Securitymen stand guard at the Reserve Bank of India during the RBI’s credit policy review meeting with bankers in Mumbai on Tuesday. India’s central bank raised its key interest rate by half a percentage point Tuesday, its ninth hike in just over a year, warning that persistent inflation has become a threat to growth in Asia’s third-largest economy. (File photo by Nagesh Ohal/India Today Group)
The importance of a robust banking sector cannot be overstated. Often, when banks have gone down, economies have come undone. It is the lifeblood of economic activity in a country. The last four years have been traumatic for this crucial sector as banks grappled with huge non-performing assets (NPAs) on their books. As of March 31 this year, India’s scheduled commercial banks had gross non-performing assets (NPAs) worth Rs 9.49 lakh crore.Asset quality of banks has improved with the recoveries and resolutions under the Insolvency and Bankruptcy Code (IBC), but it is still a work in progress.
As banks were forced to come out clean, what followed has been a process of improving the banking sector, largely dominated by government-run banks, with reforms that have been accompanied by a lot of pain in the sector.
Certain high-profile cases, like the Nirav Modi and Mehul Choksi case where bank officials worked in connivance with those who defrauded the bank-highlighted a major governance issue. It has not only eroded the public’s trust in the banking system, but has led bankers to tighten their purse strings for fear of getting falsely implicated in case a loan goes bad.
This Union Budget 2019-2010 will have to address this pain in the banking sector as the country’s economic growth hits a five-year low of 6.8 per cent. It will need to, firstly, spur credit growth in the conventional banking sector, second, address the issues of the non-banking financial sector and, third, make public sector banks more competitive through consolidation and governance reforms.
Bank recapitalisation: Most experts are of the view that the government should infuse more money into public sector banks in order to support credit growth. The interim budget this year had not provided any allocation for bank recapitalisation. With five banks still under the prompt corrective action (PCA) framework of the Reserve Bank of India (RBI), there are restrictions on lending operations. In 2018-2019, public sector banks had received Rs 1.6 lakh crore that helped five banks come out of the PCA framework and many expect finance minister Nirmala Sitharaman to announce a further succour in the Budget. “Recapitalisation has ensured that a number of public sector banks have the balance sheet strength to provide for reasonable haircuts on resolution of stressed assets”, said Crisil in a note.
Further, incentivising banks to buy good quality assets in non-banking financial companies (NBFCs) could help the financial sector which is reeling under a double whammy-a stressed banking sector and shadow banking sector that has literally collapsed.
Reviving NBFCs: India’s shadow banking sector lends to several businesses, from micro and small entrepreneurs to real estate developers and car dealers. Loans from the sector expanded as the conventional banking sector battled the NPA crisis. NBFCs have accounted for nearly a third of all new credit over the past three years.
The Budget will hopefully spell out what the government intends to do with the $42 billion (Rs 2.88 lakh crore) NBFC sector that came into the spotlight after Infrastructure Financing and Leasing Services Ltd (IL&FS), the nation’s biggest infrastructure lender, defaulted on debt repayments in 2018. Again, in June 2019, mortgage lender Dewan Housing Finance Corp delayed bond interest payments. The crisis in the sector has had a ripple effect in the economy, affecting liquidity in the financial system. Will the government announce a bail out for NBFCs ? Or will it let the NBFCs fail but announce measures to prevent a contagion effect on the entire financial sector? The Budget may have some answers for these, something the RBI has stopped short of putting forward. The focus will also have to be on further strengthening of regulation, supervision and risk management practices in both banking and the NBFC sector.
Consolidation: The government has already initiated the process of consolidation of public sector banks. Effective April onwards, Vijaya Bank and Dena Bank have merged with Bank of Baroda (BoB), making BoB the third largest lender. The three-way merger was the first step in the consolidation of the public sector banking industry, recommended in 1991 by the Narasimham Committee report. There are several small public sector banks that are not in the competition commercially and have a poor governance record. Consolidation, along with administrative and governance reforms, is expected to strengthen these banks.