The articles in this column will be topical. I will invite other senior colleagues in the banking industry to write for this column such that members will have access to various topics and views. It is proposed to write on issues that touch upon the lives of members in their day-to-day business of banking. I am keenly aware that most members read quite a range of periodicals and magazines and perhaps news digests on matters of importance to the banks. This column will therefore try not to be a news digest, but a commentary on all the news and happenings in the world of banking and finance. Necessarily, as the banking world is a part of the larger world, and whose interactions affect it I would define the horizons for the column as the universe of the economy, both Indian and the world. It will also contain an analysis of certain themes with a focus on knowledge building with the associate and diploma exams offered by the Institute in mind. It is hoped that the column will also serve as an update for those members who have completed the associate examinations.

In this direction Budget 2005 is the first theme. The focus is on the impact of budget on the banking and financial world. I am sure members are fully familiar with the tax proposals for individuals by now and I do not propose to touch upon them. A brief mention is made of tax proposals for corporates. Definitely, Tax proposals on corporates will impact banks too. It will be difficult to analyse these in detail in a single article. May be we will attempt one in the next few months.

On the eve of the finance bill, the banking and financial sector was in the pink of health with a healthy bottom line for banks, a reversal of past few years trend of fall in market interest rates and a thrust on rural lending. There were disturbing signals coming from cooperative banks (both UCBs and ST Coops). Mergers among PSU banks are in the air for some time now. Will a merged entity- on account of its size and strength- have a greater credit reach? Will the new merged entities become strong? Strong enough to be counted among the top 10 or atleast the top 50 in the international bank ratings? Will they become totally commercial or like IDBI- IDBI bank, post merger, retain a major thrust on development banking?

In this background, the current Finance Bill has a great significance for banks and financial institutions. Banking is going to change. The policy pronouncements made in the budget harbinger changes for all banks, and of course will impact banking in the corporate office as well as branches. Mergers will make the Indian banks larger and stronger. Foreign investments, even in small annual instalments, will bring in new management philosophies in the private sector banks, which attract such investments. New methods, new approaches, new ways of doing things, will ring in changes. An understanding of how the of budget will impact banks will be an interesting study.

The budget has a reform focus but a human face. The thrust given to agriculture credit will positively impact more than 65% of the population. Improvements in the micro-finance sector will help in poverty alleviation, and change the life of the poor for the better. There is increased emphasis on rural credit on the one hand. On the other, there are proposals to bring about a long overdue reform in SLR, changes in definition of security, enabling MBS and trading thereon, making possible demat trading in "gold securities", opening the preference share capital route to banks and most importantly allowing changes in the Banking Regulation Act. It makes for an interesting bill.

The tax on cash withdrawals beyond a threshold level, has been introduced to encourage the cheque habit. Another objective is to track cash transactions so as to discourage the black economy. It appears that banks may not welcome the move at this stage, which is transaction intensive.

A discussion of some of the tax proposals and their impact on banking sector follows.

Corporate tax: Corporate income tax for domestic companies is being reduced to 30 pc. The ten per cent surcharge continues. Minimum Alternate Tax will continue. Simultaneously there are certain changes in the depreciation rules and imposition of fringe benefit tax. It is argued that reduction in tax rate is more than offset by other changes. (It is believed that some of these proposals may undergo modifications.) The general sense though is that the proposed changes are beneficial and will improve the cash flow of coporates and help in credit management of banks.

Reforms in Banking: RBI will prepare a roadmap for banking sector reforms and the Government will introduce a comprehensive amendment to the Banking Regulation Act. The government is keen on making the Indian banks larger in size so that they compare with international banks and can compete with them. More foreign direct investment is also being allowed in private banks alongside increase in voting rights. There will be significant changes in the banking scenario. One can look forward to introduction of steps that will eventually make banks comply with Basel II. It is hoped that RBI will keep in mind that Indian Banks will have to undertake developmental finance. The introduction of OTC traded derivatives could be useful in managing the risk associated with development finance. The roadmap will also aim at improving competition among nationalized banks.

Sugar Industry: Sugar Sector has been, in the past few years, reeling under price risk and continuous drought in many parts of the country. Government has accepted the recommendations made by Tuteja Committee Report on Sugar industry and a financial package for revival of sugar factories with a two-year moratorium having regard to their commercial viability has been announced. As many of the sugar factories are treated as NPA s in the books of banks, the package will help restructure the accounts. The suggestion that the ROI on these loans may be given a re-look augurs well for the sector wherein certain banks have been charging very high rates.

Credit delivery: Presently formal institutions account for a major share of credit disbursement in the country. At the village level we have PACS. (numbering nearly a lakh but many being unviable). There are a large number of branches of Commercial Banks and RRBs. The Finance Bill, following recommendations of the National Commission for Farmers under the Mission 2007, has proposed that knowledge centers/kiosks be set up in villages (for education and health management). The Finance Minister has stated that banks could use such centers as agencies for lending. MFI's could also take up agency based lending. It may be recalled that Post Offices were previously identified for purveying rural credit. It is expected that sum of these measures will result in increasing rural credit outreach. Identifying more and more such units for rural credit is a timely warning for the coop sector to clean up their act and fast.

