Banks must be prepared for next boom or bust

Banks must be prepared for next boom or bust
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Highlights

Economic Survey has warned banks to be prepared for next boom and bust comes around and work out the way it needs to distribute pain between promoters, creditors, consumers and taxpayers.

Survey suggested ‘4-D model’ as a solution

New Delhi: Economic Survey has warned banks to be prepared for next boom and bust comes around and work out the way it needs to distribute pain between promoters, creditors, consumers and taxpayers.

"Being prepared for the clean-up is as important as the being prudent in the run-up," the Economic Survey said.

For the public sector banks, in particular, that are exposed to governmental accountability and oversight, lending in a situation of NPAs is not easy because of a generic problem of caution, afflicting bureaucratic decision-making. Bad loans in public sector banks more than tripled to about Rs 2.17 lakh crore in three years to March 2014.

The Survey noted that the policy challenge relates to financial repression. The Indian banking system is afflicted by what might be called "double financial repression" which reduces returns to savers and banks, and misallocates capital to investors. Financial repression on the asset side of the balance sheet is created by the statutory liquidity ratio (SLR) requirement that forces banks to hold government securities, and priority sector lending (PSL) that forces resource deployment in less-than-fully efficient ways, it added.


"First, there appears to be a lack of competition, reflected in the private sector banks' inability to increase their presence. Indeed, one of the paradoxes of recent banking history is that the share of the private sector in overall banking aggregates barely increased at a time when the country witnessed its most rapid growth and one that was fuelled by the private sector," the Survey said.

Second, there is wide variation in the performance of the public sector banks measured in terms of prudence and profitability.

For which, the survey has prescribed a '4-D model' for the sector to face competition in the changed environment.

"Banking is hobbled by policy, which creates double financial repression, and by structural factors, which impede competition," the Survey said.

"The solution lies in the 4 Ds of deregulation (addressing the statutory liquidity ratio and priority sector lending), differentiation (within the public sector banks in relation to recapitalisation, shrinking balance sheets and ownership), diversification (of source of funding within and outside banking), and disinterring (by improving exit mechanisms)," it said.

The Survey has recommended SLR, a portion of deposits mandatorily invested in government securities, requirements can be gradually relaxed. This will provide liquidity to the banks, depth to the government bond market, and also encourage the development of the corporate bond market, it said.

The right sequence would be to gradually reduce SLR and then provide incentives for a deeper bond market, it added.

The Survey further said that the analysis suggests that there is sufficient variation in the performance of public sector banks. It suggested that more banks and more diversified ones must be encouraged.

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