Editorial✍ Live Mint

Putting public sector banks back on track

NPA problem in banking sector:

  • The Indian banking sector (particularly the public sector banks (PSBs)), continues to struggle with higher non-performing assets (NPAs).
  • To address this and roll back the adverse effects on productive sectors of the economy, many measures are being taken.

There are more issues to be considered:

  • There are a number of issues surrounding it that also need to be considered, however.
  • The standing committee on finance has considered these issues with its latest report.
  • Example – Human Resources:
    • State-run banks are facing serious challenges on this front.
    • A large number of senior employees will be retiring over the next five years; 95% of those at the general manager level will be out of the door by 2019-20.
    • It will be a challenge to fill the resource gap at this scale without major changes in human resource policies.
    • This, in turn, will also affect the governance and operational issues that have played into the NPA mess.


Committee’s recommendations need wider deliberation:

  • The complexity of such problems is reflected in the deliberations of the committee and submissions made by various stakeholders, including the Union government and the Reserve Bank of India (RBI).
  • Some of the recommendations of the committee need wider discussion.

Committee recommendations and comments on them:

  1. Capital adequacy rules:
  • The committee has questioned the capital adequacy rules imposed by RBI, particularly for banks that do not have international exposure and are under the prompt corrective action (PCA) framework.
  • Relaxing the norms will improve their lending capacity and generate higher interest income.

Issues with this recommendation:

  • It is well accepted that higher lending capacity in the banking system will benefit the economy.
  • However, relaxing capital adequacy norms, particularly for weaker banks, could be risky and affect financial stability.
  •  It is possible that these banks will end up accumulating more bad loans.
  1. Separate treatment of certain NPAs:
  • The committee has suggested that RBI should consider separate treatment for NPAs arising due to wilful defaults and those because of external shocks, such as policy or judicial interventions.

Issues with this recommendation:

  • This step could lead to unnecessary complications.
  • In this context, the RBI has done well by not relaxing rules for power producers.
  • Even if some loans have become non-performing because of external factors, there is no guarantee that banks will be able to recover money by holding on to them for an extended period.
  • In fact, it is in the interest of banks to get out of such assets in a fair and transparent manner.
  1. Fixing base price during bankruptcy process:
  • To avoid large haircuts, the committee has recommended fixing a base price for bidding of assets under the bankruptcy process.

Issues with this recommendation:

  • This will impede timely resolution.
  • Fixing a floor price will affect price discovery and discourage bidders.
  • It is important to recognize that the resolution system under the Insolvency and Bankruptcy Code (IBC) is still at an early stage and dealing with a large volume of cases.
  • Therefore, it is likely that valuations will be affected in the near term due to demand-supply mismatch.
  • However, as the system stabilizes, outcomes are likely to improve for creditors.
  • NCLT capacity should be increased:
    • In this sense, the committee has done well to suggest that the capacity of the National Company Law Tribunal be improved.
  1. Specialized long-term finance institutions should be considered:
  • The committee has noted that banks lack the resource base and expertise to engage in long-term project financing.
  • Therefore, the architecture of specialized long-term finance institution should be reconsidered.

This recommendation should be tried:

  • The idea of long-term finance banks is worth trying. Specialized institutions will be in a better position to evaluate long-term projects.
  • However, it will be important that they are designed well with a supportive regulatory environment.
  • The earlier experiment with long-term finance institutions did not fully work as desired.
  1. Giving more powers to RBI:
  • The RBI told the committee that it does not have adequate powers to control PSBs.
  • The parlimentary committee has recommended constituting a high-powered committee to evaluate the powers and authority of RBI, among other things.

This could be considered:

  • Since questions have been raised by the regulator and other stakeholders, it would be advisable to study the issue in detail, as it will help strengthen the overall regulatory architecture.


Way ahead – crisis is an opportunity to reform:

  • PSBs are currently dealing with difficult issues with no easy solutions.
  • But the current situation is also an opportunity to undertake reforms and strengthen state-run banks.
  • The new framework for the resolution of stressed assets and IBC will check accumulation of bad debt in the future.
  • Concurrent with that, operations and governance in PSBs require reform.
  • The future of banking sector will depend on the way the current crisis is managed.



GS Paper III: Indian Economy

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