3-January-2024-Special-Article

BANKS ARE FINE, BUT THERE ARE RISKS

In recent times, India’s banking system has experienced a noteworthy resurgence after grappling with bad loan challenges for nearly a decade. This positive transformation is attributed to the collective efforts of policymakers and proactive measures taken by banks, positioning the sector on a more secure footing. However, historical patterns and external uncertainties, such as geopolitical risks, pose potential challenges to the positive trajectory.

Evolution of Indian Banks Over the Years:

• First Generation Banking: Pre-Independence era led to the establishment of small, local banks due to the Swadeshi Movement, facing challenges like internal frauds and interconnected lending.
• Second Generation Banking (1947-1967): Indian banks consolidated resources towards a limited number of business families, overlooking credit flow to the agriculture sector.
• Third Generation Banking (1967-1991): Nationalization of major private banks and introduction of priority sector lending led to ‘mass banking,’ expanding branch networks and credit flow to agriculture.
• Fourth Generation Banking (1991-2014): Significant reforms included new licenses to private and foreign banks, leveraging technology, adopting prudential norms, and fortifying the capital base.
• Current Model (2014 onward): Embracement of the JAM (Jan-Dhan, Aadhaar, and Mobile) trinity and granting licenses to Payments Banks and Small Finance Banks for financial inclusion.

Current Status of the Indian Banking Regime:

Background:

• Recent history saw bad loans causing stressed assets, particularly affecting government-owned banks with gross NPAs reaching 14.6%.
• A 4R strategy—Recognize NPAs transparently, Resolution and recovery, Recapitalization of PSBs, and Reforms—was implemented by the government and RBI.

Profitability and Asset Quality Improvement:

• Gross NPA ratio in FY23 dropped to 4.41%, the lowest since March 2015.
• PSBs collectively crossed the Rs 1 lakh crore-mark in profit.
• RBI’s Financial Stability Report indicates a robust Capital-to-Risk-Weighted Assets Ratio (CRAR) of 16.8%.

Policy Reforms and Financial Discipline:

• Eight years of reforms focused on credit discipline, responsible lending, improved governance, and technology adoption.
• Mergers of PSBs contributed to reducing NPAs.

Robust Financial Indicators:

• Banks exhibit strong liquidity levels despite the RBI’s recent monetary stance.
• Major banks demonstrate a capacity to lend “higher for longer.”

Obstacles Ahead for the Indian Banking Sector:

Infrastructure and Capital Investments Risk:

• Bank lending for infrastructure and capital investments poses risks due to stretched State finances.
• Internal exposure limits based on fiscal assessments of States are advised.

Stock Market and Retail Exposure Risk:

• Runaway stock market poses risks to retail exposures.
• Integrated supervision and stress tests on retail portfolios are recommended.

Interconnected Lending and Governance Challenges:

• Default contagion risk due to interconnected lending and lax governance norms.
• Focused risk monitoring emphasizing good governance is necessary.

SME Challenges in a Re-Globalizing World:

• Re-globalization and geopolitical shifts may challenge SMEs.
• Banks need to assess and prepare for potential risks, considering disruptions to cash flows.

Changing Liabilities Landscape:

• Digitization and evolving consumption trends impact retail deposits.
• Structural shift in Indian savings requires caution and prudence.

Fortifying the Indian Banking Sector Moving Ahead:

• Building Big Banks: Implementation of Narasimham Committee Report (1991) to establish three or four prominent commercial banks. Consolidation of PSBs and establishment of entities like Development Finance Institution (DFI) and Bad Bank.
• Differentiated Banks: Establishment of distinct banking entities to address the unique needs of diverse customers and borrowers. Specialized banks for retail, agriculture, and MSMEs to facilitate financial access.
• Blockchain Banking: Implementation of Blockchain for enhanced risk management and digital financial inclusion.
• Addressing Moral Hazard: Emphasis on increased individual deposit insurance and efficient orderly resolution mechanisms. Reducing moral hazard and systemic risks.
• ESG Integration: Distinctive Banks listing on reputable stock exchanges and embracing ESG framework.
• Enhancing Banking Institutions: Refining regulatory measures to enable diversified loan portfolios. Granting regulators increased authority to handle deliberate defaults.
• Facilitating Corporate Bond Market Growth: Promotion of corporate bond market growth for a responsive banking system.
• Enhancing Risk Management Models: Development and implementation of internal risk models tailored to individual States.
• Addressing Changes in Liabilities: Recognition of changing liabilities influenced by digitization. Strategies to adapt to shifts in retail deposits.

Conclusion:

While celebrating the current success of the banking sector, a proactive and vigilant stance is crucial to navigate the complexities and uncertainties of the times. The recommendations for fortifying the sector emphasize adaptability, innovation, and responsible governance to ensure sustained growth and stability in the dynamic economic landscape.

Mains Question:

1. Despite the recent strong performance of the Indian Banking sector, there are specific risk factors that could present potential challenges. Discuss these challenges in detail and propose appropriate measures to address them. (150 WORDS)