Banking reforms the Budget must address

B Yerram Raju | Updated on January 17, 2020 Published on January 17, 2020

The FM will do well to reorient NABARD and SIDBI, improve the quality of bank boards, and not set crop loan targets

The overall objective of India’s economic policy has been accelerated inclusive growth with macroeconomic stability. The upcoming Budget is likely to give a push towards achieving this objective.

In order to take the States on board, Finance Minister Nirmala Sitharaman will do well to announce clearance of all GST dues to the States once the present audit of GST concludes. She may also like to usher in a new financial sector reform agenda to resolve the existing imbroglio.

The performance of public sector banks (PSBs) and the failure of some of the NBFCs are issues of concern. While the RBI is balancing inflation and growth objectives, the recently released Financial Stability Report re-emphasises on the need for ‘good governance across the board’, improving the performance of PSBs and the necessity to build buffers against their disproportionate operational risk losses.

None of the recent bank mergers has been a source of comfort for the Finance Minister. Hence, there is a need to look at the unfinished reform agenda suggested by various committees since 1991 and announce either a new agenda or appoint a high-level committee with a specific timeframe for actionable agenda that could stonewall criticism against the PSB failures, bank frauds and twin balance sheet problems..

The moral hazard of bank bailouts is worrisome and, therefore, the Finance Minister may refrain from any further bailout announcement. Stress in the NBFC and cooperative banking sectors seems to have forced a re-look at the Financial Resolution and Deposit Insurance Bill, 2017. While the Bill proposes to establish a Resolution Corporation to monitor the health of the providers on an ongoing basis, the bail-in by depositors and stakeholders is worrisome.

Increasing stress in various buckets of assets calls for a surgical strike. Banks’ credit origination risks need urgent evaluation. It is important to relook the universal banking model the country has adopted, aping the West. Customer preferences and customer rights have taken a back seat. Market-led reforms of the past have replaced social banking with profit-centric banking. There is a need for reconciling satisfactorily the dilemma of policies appropriate for short term with those suitable for the long term.

The RBI Governor in a recent address indicated that he would like to look at the priority sector categorisation afresh. This assumes importance in the financial inclusion agenda, as schemes such as Jan Dhan and Mudra have not been able to make qualitative advances. Provision of adequate and timely credit to agriculture, micro and small enterprises and the weaker/vulnerable sectors have remained a major challenge for Indian banks for decades.

Direct credit programmes in Korea and Japan in the 1950s and 1980s reveal that narrowly focussed and nuanced programmes with sunset clauses delivered results. The problem with directed credit is essentially three-fold: pricing at its true market level; weeding out persons who are not credit-constrained; and selection of areas and regions bereft of political interference.

Loan write-offs

Credit discipline and equity have suffered with politically motivated loan write-offs in several States. Both farmers and MSMEs require credit along with hand-holding, monitoring and supervision.

Budget 2020-21 should make a bold and strategic announcement that will ensure responsible credit flow to the farm sector. The Finance Minister would do well to avoid announcing any crop loan targets and leave the same to the RBI’s priority sector reformulation.

Supply-side issues cannot be adequately addressed without institutional reforms. One step could be the restructuring of NABARD, giving it a new mandate consistent with the future goals of the economy. SIDBI, the second surviving DFI, is surviving on interest arbitrage and the munificence of the Finance Ministry, to the detriment of the sector it was intended to protect and promote. This begs either its closure or restructuring.

As regards governance of banks, the following unattended reforms suggested by Narasimham Committee II deserve attention: removing 10 per cent voting rights; reducing the legally required public shareholding in PSBs from 51 to 33 per cent; and improving the quality of bank boards through well-defined roles for independent and functional directors.

Since the Finance Minister has already announced that she is exploring amendments to the Cooperative Act — to remove duality of regulation of cooperative banks by both the Registrar of Cooperative Societies and the RBI — she may go one step further in eliminating similar duality between the Department of Banking and the RBI insofar as PSBs are concerned, particularly because the RBI has separate Departments of Supervision and Regulation and College of Supervisors to improve the skills of RBI personnel.

The writer is an economist and risk management specialist

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Published on January 17, 2020
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