Indian Banking Sector Flashcards
To many economists, the solution to India’s bad-loan crisis appears as obvious as the problem: Privatize state-owned banks, which have racked up billions more in soured loans and performed much worse than their private-sector counterparts. Yet, unless the government first strengthens its ability to supervise all banks, public and private, selling some of them off will be slim guarantee against another crisis.
One can understand the urge to privatize. A long-mooted bankruptcy law finally passed last year allows any single creditor to initiate the bankruptcy process. This has disrupted the earlier cozy system, whereby banks hid the full extent of their soured loans and the Reserve Bank of India, which oversees the sector, looked the other way.
As bad loans tumbled out of the closet, it quickly became clear that banks didn’t have nearly enough equity capital. The government has proposed a $32 billion recapitalization package. Saddled with this enormous bill, taxpayers rightly want some assurance that their money isn’t going to waste.
Propping up bloated and inefficient state lenders would seem to ensure a repeat of the current crisis. As long as the government dominates the banking sector, politicians will continue to interfere with lending decisions. Boards will be stacked with indifferent yes-men and yes-women. Managers will face little pressure to improve
The recent $2 billion scandal at Punjab National Bank— the second-biggest state lender— has focused voter anger. A politically well-connected jewellery magnate, Nirav Modi, allegedly bribed PNB officials to provide him letters of credit overseas. The accused officials were reportedly able to hide their activities by taking advantage of the bank’s poorly integrated IT systems and lax oversight.
In recent weeks, though, the performance of two of India’s biggest and most respected private banks has called this easy narrative into question.
That’s true. It’s equally true that the common factor across both sets of bad-loan crises has been the striking ineffectiveness of external supervision. Either knowingly or unknowingly, the RBI allowed both private and state-owned banks to build up dangerously large amounts of stressed assets. Officials may have reasoned that banks didn’t have the resources to provision for bad loans. In that case, however, they shouldn’t have allowed those banks to expand their books.
At a minimum, the RBI’s supervisory capacity needs strengthening—including better training, more specialization and longer tenures for officials, among other measures that the bank itself has recommended. In today’s increasingly complex financial world, supervisors also need to have processes in place to evaluate bank corporate governance and clearly set out expectations for boards.
But that alone isn’t likely to be adequate; greater checks and balances need to be built into the system. The government is looking to create a resolution corporation, similar to the US Federal Deposit Insurance Corporation, which would partner with the RBI in handling failing banks. As currently envisioned, the corporation could only get involved at later stages, once a bank is classified as troubled. Instead, it should be able to look over the central bank’s shoulder in evaluating all banks, including those considered at low or moderate risk. Otherwise there’s a chance that danger will be identified too late, when financial firms are in serious trouble and can no longer be sold as running concerns.
