The banking space is always full of activity, with RBI in particular being under the lens not just for the decision on interest rates but the financial environment as well. It is not surprising that the Banking Law Amendment Bill has raised interest once again for not being passed.
The Bill, when viewed along with the passage of changes in the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, reads well for the banking sector as it addresses the issues of both capital and asset quality (subsumed under prudential banking) in a limited manner. We all know that for sustaining growth of 8% per annum in the future, bank credit has to increase by over 20% per annum. This requires capital for banks, which will progressively pose a challenge given that we are moving over to Basel III, where the capital and liquidity requirements are more pressing. Therefore, having new banks makes a lot of sense as this will bring in the capital that is required. The next stop would be for RBI to work out the game-plan and set the ground rules. There are a number of corporate houses like Tata, L&T, Birla, etc, that are prepared to start such outfits or have their own NBFCs converted to a bank.
The second area where the Bill has focused on is the voting rights privilege. Increasing it to 10% for public sector banks (PSBs) and 26% in private banks is pragmatic as it provides more incentives to involve shareholders in the running of the bank, which improves transparency as well as governance and efficiency. This could be a useful step in moving further towards disinvestment of public sector banks as we get used to more private participation in the affairs of the bank. Third, RBI will have more powers to regulate acquisitions in this space. This does not really matter much as RBI is already quite powerful and we may not be seeing such activity concerning large banks. More likely, this would be for weaker or smaller banks, where there would not be any serious issue.
Fourth, the question of banks and ARCs being allowed to convert outstanding debt owed to them to equity or bidding for immoveable property that has been put for auction is useful for them as it means that they will address the critical part of NPAs. Banks should be pleased with this move as they are offered more options at a time when their NPAs have increased and they have been saddled with progressively increasing restructured assets. Discussions on these issues have, by and large, been more or less according to the script, which over months has managed to garner a reasonable level of acceptance. However, the issue that has become controversial pertains to allowing banks to enter the commodity futures market. This would have probably been one of the most revolutionary decisions taken by the government because given the pro-cyclical nature of growth of NPAs with agricultural production and industrial growth, there is a pressing need for a cover to be procured by banks. At present, agriculture has crop and weather insurance, which provides cover to the farmers, though not to the bank as recovery would still be its job.
As bank lending is predominantly against the existence of a commodity somewhere in the input-output matrix for a company or directly for farmers, there is a commodity price risk that is carried on its books. At the pre-harvest stage, the farmer carries a price and volumetric risk, of which the latter is covered by the insurance company. The bank lends to the farmer for inputs and the latter’s ability to repay the loan depends on the price at the time of harvest. Intuitively, it can be seen that the bank is better off in case the farmer hedges his price risk on a commodity exchange. However, today, farmers cannot access this market due to the absence of knowledge as well as their trading lot size, which is too small. A solution is for banks to act as aggregators for farmers as it pays them to hedge their risk in the eventuality of the crop failing. The banker only needs to convey the quantity of crop involved to the central treasury which puts in the order. This is what RBI had recommended in the draft report on warehouse receipt finance in 2005.
The same analogy can be carried for non-farm products, where often banks are impacted by volatility in prices of specific commodities like oilseeds, sugarcane, steel, aluminium, wheat, crude oil, etc. Here, banks can provide cover for themselves in case they take a corresponding position in the commodity derivative market with active trading in farm products on exchanges like NCDEX and energy products on MCX. Most of these products are offered on these exchanges or have proxy products that may be used. In fact, banks would be better off in case ‘options’ were permitted in this market as futures protects against downside risks while options lets one exit when conditions are better at the time of settlement of contract. But this needs the Forward Contract Regulation Act (FCRA) to be changed, which is another Bill pending in Parliament.
The FCRA Amendment Bill seeks to give autonomy to the Forward Markets Commission (FMC), which, in turn, would give it power to introduce new products which will include options and indices (intangibles). Therefore, for banks to be allowed into the commodity market, it would also be necessary to amend this Bill so that options are permitted as in the capital market. An interesting corollary here is that banks could also take proprietary trading positions in this segment, just like they do in the capital market. RBI would, however, have to set the regulatory processes to ensure that there is controlled trading that does not distort their own business models. This may still be a long way off.
The impasse in Parliament is ostensibly on account of futures trading by banks. Logically, the other elements that have been agreed upon should be passed immediately so that work can begin, especially on the issue of new banks being permitted, while the issue of futures trading can be separately debated. Or else we will have to wait again for a longer time period, which is not desirable for the banking system as we always seem to be returning to the starting line of a race that never seems to begin.
