Is Indian Banking Sinking in Deep Trouble?

Posted in Finance Articles, Total Reads: 733 , Published on 28 March 2016

The Great Indian dream of becoming an economic superpower and a financial hub for the whole world to look up to, looks poised to pan out in the years to come. Major economic reforms and dramatic changes in the banking framework, initiated by the Government and the RBI, are all foundations for the now forward-looking Indian banking sector which finds itself faced with a crucial need to mature into a well-oiled machinery and a robust pillar for growth.

Now, that everything is in order, we’re ready to take that giant leap forward, that’ll most certainly make us a new, more commercialised, more business-friendly, more capitalist India. Or will it? Let us take a moment and talk about the elephant in the room. While it is true that our economy is stable and the path for our growth is well laid out, but that path is only one of the two that we are faced with. There is no point in looking through a pinhole and drawing conclusions. The foundation of our banking sector is on shaky ground, now more than ever, and these new ‘measures’ are only making us more vulnerable to collapsing like a house of cards. Pushing for economic growth and commercial development is very good, but not at the risk of finding ourselves in the midst of nothing but rubble when all of this ends.

Image: pixabay

The recent financial stability report of the RBI highlights these concerns, or atleast its symptoms. The state of the Indian banking sector is worsening. It is dying a slow death and its own hands are stifling it. The report outlines that the risks to the banking sector, based on its own past & current decisions, increased significantly since the last report. The increased risk has been fuelled by deteriorating asset quality, reduced profitability, falling efficiency & soundness, set in the backdrop of a generally slowing economy. Around 70% of the total assets of the Indian banking sector are held only by Public Sector Banks. This is worrying, given that the net NPAs of the PSBs have increased significantly. Going from March’15 to September’15, net NPAs are up from 2.5% to 2.8% (expressed a percentage of net advances).

These figures are even more bothering when we realise that the impaired assets of these banks at the end of September’15, have a value of more than 7 lakh crores, which represent around 12.6% of our total advances. This value stood at around 6 lakh crores only a year earlier. The public sector only has itself has to blame for this, as they have lent far too much money to far too many risky or unprofitable projects and organizations, in the past few years. It is primarily the badly managed infrastructure and steel companies that have wasted useful resources for construction & road projects, energy initiatives and setting-up factories and constitute a hefty portion of these NPAs. PSBs report a very high level of stressed assets (14.1 per cent), as compared to the private sector (4.6 per cent) and also foreign banks (3.4 per cent). While promoting energy and infrastructure is of utmost importance, it’s important to realise that economic growth is faltering owing to domestic and international factors, and accumulating an ever increasing quantity of NPAs and bad loans will cause the only potential financiers of an economic recovery, i.e. Indian banking sector , to sink deeper in trouble.

Allowing Government organizations and corporates to borrow more, even without very strong credentials and then also allowing them to pay late without pushing them too hard, might allow for some growth but in the Indian context, it risks way too many defaults. For many such banks, bad loans, NPAs and stressed assets added up to more than 14 per cent of their total resources by the end of June’15. Injecting new capital or infusion of collateral will be bad ideas in the current circumstances. They will suppress the symptoms of the deeper rot and keep the banking sector limping along, further worsening the problem and pushing it to the future. If such a thing happens, we can be sure that the more we push the inevitable, i.e. finding a quality solution, the bigger the collapse will be, if and when it happens. It’s very easy to say, in retrospect, that this is not the kind of growth journey we should have undertaken. But let us look at more viable ideas to inject some stability into the banking system, to manage the current veiled crisis and also for the future. First of all, I suggest that the Govt. should be willing to give up its controlling stake in all the major PSBs and allow privatization.

These PSBs need the Government’s resources and its support, but not its control and ideology. Privatization will introduce a more profit-driven approach, stricter quality control on acceptance of projects, better lending practices and increased efficiency. The top management of such PSBs might also need a revamp. These PSBs should also be willing to drop organizations who are hurting them, while the Government should be willing to kill organizations who have been sucking capital from the banks and the economy in general, but are sick and don’t look like they can be revived. Especially, if they are leverage heavy. These steps will pave the way for more refined lending policies. In turn, more refined lending policies will lead to higher quality credit. Better technology adoption and restructuring the banking framework are also viable solutions.

The Indian Banking sector is very well endowed with the capability to support India's flight towards development but because it is so important, a weak or even an anxious banking sector can spell doom for the nation. Whatever we do, we must ensure that it helps in the creation of a banking system that spurs growth and is able to stall the economic slowdown and any potential economic downturn. But looking at the far end of the road we've decided to tread upon, I only see a banking system that is the potential source of and not a protection against, an economic upheaval. Mr. Modi, Mr. Rajan and important banks like the State Bank of India are frantically searching for answers and trying to shoot down all our banking issues, but I fear that they're firing in the wrong direction. India's sweet growth story can go horribly sour if we don't wake up to our reality and the risks we face, immediately.

This article has been authored by Indroneel Das from IIM, Indore







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