Every crisis in the financial sector brings to the fore the segment that has stirred the pot. When the NPA issue went out of hand, public sector banks (PSBs) held centre stage and levels of above 20% caused shock and umbrage. Later, private sector banks cleaned up their books and their NPAs came to the fore. Subsequently, the non-banking financial company (NBFC) crisis came to light, and after being lauded for their amazing contribution to financing India Inc, especially post-demonetisation, the flaws of asset and liability management (ALM) mismatches made them the fall guy. More recently, the PMC Bank exposé has brought to light the inherent conflict of interest in the model of urban cooperative banks (UCBs) and raised a different kind of storm. Against this background of sequential contagion across financial groups, how should one look at the financial system?
While banks have been closely monitored by RBI, the so-called shadow banking segment, i.e. NBFCs, were only partly regulated, and for all practical purposes were independent in operations. Hence, when they did put in their applications for a banking licence, the first thought that came to mind was that they would be subject to RBI regulations and norms like priority sector lending, CRR and SLR. Now with the PMC problem, attention has turned to the cooperative banking sector.
The financial system is, hence, quite large and goes beyond banks. To get an idea of the overall size of the institutionalised lending market, one can look at some numbers. As of March 2018, commercial banks had an asset size of Rs 152 lakh crore. NBFCs had a size of `21.76 lakh crore—i.e. 14% of banks’ balance sheet. Housing finance companies (HFCs) came in next, at Rs 11.6 lakh crore—around 8% of banks’ size. The overall cooperative banking system as of March 2017 was Rs 16 lakh crore (11% size) and can be called the ‘covered shadow banking system’ that has been in existence for long and yet has never quite been studied in detail. Hence, the non-banking segment is around one-third the size of the banking system or has a share of around 25% in the financial system (excluding All India Financial Institutions, or AIFIs, which comprise regulatory bodies like NABARD, NHB, SIDBI and EXIM Bank, and have a size of Rs 7 lakh crore).
The accompanying table provides some interesting information on this ecosystem. Data for all institutions except cooperative banks (excluding UCBs) is for March 2018, while it is March 2017 for the latter. This helps one grasp the magnitude of the financial system, which should ideally be integrated through regulation.
The interesting thing here is that the cooperative banking system comprises over 98,000 banks/societies; the number is really large. Intuitively one can see that regulating such units is a major challenge given the limited bandwidth of the regulator. The combined NPA ratio for them is 12.8%, which is very high, with the primary agricultural credit societies (PACS) in particular being horrendous at 26.6%. While the recovery rate is fairly high (75%) for them, the fact that these loans do not get paid on time does raise a question of evergreening that may be taking place. In fact, recovery rates for state cooperative banks (SCBs) and district central cooperative banks (DCCBs) are higher, though NPA ratios lower. The universe of UCBs is also wide, with there being around 1,500 such banks where the NPA ratio is 7.1%. Thus, there is a need to take a closer look at the models being used by PACS. Also following from the fiasco at PMC, there is a broader issue of supervision and inspection that is required, as this space is quite opaque with little known on how business is conducted.
For state cooperative agriculture and rural development banks (SCARDB) and primary cooperative agriculture and rural development banks (PCARDB) that offer long-term loans to farmers, recovery rates are 44-50%, while NPA ratios are high, too, at 23-33%. This is not a good picture even though the size of loans is not very high to cause any kind of systemic risk to the system. But for sure it is necessary to review the entire cooperative banking system that has an important role to play as it deals with the overall objective of financial inclusion since it covers largely the rural population and SMEs (when it comes to UCBs). By their sheer number, they are difficult to regulate as even maintenance of accounts does not tend to be formal as one steps down to the PACS level.
A pointer can be that RBI should consider integrating these societies into the banking system. The move towards getting in payments and small banks was to foster financial inclusion. Given that the ‘covered shadow banking system’ is large at Rs 16 lakh crore—a level that new banks will take years to achieve—integrating them with the formal system makes sense. Surprisingly, all the various committees on banking that have focused on reforms in commercial banking have not quite touched on this parallel formal institutionalised system, which occupies a very important place in the flow of credit especially to the rural and SME segments.
NBFCs and HFCs have a crucial role to play in the structure of finance as they have niche customers. HFCs have added a new dimension to housing finance and enabled the achievement of the objective of successive governments to provide access to households for buying homes.
At a broader level, RBI should ideally be regulating all these entities as a single regulator makes sense for better coordination. This also ensures that the scope for regulatory arbitrage reduces. From the point of meeting the objective of financial inclusion, quite clearly the ‘covered shadow banking system’ has a very important role to play. While nudging commercial banks to do their bit is okay in the short run, ideally the rural responsibility has to be shifted to the cooperative system, which, admittedly, has to be strengthened substantially. At present, the focus has been on creating a new category of banks, like small and payments banks, and merging PSBs. As part of this transformation, the integration of cooperative banks and NBFCs should proceed in parallel and the expertise created with the regulator.
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