Creating an enabling environment for banking sector
The Indian banking scene has undergone a sea change in the last couple of years which can be said to have given us an augmented financial reality. The changes have been in three main directions, though there have been some parallel enabling developments as well. The cumulative and combined impact of these would work out over years to strengthen the financial sector.The first and foremost change is the extension of its reach. The prime minister’s Jan Dhan scheme entailing opening of bank accounts for every adult Indian, irrespective of economic status, was an act of faith. Banking, as it was generally viewed, was the prerogative of only those who had money. However, under the Jan Dhan scheme even those without any stable and steady income, or those who did not possess most of the standard reference points, were allowed to open bank accounts.These zero-balance new accounts later on proved to be good enough for banks as well. Because as the government started remitting the welfare benefits of the poorest to their bank accounts, they no longer remained zero balance. The direct transfer of benefits stopped leakage of funds to the real beneficiaries as well, bringing about a real metamorphosis in distribution of welfare. The large number of these accounts would surely help foster an all inclusive financial system.Secondly, the government has set about strengthening the institutional structures for the banking sector. Two major steps could be cited in this sphere. One is the new emphasis on professionalization of public sector bank boards. Even today, the public sector banks are the bulwark of Indian financial system and the professionalization of their boards could not be overemphasized.We have seen earlier how the bank boards were filled in with those who did not have any expertise or knowledge of banking or financial sector. They were there only because they were aligned to the ruling political dispensations of the time. We have seen governments filling in PSU bank boards with their nominees at the penultimate stages of their tenure. In one instance even the Election Commission had to issue directives preventing hasty appointments to bank boards.Since most of these were political appointees, there were instances of board members seeking to influence credit decisions. Even those not credit worthy could get bank funds. No wonder many of these borrowers subsequently failed to return their loans.Creation of the institutional mechanism for selection of board members should hopefully result in strengthened bank boards. The selection committees could be expected to pick up only those who are qualified and have the requisite professional expertise. Selection of board members is no mean job with so many public sector banks whose boards will have to be filled periodically.The other institutional step taken recently has great policy import. Until now, the Reserve Bank’s monetary policy used to be formulated by a body which was principally advisory in nature to the RBI governor. In the end, the policy decisions used to be that of the governor rather than a collective decision of the governor and his policy council. A high level RBI committee had suggested modernisation of the monetary policy committee which collectively should decide the central bank’s policy stance.So, the Monetary Policy Committee (MPC) was instituted and since then the monetary policy decisions are the prerogative of this committee, where the central bank chief has a voting power along with other members. It may be stated that monetary policy is decided collectively thorough a committee in most of the advanced economies like the US or UK. This would take away scope for individual errors and one-track thinking.Another institutional innovation recently has been the introduction of diversity into Indian banking in two major ways. Firstly, the authorities allowed fresh banking entities which brought new ideas, players and competition on the ground. The new private sector banks are as yet fledgling. But surely, they are already showing their dynamism with a different approach to both deposit mobilization from hitherto neglected sectors and in giving funds to new smaller business units. The second institutional innovation in this area has been the infusion of specialized banks. Take for instance “Payments Banks”. Even a few years back, this kind of bank was inconceivable.Last, and most recently, the government has made a serious move in addressing the bulging bad debt portfolio of the public sector banks. At the time of writing this Article, the details of the steps being taken are yet not fully known; but the outlines are enough indication that this time it is a determined bid to settle this most vexed issue which could be threatening the very foundation of Indian banking sector.Flow of credit in an economy is like circulation of blood in a body. If the circulation gets clogged, body system collapses. Mounting bad debts can do exactly that: it can bottle up the flow of credit. Bad debt means you are locking up these funds from circulation and become a stagnant cesspool. How threatening this could be was illustrated by none else than the sudden eruption of “sub-prime loan crisis” and the resultant credit freeze striking American banks. The crisis itself then metamorphosed into the global financial crisis of 2008. These illustrations from financial history underscores the importance of resolving the issue of bad debts with banks. Banks’ balance sheets must be clean and robust; not encumbered and sick with bulging burden of bad debts.The recent ordinance empowering the Reserve Bank to directly intervene in individual banks for taking actions to resolving their bad debts portfolios is a significant forward movement. What has been happening is that individual bank managements were reluctant to take decisive steps with defaulting groups of companies and home in on a package. The fear of future allegations of corruptions against bank managements was one of the factors for inaction because any settlement of bad debts invariably involve some haircuts. With the RBI on board, driving measures against defaulting companies, the managements could become much bolder in handling such large corporate borrowers.Still no amount of specific actions can be successful unless an overall atmosphere of seriousness is created that the government and RBI means business. Fortunately, several other accompanying steps vindicate that. The most important among these is the creation of a legal framework for bankruptcy. Without proper bankruptcy laws, the cases against defaulting companies – and in many cases willful defaulters—used to drag for years. This would defeat the very purpose of moving against the defaulters. Now that the bankruptcy board is in place and specific time lines have been stipulated for action, one can hope the legal cases against default and non-payment of dues would be settled expeditiously.The end result of all these measures could be that Indian banking system now has the enabling environment for sound growth in the future. Hoe these pan out, we will now wait.