Banking Sector Reforms
- 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:
- Millennial 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.
- Second Generation Banking (1947–1967): Indian banks encouraged resource concentration in a small number of business families or groups (mobilised through retail deposits) and disregarded loan flow to farmers as a result.
- Baking 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.
- Fourth Generation Banking (1991–2014): During this time, significant reforms were made, including the granting of new licences to domestic and international private banks in an effort to increase competition and boost efficiency and productivity.
- 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 design: 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 Future Major Banks: According to the Narasimham Committee Report from 1991, India should have three to four sizable commercial banks with both local and overseas operations in addition to foreign banks.
- 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.
- Developing Banks: By enabling them to create diverse loan portfolios, establishing sector-specific regulators, and giving them additional authority to deal with willful defaulters efficiently, the government should tighten the loose ends.
- 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.
