Dr Patel: Idle Funds, Would You Please Stand Up?

Fri, 26 Aug Pre-Open

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Could Dr Patel meet the same fate as Dr Rajan? This is something we wrote about in one of our recent articles. The article revolved around the idea that unless the government aims at some structural reforms, it would be hard to bring down the interest rates. And if that be the case, Dr Patel too will be pressurized on reducing the interest rates.

Now while this remains true, there's one more area where Dr Patel could meet the same fate as Raghuram Rajan. It's the banking sector that has been plagued by the bad loans for a while now. However, whatever be the case, there is some relief sought for the common man. This we say because when it comes to what matters, Rajan and Patel are like peas in a pod.

If we had to rewind, Rajan's work clearly depicts his views to crack down on the bad loans in public sector banks. And if one has to compare Urjit Patel on this front, his views lie on the same line. In fact, days seem even harder for the public sector banks with him being their boss. This we say as an article in the Economic Times states that Urjit Patel has every intention of taking away their unproductive funds. Allow us to explain...

The present play among the public sector banks is that they invest a large chunk of their funds in government bonds. This is mostly done in order to safeguard themselves from the consequences of their lending mistakes. The amount invested earns a nominal, risk-free profit. And this in turn serves as an income stream and also help them set-off their bad loans - to a very little extent though.

Going by the data in this regard, the aggregate funds that Indian banks owe to depositors at present stands at US$ 1.57 trillion. Further, New Delhi demands that banks invest 21% of these funds in government securities and other approved assets. If that is not enough, many of the banks go ahead this and plonk 27% of their deposits in such risk free securities. And if one has to know the amount here, it roughly stands at US$100 billion more than the so-called statutory liquidity ratio.

The above practice is mostly visible, as you can guess, in state run banks. The article states that India's three largest state-run banks alone held US$ 113 billion (Rs 7.6 trillion) of government bonds in March. This was recorded more than a quarter of what the entire banking system, including private-sector lenders, owned.

The main influence behind the above practice is that the government gets funded cheaply with banks' funds (or call it public funds). It has very little to do with the idea of protecting lenders from unforeseen shocks. However, if this doesn't get sorted out soon, there's a huge loss of opportunity for the banks, government, and the Indian economy at a whole.

This we say because of many reasons. One is that government loses surplus funds that can be earned by lending the money to public. The 10-year government bond yield in India is 7.15%. On the other hand, banks in India make loans at a spread of about 4% to government bond yields. So basically, by sitting on US$ 100 billion in surplus public debt, banks are wasting out US$ 4 billion of potential profit.

Second, such a practice also means that these funds are deprived of investments. If not flown into bonds, banks would have lent these funds to borrowers. And this in turn would have meant an uptick in corporate and other lending.

So going by the above arguments, it clearly seems that many funds are wasted by not being invested productively. There is a need that the government recognises what opportunity it is losing on and at the same time banks get some training on how to deploy their funds more productively.

With Urjit Patel donning the role of RBI governor from the next month, one can expect some reforms that make these cases stronger.

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