Inefficient Banking
T T Ram Mohan, Professor, IIMA in Economic Times. He gives some reasons for the high cost of banking in India, even after liberalisation. Click here for a previous entry on high cost banking by Ramesh
A widely used measure of efficiency is the net interest margin, the difference between interest income and interest expense, as a proportion of assets. The more efficient the banking system, the lower the margin. The margin has widened in recent years after a dip in the early years of liberalisation. Fees charged for banking services have shot up. Financial inclusion, the provision of banking services to low income people, is unsatisfactory.
Mention the widening in the margin to bank managers and they will bristle. Whether it is corporate loans or retail loans, there is intense competition, they will say. But the aggregate figures provided by the RBI do not deceive. True, the weighted average lending rate has declined. But the cost of funds has declined even more.
The widening of the margin may not be the result entirely of the steep decline in deposit rates. If interest income includes various fees and charges levied by banks, then an increase in the latter would bolster bank margins. Customers are free to shop around for the lowest rates on corporate and retail loans. The requisite information is readily available and transaction costs are low. But when it comes to fees for various banking services and penalties for, say, not maintaining the minimum balance, customers are truly at the receiving end.
Bankers will claim that there is full disclosure of fees and charges. But these disclosures are buried in fine print in letters that few customers can be bothered to wade through. Besides, a bank may entice customers with low fees and revise these a few months later, knowing that the customer will not notice. The question is whether fees and other charges including penalties have any relationship at all to underlying costs. The evidence from other banking systems, including that of the UK, is that they don’t. Banks charge fees and penalties pretty much as they please.
RBI governor Y V Reddy said recently that two banks had earned over Rs 100 crore from penalties that depositors had paid for not maintaining the minimum balance. Dr Reddy observed, “There is something wrong with the whole relationship”. Of course.
Why does competition among banks not address this problem? One reason, as mentioned, is imperfect information — few customers know exactly how much they are coughing up over the year. Another is that switching accounts from one bank to another is not costless. The competing bank may not be as closely located. Opening and closing accounts involve a fair degree of paperwork. A bigger hassle, if one is getting interest and dividends directly paid into the bank account, is to time the change in bank account correctly and notify the parties that make payments. In other words, many of the basic banking functions are fraught with rigidities.
But the nub of the issue is that, for all the appearance of competition among banks, there is an anti-competitive character that is inherent in banking. This is because entry into banking is restricted and banks are shielded in many ways from competition from non-banks. Non-banks may be able to compete in respect of loan products but not effectively enough in respect of deposit-taking and the provision of payment services. So “market forces” alone cannot deliver a better deal for customers. A stiff dose of regulation is inescapable.
A widely used measure of efficiency is the net interest margin, the difference between interest income and interest expense, as a proportion of assets. The more efficient the banking system, the lower the margin. The margin has widened in recent years after a dip in the early years of liberalisation. Fees charged for banking services have shot up. Financial inclusion, the provision of banking services to low income people, is unsatisfactory.
Mention the widening in the margin to bank managers and they will bristle. Whether it is corporate loans or retail loans, there is intense competition, they will say. But the aggregate figures provided by the RBI do not deceive. True, the weighted average lending rate has declined. But the cost of funds has declined even more.
The widening of the margin may not be the result entirely of the steep decline in deposit rates. If interest income includes various fees and charges levied by banks, then an increase in the latter would bolster bank margins. Customers are free to shop around for the lowest rates on corporate and retail loans. The requisite information is readily available and transaction costs are low. But when it comes to fees for various banking services and penalties for, say, not maintaining the minimum balance, customers are truly at the receiving end.
Bankers will claim that there is full disclosure of fees and charges. But these disclosures are buried in fine print in letters that few customers can be bothered to wade through. Besides, a bank may entice customers with low fees and revise these a few months later, knowing that the customer will not notice. The question is whether fees and other charges including penalties have any relationship at all to underlying costs. The evidence from other banking systems, including that of the UK, is that they don’t. Banks charge fees and penalties pretty much as they please.
RBI governor Y V Reddy said recently that two banks had earned over Rs 100 crore from penalties that depositors had paid for not maintaining the minimum balance. Dr Reddy observed, “There is something wrong with the whole relationship”. Of course.
Why does competition among banks not address this problem? One reason, as mentioned, is imperfect information — few customers know exactly how much they are coughing up over the year. Another is that switching accounts from one bank to another is not costless. The competing bank may not be as closely located. Opening and closing accounts involve a fair degree of paperwork. A bigger hassle, if one is getting interest and dividends directly paid into the bank account, is to time the change in bank account correctly and notify the parties that make payments. In other words, many of the basic banking functions are fraught with rigidities.
But the nub of the issue is that, for all the appearance of competition among banks, there is an anti-competitive character that is inherent in banking. This is because entry into banking is restricted and banks are shielded in many ways from competition from non-banks. Non-banks may be able to compete in respect of loan products but not effectively enough in respect of deposit-taking and the provision of payment services. So “market forces” alone cannot deliver a better deal for customers. A stiff dose of regulation is inescapable.
