Public sector banks face uncertainty

India can hardly remain one of the fastest growing economies in the world with a significant section of its banking sector rendered non-functional, being allowed only to take deposits and make remittances. If the present situation continues for long, bad debts will pile up again.

Subir Roy
Senior Economic Analyst

INDIA’S public sector banks, accounting for over two-thirds of the banking sector, are facing a period of uncertainty. What makes it a bit acute is that there is no indication as to when or how the present situation will make way for a more firm and clear environment.

During the phase when the banking regulator, Reserve Bank of India (RBI), was led by then Governors Raghuram Rajan and Urijit Patel, things were not hunky-dory, but there was no uncertainty as to where things stood. The sector was diagnosed with a fairly serious malady and had been put under powerful medication.

Right now, the regulator itself is in a state of uncertainty, with all trying to guess how the new Governor, Shaktikanta Das, will go forward — how far he will tilt in favour of the government or the RBI’s independent thought. Once he is able to negotiate the quicksand and devise a clear stance, the RBI will know its mind and public sector banks will know what is expected of them. It is, for example, important for them to be clear what should be their prime focus — setting their house in order (what the RBI has till lately been asking for) or financing economic buoyancy (what the government will want in the run-up to this year’s General Election).

The dilemma is best illustrated by the first high-profile decision that Das has taken on assuming charge at Mint Street. Norms covering the regulation of loans to small and medium businesses with outstanding amounts up to Rs 25 crore were relaxed. This immediately buttressed the belief that Das was indeed falling in line with what the government wanted — greater forbearance and an easier play for small businesses with overdue loans.

But on a closer examination, it became clear that the concession was indeed minor — a fractional relaxation of norms for banks in classifying outstanding loans in the particular category as non-performing assets but not easier lending norms as such. This created the sense that while Das was seeking to tell the Finance Ministry that it was being heard, the regime for banks remained virtually the same.

The big point here is that bank managements do not know right now how to second-guess the RBI because the regulator itself is feeling its way about in second-guessing the sovereign.

There are two major issues which account for the current scenario. A committee headed by former RBI Governor Bimal Jalan will take a view on how much of reserves are good enough for the RBI and consequently how much of surplus can be transferred to the government without in any way weakening the RBI’s ability to intervene in markets to maintain internal and external stability.

The other, and perhaps the most crucial, decision awaited is that of the RBI’s committee which will look into the contours of the “prompt corrective action” regime which has stopped 11 weak public sector banks from giving fresh loans. On this hinges the public sector banks’ 

ability to play Santa ahead of the General Election.

If banks across the board can again get back to giving loans the way they have been doing, we can see ahead of ourselves another mountain of bad debt piling up, as has happened up to now. On the other hand, India can hardly remain one of the fastest growing economies of the world with a significant section of its banking sector rendered non-functional, being allowed only to take deposits and make remittances.

Hopes are pinned on the good sense of the Bimal Jalan committee and Jalan himself looking into the capital adequacy of RBI. He can sense the government mood of the day. Additionally, none will expect him to come up with a solution which will be detrimental to the good health of the banking regulator. His asset is his ability to deftly step around pitfalls without losing sight of the basic goals. Das, a professional in the same mould, can be expected to take a cue from Jalan.

This scenario is daunting enough. What raises the challenge further is the international scenario, a world in which the Indian economy has to live and survive, given its increasing openness in bringing down insular barriers. The global economy is in fact more fraught than the Indian situation. Smooth flow of international trade has been put at risk by the growing tensions between the US and China. Plus, the long high growth record of the US economy is likely to prompt the Federal Reserve to tighten financial conditions to ensure that there is no overheating.

In a likely hardening of US interest rates, global capital will start exiting emerging economies and head for the US. This makes it imperative for the monetary and fiscal authorities in India to work with strong coordination. A conflict, open or subterranean, is quite unaffordable, but it is not possible to say that the recent tensions have been put behind us. This brings us back to the gnawing uncertainty that is the order of the day.

In this scenario, there is one positive indication. The latest financial stability report has indicated that banks’ non-performing assets have come down in the past half year and are likely to do so further in the coming half year. This shows that the system is not heading towards a crisis. But it will be foolhardy for the government to feel that the crisis in public sector banks is on the way to being resolved and all that is needed is for the present regime to continue and do nothing to upset the present calm.

The fundamental crisis remains to be addressed. Present trends, aided by the progress in recovery made under the insolvency and bankruptcy code, can remove the past burden of bad debts. But public sector banks are yet to come under a governance system that makes for sustained sound lending. If the present situation continues for long, bad debts will pile up again. One wishes that the Banks Board Bureau had come to something.

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