Saving the Regional Rural Banks

Recent moves by the Union Finance Ministry are likely to weaken RRBs and lead to the bleeding of financial resources from the countryside.

ACCORDING to the United Progressive Alliance's Common Minimum Programme, the revival of agricultural credit is one of the important priorities of the Central government. There is no doubt that there has been some improvement in this regard since July 2004; certainly the downward movement in terms of access to institutional credit has been stopped and in several States reversed.

However, some current moves of the Finance Ministry and the Reserve Bank of India (RBI) are likely to worsen the situation and once again contribute to the bleeding of financial resources from the countryside. These moves relate to the Regional Rural Banks (RRBs), which are public financial institutions set up three decades ago to serve specifically rural needs.

These banks (which are popularly known as Gramin Banks) were set up in 1975 with the explicit objective of bridging the credit gap in rural areas, which it was hoped would thereby also check the outflow of rural deposits to urban areas, reduce regional imbalances and increase rural employment generation.

It is obvious, in the circumstances, that RRBs require special conditions given the fact that they are meant to cater exclusively to rural needs with much higher transaction costs and greater difficulties in lending and loan recovery. In the early phase, this was accepted in policy circles. However, more than a decade of financial liberalisation has sought to create a "level playing field" between RRBs and credit cooperatives, which are relatively weak financial institutions by their very nature, and commercial banks operating on market principles. Regulatory regimes, capital adequacy norms and other compliance with rules has been imposed in exactly the same way on the RRBs as on commercial banks.

Despite this, the RRBs' performance in respect of some important indicators was certainly better than that of commercial banks or even cooperatives. As of March 31, 2004, the credit-deposit ratio of all the RRBs taken together was more than 46 per cent, and the recovery of loans was 74 per cent. Despite the widespread perception that most RRBs are struggling with losses owing to bad loans in fact most RRBs have been profitable - out of 196 RRBs, 165 earned profit and only 31 incurred losses, and the group as a whole showed a net profit of Rs.754 crores in 2003-04. Non-Performing Assets (or bad loans) amounted to only 16 per cent of gross advances in 2003-04.

Further, priority sectors have accounted for over 70 per cent of RRBs' lending, with loans specifically to agriculture amounting to 46 per cent. RRBs have also performed better in terms of providing loans to small and retail traders and petty non-farm rural activities. In recent years, they have taken a leading role in financing Self-Help Groups (SHGs) and other micro-credit institutions and linking such groups with the formal credit sector.

Given these priorities and the past performance, RRBs should really be strengthened and provided with more resources with which they can undertake more of these important activities. And most certainly they should be kept apart from a profit-oriented corporate motivation that would reduce their capacity to provide much needed financial services to the rural areas, including to agriculture. Ideally, the best use of the resources raised by RRBs through deposits would be through extensive cross-subsidisation. This, in turn, really requires an apex body that would cover and oversee all the RRBs, something like a National Rural Bank of India (NRBI).

Instead, the focus has been on integrating the RRBs with private commercial banks that are "sponsor banks". Currently, there are 28 such sponsor banks, which have essentially sought to introduce corporate culture into the functioning of RRBs, with associated decline in attention to priority sector lending, especially to small producers in agriculture and non-agriculture.

In fact, the reduced attention to serving rural needs has been evident in the way the RRBs themselves have responded to the changed incentives emanating from the government and the RBI. From September 1992 onwards, the RRBs were allowed to finance non-target groups to the extent not exceeding 40 per cent of their incremental lending, and this limit was enhanced to 60 per cent in 1994. Because of this, the RRBs diversified into a range of non-priority sector advances, including jewel and deposit-linked loans, consumer loans and home loans.

The RRBs adopted new innovations for credit delivery with lower risk of default such as SHG-linked lending, non-priority sector collateralised lending, and so on. As a proportion of total advances, priority sector lending dipped from around 70 per cent in 1990 to 57 per cent in 2001. Even among the categories that were eligible as priority sector, the attempt was to minimise credit risk and make easy loans. Between 1996 and 2003, while short-term agricultural credit under the priority sector increased at about 29 per cent per annum, term loans declined by 2.6 per cent a year. Over the same period, the number of rural branches of RRBs declined by 459, even as the number of urban and semi-urban branches increased. The share of outstanding credit of RRBs going to rural customers declined from 78 per cent to 71 per cent.

So, already financial liberalisation measures and the changed messages from the RBI had led to pressures on the RRBs to move away from their basic purposes. The recent moves of the RBI are even more worrisome, since they have involved a reduction in the number of RRBs through amalgamation and even raise the possibility of merger with some of the commercial sponsor banks. In fact, the Government of India has already requested the National Bank for Agriculture and Rural Development (NABARD) to look into the implications of reducing the number of RRBs from 196 to only 62. There are already seven proposals for amalgamation from various commercial banks such as the Bank of Baroda, the Central Bank of India, the Punjab National Bank and so on.

Such a plan would have serious implications. It would mean that there would be no possibility of national level or even State-level RRB, with related impact on the possibility of cross-subsidisation. It would allow the sponsor banks to continue to siphon off deposits to urban borrowers. Essentially, the dominantly rural character of the RRB or Gramin Bank would effectively disappear.

In addition, a recent notification of the RBI (December 27, 2005) announcing a special package for the RRBs, has effectively allowed them to diversify their activities away from agricultural lending and lending for productive activities in the rural areas, to a range of other activities. While there are measures for increasing access to resources by allowing sponsor banks to provide lines of credit to the RRBs and allowing access to inter-RRB term money and borrowing, the RRBs are also being allowed to enter into ready forward transactions in government securities.

Requests from RRBs for opening of currency chests would be considered by the RBI, on a case-by-case basis, taking into account their financial position, compliance with Statutory Liquidity Ratio (SLR)/Cash Reserve Ratio (CRR)/inspection findings, the general position of management, grading, and so on.

In addition, the statement reveals that the RBI is in the process of reviewing the existing norms for conduct of various types of foreign exchange transactions by the RRBs with a view to allowing them to undertake non-trade related current account transactions pertaining to release of foreign exchange for certain specified purposes such as private visits, business travel, medical treatment, overseas education, visa fees and so on.

It is obvious that such opportunities would only encourage RRBs to move further away from the core concerns for which they were set up, and which remain vital for the urgent revitalisation of crop lending and viability of agriculture to which the government is explicitly committed.

Instead of these policies, a focussed programme for making the RRBs more viable and more able to concentrate on their social and developmental functions must be put in place. The number of rural branches should be increased rather than reduced; they should be encouraged to develop more sophisticated methods of credit delivery to meet the changing needs of farming; and most of all, there should be greater coordination between district planning authorities, panchayati raj institutions and the banks operating in rural areas. Only then will the RRBs fulfil the promise that is so essential for rural development.