The Bill, when viewed along with the passage of changes in the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, reads well for the banking sector as it addresses the issues of both capital and asset quality (subsumed under prudential banking) in a limited manner. We all know that for sustaining growth of 8% per annum in the future, bank credit has to increase by over 20% per annum. This requires capital for banks, which will progressively pose a challenge given that we are moving over to Basel III, where the capital and liquidity requirements are more pressing. Therefore, having new banks makes a lot of sense as this will bring in the capital that is required. The next stop would be for RBI to work out the game-plan and set the ground rules. There are a number of corporate houses like Tata, L&T, Birla, etc, that are prepared to start such outfits or have their own NBFCs converted to a bank.
The second area where the Bill has focused on is the voting rights privilege. Increasing it to 10% for public sector banks (PSBs) and 26% in private banks is pragmatic as it provides more incentives to involve shareholders in the running of the bank, which improves transparency as well as governance and efficiency. This could be a useful step in moving further towards disinvestment of public sector banks as we get used to more private participation in the affairs of the bank. Third, RBI will have more powers to regulate acquisitions in this space. This does not really matter much as RBI is already quite powerful and we may not be seeing such activity concerning large banks. More likely, this would be for weaker or smaller banks, where there would not be any serious issue.
Fourth, the question of banks and ARCs being allowed to convert outstanding debt owed to them to equity or bidding for immoveable property that has been put for auction is useful for them as it means that they will address the critical part of NPAs. Banks should be pleased with this move as they are offered more options at a time when their NPAs have increased and they have been saddled with progressively increasing restructured assets. Discussions on these issues have, by and large, been more or less according to the script, which over months has managed to garner a reasonable level of acceptance. However, the issue that has become controversial pertains to allowing banks to enter the commodity futures market. This would have probably been one of the most revolutionary decisions taken by the government because given the pro-cyclical nature of growth of NPAs with agricultural production and industrial growth, there is a pressing need for a cover to be procured by banks. At present, agriculture has crop and weather insurance, which provides cover to the farmers, though not to the bank as recovery would still be its job.
As bank lending is predominantly against the existence of a commodity somewhere in the input-output matrix for a company or directly for farmers, there is a commodity price risk that is carried on its books. At the pre-harvest stage, the farmer carries a price and volumetric risk, of which the latter is covered by the insurance company. The bank lends to the farmer for inputs and the latter’s ability to repay the loan depends on the price at the time of harvest. Intuitively, it can be seen that the bank is better off in case the farmer hedges his price risk on a commodity exchange. However, today, farmers cannot access this market due to the absence of knowledge as well as their trading lot size, which is too small. A solution is for banks to act as aggregators for farmers as it pays them to hedge their risk in the eventuality of the crop failing. The banker only needs to convey the quantity of crop involved to the central treasury which puts in the order. This is what RBI had recommended in the draft report on warehouse receipt finance in 2005.
The same analogy can be carried for non-farm products, where often banks are impacted by volatility in prices of specific commodities like oilseeds, sugarcane, steel, aluminium, wheat, crude oil, etc. Here, banks can provide cover for themselves in case they take a corresponding position in the commodity derivative market with active trading in farm products on exchanges like NCDEX and energy products on MCX. Most of these products are offered on these exchanges or have proxy products that may be used. In fact, banks would be better off in case ‘options’ were permitted in this market as futures protects against downside risks while options lets one exit when conditions are better at the time of settlement of contract. But this needs the Forward Contract Regulation Act (FCRA) to be changed, which is another Bill pending in Parliament.
The FCRA Amendment Bill seeks to give autonomy to the Forward Markets Commission (FMC), which, in turn, would give it power to introduce new products which will include options and indices (intangibles). Therefore, for banks to be allowed into the commodity market, it would also be necessary to amend this Bill so that options are permitted as in the capital market. An interesting corollary here is that banks could also take proprietary trading positions in this segment, just like they do in the capital market. RBI would, however, have to set the regulatory processes to ensure that there is controlled trading that does not distort their own business models. This may still be a long way off.
The impasse in Parliament is ostensibly on account of futures trading by banks. Logically, the other elements that have been agreed upon should be passed immediately so that work can begin, especially on the issue of new banks being permitted, while the issue of futures trading can be separately debated. Or else we will have to wait again for a longer time period, which is not desirable for the banking system as we always seem to be returning to the starting line of a race that never seems to begin.
No comments:
Post a Comment