Co-op Credit Delivery System: It is well known that ST cooperatives are not in best financial health. Yet they purvey a large share of rural credit. A task force had gone into these aspects and Government has accepted its recommendations on reforming cooperative banks. The main features of the recommendations are restructuring of the accumulated debt and changes in legal framework to enable RBI to enforce prudential norms and strengthen the capital base of these cooperative banks. The recommendations will be implemented if the State Governments come forward to accept these recommendations and implement legal and administrative reforms.

Agricultural Credit: In June 2004, MOF had announced a thrust on agricultural credit with a target of 30% growth in lending. As against the target of Rs 1.05 lakh crore of Agricultural credit this fiscal, as much as Rs 1,08500 crore has been disbursed. It has now been indicated that banks will be asked to increase agricultural credit by another 30 per cent in the current year.

Micro finance Sector: The Union Budget 2005-06 has several positives for the Indian micro finance sector. The initiative to enhance the role of micro finance institutions (MFI) is a step in the right direction in channeling credit to the economically challenged. The budget proposals will enhance availability of equity and debt funding, strengthen bank-MFI relationships, and open up opportunities in micro-insurance. "Access to equity capital" has been one of the constraints facing many MFIs and non-governmental organisations involved in micro finance (NGO-MFIs). To address this need, it has been announced that scope of NABARD-managed Micro finance Development Fund is being expanded to include equity contribution to MFIs. Corpus of the funds is also being increased from Rs. 100 Crores to Rs. 200 Crores. This measure is expected to address the problem to some extent.

Further, qualified NGO-MFIs may now access external commercial borrowings (ECBs), enabling them to diversify their funding profile. Reopening of this funding avenue will enable additional flow of funds to the sector, which critically needs low-cost funds to reach out to the economically challenged in rural and semi-urban areas. As a consequence foreign micro finance investment funds will be able to increase their exposure to Indian MFIs.

The proposal to allow commercial banks to appoint MFIs as "banking correspondents" is expected to strengthen bank-MFI relationships and enable MFIs to reach out to more rural people. Over the years, successful MFIs have demonstrated their appreciation of local dynamics, enabling them to offer customised services tailored to local needs. In a situation where a large number of rural poor do not have access to finance or credit functions of a bank, this move will enhance access of the rural populace to formal sources of finance. While some large MFIs are already channeling insurance for their customers, the proposal to invite MFIs, NGO-MFIs and other entities to act as micro insurance agents will translate into benefits such as improving insurance density and mitigating credit. It will also enable MFIs and NGO-MFIs to generate fee income.

Indian securitisation market: The recognition of pass through certificates (PTCs) as securities under the Securities Contracts Regulation Act (SCRA) is a crucial first step towards listing and trading of securitised debt. The listing of securitised debt will facilitate trading in such instruments, boosting secondary market liquidity. Recognition of securitised debts, as securities will provide these with much-needed acceptance, besides bringing them into the mainstream of financial instruments used by the market.

Globally, securitisation markets have grown on the back of robust legal, tax and regulatory frameworks. The Indian markets have not, so far, had the benefit of such legislation. Proposal that an Expert committee to provide a comprehensive framework for securitisation will be constituted is a vital initiative in developing a comprehensive framework for securitisation transactions.

Bank mergers: The finance bill has indicated that there will be some tax benefits on merger for banks. The merged entity can set-off and carry forward of loss and unabsorbed depreciation (of the weak bank). A new section (72AA) in Income Tax Act will allow carry forward and set off of accumulated loss and unabsorbed depreciation allowance in an approved scheme of amalgamation of banking company. As of now, only companies enjoy the benefit of setting off losses against profits between two merged entities. The proposed amendment will be effective retrospectively from 1st April 2004 and will benefit Oriental Bank of Commerce for merger of Global Trust Bank with it. This could pave way for future mergers of weak and strong banks.

Preference Shares: Banks will be allowed to raise funds through Preference Shares (without voting right) for their TIER II capital requirement. Banks may have cost advantage on raising capital through the issue of preference share vis-à-vis a public issues. This will be the one more way to shore up their capital base to take care of higher capital requirement on account of BASEL II norms. Banking Regulation Act will be suitably amended. Reserve Bank of India and SEBI will issue detailed guidelines for the preference shares issue by banks.

Preference capital may be cheaper than a public issue due to savings in the cost of book running, merchant banking fees, advertising and publicity, stationery, courier charges and postage, which are high in the case of a public issue. Cost of servicing capital will also be low on account of lower number of investors. Banks who have announced access to equity market in 2005-06 may consider this option.

