Category: Indian Economy
Title: Banking Sector Reforms
Relevance: GS 3
Introduction
Banks are the lifelines of the economy and they play a crucial role in activating and sustaining economic growth, especially in developing countries like India. With financial inclusion being one of the pillars of Transforming India initiative banks play a major role in this through the schemes like Jan dhan yojana, Direct benefit transfer and mudra yojana.
Challenges that banks face today :
The banking sector is grappling with a set of new realities that are testing its strength and resilience. Challenges like NPAs, recapitalization, increase in bank fraud, asset quality, human resource issues, are dragging down the industry performance and threatening the future economic growth – this will have implications for both banks as well as for the economy.
Impact on economy due to rising bad loans
- For the banking system, the rise in bad loans led to higher provisions, which wiped away profits and necessitated more capital infusion.
- But fresh capital hasn’t been forthcoming with the government on a path of fiscal consolidation and trying to control deficits and because of these lending has slowed down to trickle.
- In 2016-2017, banks share in the flow of funds to the commercial sector dipped to 38 per cent. This has led to reduced investments, reduced production, unemployment, economic slowdown and finally decreasing economic growth rate.
RBI’s Initiatives taken to resolve bad loans
- RBI in June had directed the banks to take the 12 largest loan defaulters, accounting for one-fourth of the industry’s bad loans, to NCLT.
- It prepared another list of 26 defaulters and decided that before initiating bankruptcy proceedings, bad assets and they should be resolved through any of the RBI’s existing bad loan resolution schemes like S4A or SDR.
- It advised all PSBs to appoint internal ombudsman.
Central Government Initiatives:
- Banks Recapitalization
- The financial resolution and deposit insurance bill, 2017
- Panel to oversee PSU banks mergers
- Banks Board Bureau
- Indradhanush plan
- Merger of SBI associates with State bank of India
- Merger of Bharatiya mahila bank with SBI
- NPA ordinance
- Passage of Insolvency and Bankruptcy Code(IBC)
Bank Recapitalization:
Government announced a plan to infuse 2.11 lakh crores into public sector banks over a period of 2 years. Of this 1.35 lakh crores will be raised via recapitalization bonds and remaining 76,000 crores will be raised by the banks from market with budgetary support.
Benefits of Bank Recapitalization:
- Helps banks to compliant with Basel 3 norms.Banks will now aggressively pursue the loan recovery.Banks with weak balance sheet problems will get relief.
- Balances demand and supply by bringing more investments in sectors like infrastructure
- Help in efficiently managing risk and credit capital related requirements of banks
- Encourages private participation and boosts economic growth
- It will address both growth capital and capital required to absorb losses arising out of provisioning of NPAs.
Cons of Bank Recapitalization:
- It will be seen as a favor to big companies and some people among small entrepreneurs.
- This is only good if banks actually recognize losses otherwise it will cause extreme inflation.
- It will certainly not solve the structural problems.
The Financial Resolution and Deposit Insurance Bill, 2017:
- The bill seeks to create a consolidated framework for the resolution of financial firms.
- It repeals the deposit insurance and credit guarantee corporation act, 1962 and amends 12 other laws.
- The central government will establish a Resolution corporation.
- Risk based classification
- The bill specifies penalties for offences such as concealment of property, and destruction or falsification of evidence.
- The service provider will automatically be liquidated if its resolution is not completed within the maximum time period of two years.
Insolvency and Bankruptcy Code
It aims at putting in place safeguards to prevent unscrupulous, undesirable persons from misusing or vitiating the provisions of the code, the code provides a time-bound process for resolving insolvency in companies and among individuals (180 days after the process initiated, plus a 90 day extension for resolving insolvency).
Advantages of Insolvency and Bankruptcy Code
- It will be easy for companies to exit and revival of business. • Banks and financial institutions can easily handle the NPAs
- Create database of serial defaulters
- This will boost the economic growth
- It will remove burden from courts because adjudicating authority would be NCLT for companies and DRT for individuals and partnership firms.
Demerits of Insolvency And Bankruptcy Code
- It is yet to address the aspects such as lifting of moratorium in case of fraud.
- Option for management of affairs by corporate debtor under supervision etc.
Merger of SBI associates with SBI:
Pros:
- After merger it can withstand the strong competition from private sector, and accumulate more resources to channelize trained manpower across its branches.
- Cost benefits by the way of using already existing branches instead of setting up new branches and Economies of scale and reduction in cost of doing business.
- Visibility of the bank at global level increases.
 Cons:
- The associate banks have regional flavor and regional focus than the nationalistic SBI culture.
- Various internal conflicts related to pay, pension, promotion and other aspects may arise.
- After the merger , SBIs employee costs could increase by 23 crores a month.
- Negative impact would be from harmonization of accounting policies for NPA recognition.
Strategic Debt Restructuring
Under SDR, banks who have given loans to a corporate borrower get the right to convert the full part or part of their loans into equity shares loan taken in the company. The SDR gives banks more power in the management of the company who has taken loan and has defaulted.
Scheme for Sustainable Structuring of Stressed Assets (S4A)
The S4A scheme aims at deep financial restructuring of big debted projects by allowing lenders (banks) to acquire equity of the stressed projects. The S4A envisages determination of the sustainable debt level for a stressed borrower, and bifurcation of the outstanding debt into sustainable debt and equity/quasi-equity instruments which are expected to provide upside to the lenders when the borrowers turn around.
Criticism of Banking Reforms Initiatives:
Though government started with many big bang reforms in banking sector still the sector is suffering from many problems
- The Banks Board Bureau has been unable to manage the problem, the human resource issue at the banks remain unchanged.
- The seven pronged strategy to revamp PSBs “Indradhanush is seems to be falling apart.
- Banks recapitalization will hurt governments debt-to-GDP ratio
- Ballooning NPAs in the Indian system tell us that banks and regulators have failed to protect public money.
 Recommendations
- It is necessary to articulate in a comprehensive and transparent manner the policy in regard to ownership and governance of both public sector and private sector banks
- Banks should adopt latest technology and move towards paper less banking.
- The need of the hour is to understand the actual structural problems of the banking sector and improve the governance of the Public sector banks.
- RBI measures such as Strategic Debt restructuring(SDR) and Scheme for Sustained Structuring of Stressed Assets(S4A) among others should be implemented effectively.
- The competition from new banks and the large number of accounts opened under the Pradhan Mantri Jan Dhan Yojana are two instances that could be turned in to oppurtunities.
- Adopt 4Rs to address the stressed assets (Reform, recognition, recapitalization, resolution).
- Set up public sector asset rehabilitation agency (PARA) to take charge of large bad loans in banks.
- Gopal Krishna committee recommendations on recruitment, training, and staff transfer should be accepted.
 Conclusion
Banking system is the lifeline of the economic system in both developed and developing countries. So technologically advanced, transparent, responsible, and efficient banking sector is the need of the hour for India. Once these issues are addressed, the Indian banking sector has the potential to become further deeper and stronger. Greater attention to these issues would facilitate finance structure of the economy and in medium to long-term lead to broad based economic growth.
