Time for banks to set their house in order

Without reforms, they will remain vulnerable to unscrupulous lenders

The Reserve Bank of India (RBI) released its biannual financial stability report on December 31, 2018. The most important finding of the report is that India’s banking system has left the worst of Non-performing Asset (NPA) crisis behind it. The share of gross NPAS in total advances of Scheduled Commercial Banks (SCBS) declined from 11.8% in the quarter ending March 2018 to 10.8% in September 2018. NPAS have been rising for a long time, especially after the RBI forced SCBS to recognise all bad loans through Asset Quality Review (AQR) in 2015. The report says that under baseline scenario, the share of NPAS in gross advances is expected to decline further to 10.3% by March 2019. Effects of this improvement can already be seen in other macroeconomic indicators. The share of investment in GDP has shown a rise in the recent period. Credit growth has also been rising. This suggests that the twin-balance sheet crisis is heading towards a resolution.

This is good news, no doubt. However, the extent of gains from these positive developments will depend on whether or not our policymakers draw the right lessons from it. In 2015-16, the Economic Survey had listed four Rs — Recognition, Recapitalisation, Resolution and Reform — as key to solving the bad loan crisis. AQRS took care of the recognition aspect. The government has made significant budgetary provisions for recapitalisation of public sector banks. Its new bankruptcy legislation has expedited the resolution process. However, little has been done on the fourth front, namely reform.

Unless banks are forced to set their house in order, they will always remain vulnerable to frauds and unscrupulous lenders. Once the damage is done, it is always difficult to rectify things. Healthy reforms on this front, on the other hand, will allow us to limit most future NPAS. Achieving this will require, most of all, a synergy between the government and the RBI.