What went wrong with RRBs?
Originally, the Regional Rural Banks were conceived as low cost institutions having a rural ethos, local feel and pro poor focus, but these original assumptions were belied as within a very short time, most banks were making losses.
In the initial decade of their existence the regional rural banks were operating on the basis of a policy frame work that they will lend only to the weaker sections of rural society, charging lower interest rates, opening branches in remote and rural areas and keep a low cost profile.
RRBs had been allowed 100 per cent refinance on their lending so incentives for internal resource mobilization were, therefore, absent.
Expansion of Business without making any analysis of margins available in each segment of the banking business also proved to be an imprudent practice.
Initially the branch network of RRBs expanded very fast. By the end of year 1985 RRBS had opened 12606 branches. During this period their credit deposit Ratio (C.D.R) expanded very fast. In 1976 it was 165% and gradually declined to 104 & December 1986. The Credit Deposit Ratio continuously declined thereafter.
First Committee to raise a question on the RRBs was the Khusrau Committee of 1989, which was of the view that “the weaknesses of RRBs are endemic to the system and non-viability is built into it, and the only option was to merge the RRBs with the sponsor banks.
The objective of serving the weaker sections effectively could be achieved only by self-sustaining credit institutions.
The Khusrau Committee which was also known as Agricultural Credit Review Committee made an argument that RRBs have no justifiable cause for continuance and recommended their mergers with sponsor banks.
But, this was a challenging and politically risky move for the government, so the government dumped the report and no issues were debated publically.
Once again, the Committee on Financial Systems which is called First Narasimham Committee again raised the question on the financial viability of the RRBs and highlighted the poor financial health of the RRBs.
By 1993, 172 of the 196 RRBs were recorded unprofitable. The paid up capital which was ` 25 Lakh at that time was not able to absorb the loan losses of most of the RRBs. The loan recovery was around 40%.
The First Narasimham Committee recommended that –
RRBs should be permitted to engage in all types of banking business and should not be forced to restrict their operations to the target groups.
This proposal was readily accepted by the government.
In the same report, there was a reiteration of the Khusrau Committee recommendations but now in a slightly modified form.
The first Narasimham committee recommended that there should be mergers of the RRBs with their sponsor bank, BUT the “sponsor banks might decide whether to retain the identities of sponsored RRBs or to merge them with rural subsidiaries of commercial banks to be set up on the recommendation of the committee”.
However, this recommendation was put on hold for the moment.