years, synchronising
with the harvest.
This decision was reversed in April 1997 when the RBI
advised the banks to reduce the interest overdue period
of two half-years in the case of agricultural advances,
to two quarters i.e. from 12 months to six months, from
1997-98 onwards. This was bound to accelerate
the process of agricultural loans getting increasingly
classified as NPAs and negate the effect of the continuous
increase in the recovery performance of agricultural
loans. |
