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Why India’s banking sector is among the most vulnerable in G-20 economies today
- The capital adequacy ratio of India’s banking system is much worse than that of peers.
Poor situation in banks:
- A high bad loans, poor accounting standards and growing evidence of lax supervision and banking fraud highlight the deep rot at the core of India’s financial system.
- In 2009, India had among the lowest ratio of non-performing assets among the largest economies of the world, which form the elite G – 20 club. Eight years later, it has among the highest ratio of such assets.
- India’s central bank has been prodding banks to recognize such toxic assets over the past few years.
- The rise in bad loans and the lack of adequate provisions has put Indian banks in a tight spot now.
- India’s banking sector lags those of most other large economies in terms of capital adequacy.
What is capital adequacy?
- Capital adequacy refers to the ability of a bank to withstand significant losses on its risky assets. India fares poorly in this regard despite a relatively conservative loan-to-deposit ratio.
- The RBI has set 9% as the minimum threshold for total CAR.
- Total CAR refers to total equity and reserves of a bank, expressed as a percentage of its risk-weighted assets.
- All of India’s bad loans may not have been accounted for yet.
- While the bad loan problem is more acute among state-owned lenders such as SBI, even private banks may not be fully accounting for their share of toxic assets.
- If the pile of bad loans grows even bigger, India’s capital adequacy ratio could slip to dangerously low levels despite a generous bank recapitalization announced late last year.
According to IMF report:
- Indian banks may find themselves to be much more vulnerable to financial shocks than their counterparts in other large emerging markets.
- Under an adverse stress scenario, nine out of 12 state-owned banks will breach “hurdle rates”, i.e. rates prescribed by Reserve Bank of India for various capital adequacy ratios.
Measures taken by the RBI:
- A committee to examine the weakness in state-owned banks and to suggest reforms was set up by the Reserve Bank of India under the chairmanship of P.J. Nayak.
- The committee had flagged the issue of inadequate compensation for top management in state-owned banks compared to peers in private banks.
- This affects the ability of state-owned banks (or public sector banks) to attract and retain talent.
- While overall employee costs of state-owned banks remain bloated, top executive compensation continues to suffer, pointing towards inefficient functioning.
- The Nayak committee had recommended diluting the stake of the government in PSBs below 50%, so that banks could be freed from external vigilance emanating from the Central Vigilance Commission, the Right to Information Act, and from government constraints on employee compensation.
- It also proposed creation of a Bank Investment Company to act as the holding company for various PSBs. However, there has not been much progress in reforming the way PSBs are governed.
- The newly constituted Banks Board Bureau too has been unable to make much of an impact.
|Key recommendations of PJ Nayak committee||Status|
|Repeal various acts such as the Bank nationalization Act (1970, 1980), SBI Act, SBI subsidiaries Act, etc. to allow government stake in PSBs to fall below 50%.||Not implemented.|
|Create a Bank Investment Company (BIC), which would act as a holding company for various public sector banks (PSBs) and hence improve autonomy in functioning of PSBs.||Not yet created.|
|Set up a Bank Boards Bureau (BBB) until the creation of BIC. The Bureau would advise the government in appointing board members to banks, bank chairman/CMD and executive directors.||BBB was set up in 2016. However the extent of authority enjoyed by the Bureau remains questionable.|
|RBI should designate a specific category of investors as authorized bank investors (ABI), and allow them to hold upto 20% in banks without regulatory approval.||Not implemented. RBI caps the shareholding by a single entity at 10%.|
- The government needs to undertake structural reforms to overhaul the way in which state-owned banks are managed.
- This will improve the Indian financial system and promote growth and investments over the long term.