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Why India’s banking sector is among the most vulnerable in G-20 economies today

Why India’s banking sector is among the most vulnerable in G-20 economies today

Context:

When the Indian economy and its banking sector emerged relatively unscathed after the global financial crash of 2008, India’s financial system became the envy of the world. That seems a distant memory today as the banking sector of the country reels under one of the worst crises it has faced in a long time. A mounting pile of bad loans, poor accounting standards and growing evidence of lax supervision and banking fraud—unearthed over the past few weeks by several government agencies—highlight the deep rot at the core of India’s financial system.

Increase in non-performing assets:

  • In 2009, India had among the lowest ratio of non-performing assets among the largest economies of the world, which form the elite G-20 club. Eight years later, it has among the highest ratio of such assets.
  • The fact that India’s bad loan ratio looks grim today has a lot to do with the fact that India’s central bank has been prodding banks to recognize such toxic assets over the past few years—after long years of quiet forbearance. Be that as it may, the rise in bad loans and the lack of adequate provisions has put Indian banks in a tight spot now.

Capital adequacy

  • India’s banking sector lags those of most other large economies in terms of capital adequacy. Capital adequacy refers to the ability of a bank to withstand significant losses on its risky assets. India fares poorly in this regard despite a relatively conservative loan-to-deposit ratio.
  • The actual capital adequacy in Indian banks might be much worse than reported.
  • The IMF had conducted stress tests on India’s fifteen largest banks—12 public sector banks and three private banks—last year. In its report released in December, the IMF said the overall system is quite resilient and 64% of the assets of the top 15 banks are with the ‘resilient’ ones.
  • But the other banks, comprising the remaining 36% of assets, will find themselves in a precarious position even under baseline assumptions.

P.J. Nayak committee:

  • A committee to examine the weakness in state-owned banks and to suggest reforms was set up by the Reserve Bank of India more than four years ago under the chairmanship of P.J. Nayak. The Nayak committee submitted its report almost at the same time as the National Democratic Alliance (NDA) government was sworn in, during the summer of 2014.
  • Yet, three-and-a-half years down the line, very few of the committee’s recommendations have been acted upon.
  • The Nayak committee had recommended diluting the stake of the government in PSBs below 50%, so that banks could be freed from external vigilance emanating from the Central Vigilance Commission, the Right to Information Act, and from government constraints on employee compensation. It also proposed creation of a Bank Investment Company to act as the holding company for various PSBs.
  • However, there has not been much progress in reforming the way PSBs are governed. The newly constituted Banks Board Bureau too has been unable to make much of an impact.

Way forward:

Unless the government undertakes structural reforms to overhaul the way in which state-owned banks are managed, they will continue to be the Achilles heel of the Indian financial system, dragging down growth and investments over the long term.

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