Banks can now unlock funds & let them rock

Banks will have a new way to raise long-term capital and a greater choice to put money where it fetches a better return. Legal reforms are underway which could unlock funds tied up as cash and low-yielding government bonds. And, who knows, it could be a step towards full convertibility of the rupee.

The FM has said RBI can fix the bands on reserve requirements like the cash reserve ratio (CRR) and statutory liquidity ratio (SLR). Banks are required to park 4.5% of their net demand and time deposits as cash and 25% as gilts with RBI.

Under the law, the lower band for CRR is 3% and that for SLR is 25%. The industry average of SLR is 35%, but a lower SLR floor will help smarter banks move out of gilts. It could also be a way to free resources for banks which are being prodded to step up lending to farmers and small businesses.

Bankers feel that lower ratios would also give the banking regulator greater flexibility in managing liquidity, while preference shares would help them to comply with the stringent international capital norms that will be in force from ‘07.

“All indications are that credit growth will be robust next year and banks will require capital. Preference shares will be extremely beneficial,� said AK Purwar, chairman, SBI. “Even for inorganic growth, we will need capital to figure among the top 20 top banks in the world,� he added.

The preference shares will be treated as a bank’s Tier-II capital, but subscribers to these shares will not have voting rights. Banks are required to maintain a 9% capital adequacy level, which includes Tier-I (equity and free reserves) and Tier-II capital (mainly debt substitutes).

“This will open one more window for banks to raise long-term capital,� said Cherian Verghese, CMD, Union Bank of India.

Unlike private banks, there is no legal bar on PSU banks to raise preference shares. To maintain a level playing field, RBI did not allow even PSU banks to raise preference shares.

Since PSU banks can’t lower government holding below 51%, this will be a key tool to raise resources. Most banks are looking at a second round of public issue.