OTC Derivatives: Finance Bill has proposed amendments to the Securities Contract Regulation Act to facilitate trading in over the counter derivatives. So far, OTC derivatives are not permitted under SCRA though OTC transactions are permitted on a spot basis. It is well known that OTC contracts do not have advantage of transparency as available in exchange traded contracts. OTC derivatives will get the legal validity on amending the definition of securities as defined in the Act to include OTC derivatives. It will facilitate the Banks to hedge their exposure, mainly on lending against shares, through OTC derivatives. It will open up another avenue to hedge the risk outside the market. It is important that adequate caution is exercised in developing and trading OTC derivatives with good risk management practices in the form of exposure limits and disclosure policies such that banks do not hurt themselves.

SLR and CRR: RBI has been given the freedom for prescribing varying levels of SLR to different banks. Lower SLR will help banks to move out of gilt-edged securities to unlock funds and redirect it to lending activities. This initiative will also help banks to manage their liquidity with greater flexibility.

Stamp duty on Commercial Paper: Stamp duty payable by Corporate on issue of commercial paper is being rationalized. Currently, stamp duty payable on commercial paper by corporates is approximately four times that payable by a bank (i.e. if the issuer is mutual fund or insurance company). This move may affect the business of banks as a corporate may now access the CP market direct for their working capital requirements without the intervention of a banker. They may also reach out to a wider investor market.

Golden Opportunity: It is announced that SEBI and RBI would together work out the modalities for trading of yellow metal (i.e. GOLD) in paper form. This will help households buy and sell gold in units for as little Rs 100. For this idea to be implemented, gold will have to be securitised and traded in the demat form. Banks will have opportunities to start functioning as Gold Depository. This is a good business opportunity.

Securtising old loan and listing thereof: Previously SARFAESI Act had enabled securitisation of banks' dues for recovery purposes. The Act did not enable securitisation as a financial tool. Banks and Housing Finance Companies can now raise cheap funds by securitising loans and listing them on exchanges. This will be facilitated by amending the definition of security to include "Mortgage-backed securities" (MBS) as security in the SCRA 1956. An active market for securitised debt will improve home loan markets and provide a direction for banks to price their loan products. Ultimately customers should benefit, as this sector, which has a good recovery rate, has not got the benefit of a lower ROI. This will give a fillip to a long-standing demand for MBS as a traded instrument.

These are some of the budget related issues. Before I conclude I wish to comment on the economic survey vis a vis the budget.

Economic Survey is an exclusive domain of the finance ministry and articulates developments/views that give rise to optimism and hope and those that could cause concern. One can interpret the survey's position on issues as a signal on initiatives that will be taken in the Budget. For the current year it was evident that fiscal consolidation was top of the list and since this is within the ministry's domain, was clearly top priority in the Budget. The statement had set a basic tone of cautious, calibrated adjustment, driven by the need to balance tax rationalization while simultaneously maintaining a revenue flow. As regards tax reforms, the signal was clear that indirect taxes, which constitute the bulk of revenues for both central and state governments, would be rationalised, but only gradually. It was evident that there will be certain direct tax reforms by phasing out exemptions, but no explicit commitment to a lower rate which would have been a logical consequence. What was emphasized was the increased use of technology to identify taxpayers and match declarations with payments. There is also a mention of aligning customs duties to ASEAN levels, which has been discussed for many years now, but in the current context, may not be possible as it would result in a lowering of the peak rate. The tax proposals were in alignment with the above reading.

The second issue that was given prominence in the economic survey was the efficiency of the financial sector. In terms of the basic objective of increasing access to and lowering the price of credit to all classes of consumers, be they farmers, businesses or consumers, the budget was expected to give an aggressive push towards facilitating consolidation amongst public sector banks as well as a more liberal position on foreign ownership and control. These are not directly referred to, of course, but are logical implications of the goals for this sector.

The third issue is FDI. The survey argues for increasing foreign investment, both of the direct and portfolio varieties. It states that the India is well positioned to capture the potential benefits from these flows and not vulnerable to possible or negative impacts. In particular, insurance, coal mining, construction and retail trade are likely to generate significant benefits with the entry of foreign investment. This is in line with the path of reforms. At the same time it is possibly one of those things that may not happen immediately.

Three other priority issues that the survey has listed are infrastructure, agricultural reforms and exit barriers. These are areas where the limited span of control of the ministry is going to be a constraining factor in implementation.

Though MOF had greatly facilitated the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, legislated in 2003, constraints due to labor laws on retrenchment and lack of flexibility on land redeployment have come in the way of realizing full potential of the Act.

The survey's discussion on infrastructure points out to the need for creative combinations of public and private activity, such as the minimum subsidy bid approach. Developing viable business models in these sectors would depend on supportive policy form the respective ministries, both at the central and state levels.

Higher investments in agriculture and rural sector are absolutely essential if agricultural productivity is to be maintained. The survey, therefore advocates certain a changes in the agriculture sector in areas such as price support, input subsidies and the like. It brings home the point that had not funds/ resources been gobbled up by subsidies higher investments in rural infrastructure would have been possible.