09 January 2024 – The Indian Express

Changing Trends in India’s Banking Sector

• After nearly ten years of battling growing problems with bad loans, India’s banking industry has shown signs of recovery recently. The industry is currently in a more stable position because of the proactive actions taken by banks and the combined efforts of policymakers.
• However, taking into account past trends, the upward trajectory of Indian banks is still vulnerable to the influence of monetary policy and outside factors like geopolitical threats.

What Changes Have Indian Banks Seen Over Time?

Prior to 1947, the First Generation of Banking:  

• Before independence (until 1947), the Swadeshi Movement gave rise to a large number of small, neighbourhood banks, the majority of which failed mainly because of internal frauds, linked lending, and the combination of banking and commercial operations.

Banking in the Second Generation (1947–1967):

• Indian banks made it possible for resources that were mobilised through retail deposits to be concentrated towards a small number of business families or groups, so obstructing the flow of credit to the agriculture industry.

Banking in the Third Generation (1967–1991):  

• By establishing priority sector lending in 1972 and nationalising 20 significant private banks in two stages (1969 and 1980), the government was able to effectively sever the connection between business and banks.
• The shift from “class banking” to “mass banking” was brought about by these policies, which also had a positive impact on the large-scale development of branch networks in rural India, the significant mobilisation of public deposits, and the rise in credit flow to the agricultural and related industries.

Banking in the Fourth Generation (1991–2014):  

• Significant reforms were put into place during this time, such as the granting of new licences to foreign and private banks in an effort to increase efficiency, boost production, and bring competition.
• Using technology, enacting prudential requirements, providing operational flexibility with functional autonomy, giving top priority to putting best corporate governance practices into effect, and strengthening the capital base in compliance with Basel norms were all part of these developments.

Present Model:  

• In an effort to achieve financial inclusion, the banking industry adopted the JAM (Jan-Dhan, Aadhaar, and Mobile) trinity in 2014 and licenced Payments Banks and Small Finance Banks (SFBs) to obtain last-mile connection.

What is the Indian banking system’s current state?

Context:

• Bad loans put Indian lenders in a terrible condition not very long ago, which caused stressed assets to soar. In particular, government-owned banks were impacted, with 14.6% of gross non-performing assets.
• The 4R strategy—Recognize NPAs publicly, Resolution and recovery, Recapitalization of PSBs, and Reforms in the financial ecosystem—was put into place by the government and RBI in response to these difficulties.
• In 2023, the Indian banking industry underwent a stunning turnaround, following nearly a decade of struggling with challenges related to bad loans and a furious government.

Enhancing Asset Quality and Profitability:

• The gross non-performing assets (NPA) ratio of Indian banks fell to 4.41% in FY23, the lowest level since March 2015. The combined profit for PSBs exceeded Rs 1 lakh crore.
• The capital-to-risk-weighted assets ratio (CRAR) for scheduled commercial banks is a respectable 16.8%, according to the RBI’s Financial Stability Report, which highlights the banks’ sound financial standing.
• This highlights the strong financial standing of Indian banks, which speaks well of their capacity to take on possible risks and uphold systemic stability.

Sturdy Financial Measures:

• When it comes to money that is available for lending, banks have high levels of liquidity. In spite of the Reserve Bank of India’s current monetary policy of “withdrawal of accommodation,” banks continue to maintain a Liquidity Coverage Ratio that is at least twenty percent over the regulatory minimum.
• Major banks that have the ability to lend “higher for longer” include SBI, PNB, and Union Bank; their credit-to-deposit ratios are less than 72%.

Risk of Capital Investments and Infrastructure:

• It is advised that banks establish internal exposure limitations in accordance with the fiscal and financial evaluations of each State.

Retail and Stock Market Exposure Risk:

• To mitigate this growing risk, it is advised that retail portfolios undergo thorough stress tests and integrated oversight.

Linked Difficulties in Lending and Governance:

• One major concern is the potential for default to spread like wildfire because of interconnected loans and weak governance standards.
• It is important to emphasise that focused risk monitoring is required and that regulation cannot replace sound governance.

SME Obstacles in a World That Is Re-Globalizing:

• Small and medium-sized firms (SMEs) may encounter challenges from the re-globalization of the world and geopolitical upheavals, particularly in light of Free Trade Agreements (FTAs) and regional ambitions.
• Banks must carefully evaluate and get ready for any threats to SMEs while taking potential cash flow disruptions into account.

Shifting the Face of Liabilities:

• Bankers must exercise prudence and caution in light of the structural shift in Indian savings, which calls for close observation under favourable circumstances.

How Can We Strengthen the Indian Banking Sector Going Forward?

Establishing Large Banks:

• The significance of India having three or four major commercial banks with a presence both domestically and globally, in addition to foreign banks, was emphasised in the Narasimham Committee Report (1991).
• The second tier can consist of a large number of mid-sized banks having a broad reach throughout the economy, including specialty institutions.
• The government has already consolidated several PSBs and started steps to create organisations like a Development Finance Institution (DFI) and a Bad Bank in accordance with these recommendations.

The necessity of differentiated banks:

• Although the universal banking model has been widely supported, separate banking organisations are required to cater to the specific requirements of various clients and debtors.
• In essence, these speciality banks will open up financial access in niche markets including retail, MSMEs, and agricultural.
• Furthermore, by establishing the proposed DFIs or specialty banks as specialised organisations, better asset-liability management would be made possible and they would have access to inexpensive public deposits.

Blockchain-Based Finance:  

• It is possible to accomplish improved risk management, and neo-banks can use this technology to further digital financial inclusion and help the growing aspirations of a burgeoning India.
• The application of blockchain technology in the Indian banking sector has the potential to streamline prudential supervision and improve monitoring and control over institutions.

Taking Moral Hazard Under Consideration:

• Public sector bank failures have been rare up until now, mostly because of the hidden sovereign guarantee, which has increased public confidence. However, this guarantee is called into question by the PSBs’ growing privatisation.

Integration of ESG:  

Improving Financial Establishments:  

• In order to mitigate vulnerabilities, the government ought to improve regulatory policies by allowing banks to create diverse loan portfolios, designating regulators for certain industries, and offering them more power to deal with willful defaults.
• Moving away from a bank-centric economic model is necessary to create a responsive banking system in a dynamic real economy. This can be achieved by encouraging the expansion of the corporate bond market.

Improving Models of Risk Management:

• To evaluate possible risks related to lending to State government entities and infrastructure projects, develop and execute State-specific internal risk models, akin to the Bank Exposure Risk Index.

Handling Modifications to Liabilities:

• Acknowledge how the increasing trends in consumption and digitization are affecting the form of liabilities. Create plans to adjust to changes in retail deposit patterns, particularly in Tier 1 and Tier 2 centres.

Way Forward:

• While we should be happy for the banking industry’s current success, we also need to be proactive and watchful in order to deal with the challenges and uncertainties of the modern world.