Reforms in Public Sector Banks
- The Indian banking industry has undergone continual change, transitioning from an exclusive industry to one that promotes social change and financial inclusion. The financial sector, however, has faced numerous problems recently.
- For instance, the functioning of the Indian banking sector has been hampered by a reduction in asset quality, financial soundness, and efficiency.
- It is crucial to support fifth generation banking changes given the current issues of a growing population, the ongoing Covid-19 pandemic, and the West’s plan to move its manufacturing base to India and other countries.
The development of the Indian banking sector:
First Generation Banking:
- Numerous small and neighbourhood banks were founded during the Swadeshi Movement’s early years (from 1947 to independence).
- Internal scams, related lending, and the amalgamation of trading and banking books were the main causes of failure for the majority of them.
Banking of the Second Generation (1947–1967):
- Indian banks encouraged resource concentration (mobilised through retail deposits) in a small number of corporate families or groups, neglecting credit flow to farmers as a result.
Banking of the third generation (1967–1991):
- By nationalising 20 significant private banks in two phases (1969 and 1980) and instituting priority sector financing, the government was effective in severing the link between business and banks (1972).
- As a result of these measures, “class banking” gave way to “mass banking.”
- Additionally, it had a favourable effect on the growth of branch networks throughout (rural) India, the significant mobilisation of public deposits, and the augmentation of credit flows to the agricultural and related sectors.
Banking of fourth generation (1991–2014):
- During this time, significant changes were implemented, including the granting of new licences to private and foreign banks in an effort to increase competition, productivity, and efficiency.
- This was accomplished through the use of technology, the adoption of prudential requirements, the provision of operational flexibility and functional autonomy, the focus on implementing best practises in corporate governance, and the building of the capital base in accordance with Basel norms.
Current Pattern:
- Since 2014, the JAM (Jan-Dhan, Aadhaar, and Mobile) trinity has been adopted in the banking industry, and licences have been granted to Payments Banks and Small Finance Banks (SFBs) to enable last-mile connectivity in the effort to increase financial inclusion.
Fifth Generation Banking: The Way Forward:
- Big Banks: According to The Narasimham Committee Report (1991), India should have three to four sizable commercial banks with a presence both domestically and abroad.
- The second tier may include a number of medium-sized lenders with widespread economic presence, such as specialty banks.
- The government has already implemented some of these proposals, taking the necessary measures to establish DFI, Bad Bank, etc.
- Need for Differentiated Banks: Despite the universal banking model’s widespread popularity, niche banking is necessary to meet the unique and varied needs of various clients and borrowers.
- In essence, these specialised banks would make it simpler for people to acquire financing in places like RAM (retail, agriculture, MSMEs).
- Additionally, the suggested DFI/niche banks may be established as specialised banks in order to gain access to free public deposits and for improved asset-liability management.
- Blockchain Banking: Neobanks can use the technology to increase (digital) financial inclusion, improve risk management, and support the aspirational/new India’s higher growth.
- In this situation, Indian banking can utilise technology like blockchain.
- Blockchain technology will make it possible to more easily supervise and manage banks.
- Until now, failure of public sector banks has been an uncommon occurrence; the key factor contributing to the public’s high level of trust in the banks is the covert sovereign guarantee.
- With PSBs’ drive for privatisation, this could not always be the case.
- Therefore, in order to reduce moral hazard and systemic risks at the lowest possible cost to the public purse, the fifth generation of banking reforms should concentrate on the requirement for increased individual deposit insurance and efficient orderly resolution regimes.
- ESG Framework: In order to long-term produce value for their stakeholders, Differentiated Banks may also be encouraged to list on a recognised stock exchange and follow the ESG (Environment, Social Responsibility, and Governance) framework.
- Empowering Banks: The government should tie up any loose ends by giving banks the freedom to create diverse loan portfolios, create industry-specific regulators, and grant them additional authority to deal with willful defaulters.
- In order to develop a responsive banking system in a dynamic real economy, it is also necessary to open the corporate bond market (move away from a bank-led economy).
Conclusion:
- To increase its resilience and ensure financial stability, the banking industry needs a paradigm shift. To lessen its burden of raising extra capital, the government recently announced new banking reforms that include the creation of a Development Finance Institution (DFI) for infrastructure, a Bad Bank, and the privatisation of public sector banks (PSBs).
- But every generation of reforming the system would always start with governance improvements.
