All You Need To Know About Much-Needed Banking Reforms In India

The banking sector is one of the centers for all the economic activities in the country. A small change in its regulations can affect the entire economy. The banking sector helps the country boost its economy by capital accumulation, mobilizing, and allocating the capital for alternative uses.

One of the objectives of the country’s economic policies should be to improve the operational efficiency and upgrade the health and financial soundness of the Indian banks. Thus, various banking sector reforms have been introduced in India to promote economic liberalization and globalization. These reforms assure that Indian banks can meet internationally accepted standards of performance.

History Of Banking Sector Reforms In India

Even after independence, Indian banks used to be urban-oriented. They were out of reach for the rural population. A large section of the population had to rely on moneylenders as their resort for credit or loans. So, the government decided to nationalize 14 major private banks in India in 1969. The second such nationalization was done in 1985.

In 1991, the Narasimham Committee was appointed to restore the health of commercial banks and make their functioning profitable. The committee recommended major changes in economic policies which came to be known as the first-generation banking sector reforms in India. Many of these structural reforms have been implemented by the government of India.

In 1998, the Narasimham Committee was set up again in order to review the progress of banking sector reforms in India. The committee suggested that it would be beneficial to take into account market risks along with credit risks for capital adequacy requirements. There were various other recommendations regarding Non-Performing Assets, prudential norms, banking structure, etc.

Although the banking industry in India has been through massive banking frauds and increasing non-performing assets in the last five years, the banking reforms that started in 2015 have achieved a lot till now.

The merger of Public Sector Banks is in progress. However, restructuring of operations in order to increase efficiency and accountability of PSBs still needs to be done. So, this is the right time for implementing much-needed reforms to lift the distressed banking industry in India.

Reasons Behind Banking Reforms In India

The Indian economy has been subject to a series of difficulties such as persistent fiscal imbalance, double-digit inflation, and the balance of payment crisis, etc. At present, the industry debt is already at an all-time high and banks definitely cannot afford more NPAs. This means banking sector reforms are needed that will aim to:

• Bring structural changes in the banking system
• Make Indian banks Internationally competitive
• Improve the efficiency and stability of Indian banks
• Remove the operational rigidity in the credit delivery system

Prime Concerns For Much Needed Banking Reforms In India

Former RBI Governor – Raghuram Rajan and former Deputy Governor – Viral Acharya, in their recently published paper, have suggested ways to tackle problems of the Indian banking sector. Here are some of the main concerns they brought up:

1. Handling Bad Loans

Banks should develop an online platform for distressed loan sales to provide real-time transparency. An out-of-court restructuring framework needs to be designed for hosting negotiations between banks and creditors of stressed firms. Private firms should be encouraged to aggregate and recover loans in sectors where government interference isn’t necessary.

2. Boosting The Performance Of Public Sector Banks (PSBs)

Public Sector Banks should be operated independently according to their objectives so that the government can keep an adequate distance from the management of PSBs. Payments such as reimbursing costs for maintaining branches in remote areas should be provided by the government. It will encourage both private and public sector banks to compete for delivering on mandates. Incentive structures for management need to be strengthened to bring in state-of-the-art ideas.

3. Altering Ownership Structure Of Public Sector Banks

Ownership structures of select PSBs can be altered, where the government has brought down stakes below 50%. This will create a safe distance between the government and bank operations, improving governance. Re-privatization can be undertaken to bring in private investors who have both financial and technological expertise.

4. Improving The Lending And Capital Structure

Better capital structures need to be created for the long-term financing of infrastructure and industrial projects. Borrowers should be allowed cash-flow based lending along with asset-based lending. Transparency around frauds and group exposures should be implemented, both at the bank level and system level to discourage asset-stripping and cash-flow siphoning.

5. Strengthening Risk Management

There should be a complete external benchmarking of loans to all the market-based floating rates in order to create an automatic pass-through of monetary policy. This will promote natural interest-rate sensitivity on bank balance-sheets.

6. Creating Greater Variety In Banking Structures

On-tap licensing can be availed for banks with an annual invitation for applications. It will allow entry for better players and create more vibrant banking. This will help high-performing small finance banks to become universal banks. Likewise, poorly performing universal banks can be demoted to a lower status.

Conclusion

These are the long-overdue reforms that are more optimistic and achievable rather than being revolutionary. While revolutionary ideas have little chance of implementation, these proposals will surely bring the changes that are needed in the Indian banking sector.