The recent demonetisation drive has increased the monetary base within the formal banking system. This push will further intensify with the introduction of GST, a simplified tax structure that discourages tax evasion and expands the tax base by incentivising the move of hitherto underground transactions to the light of day. This rationalisation of the country’s complex web of taxes is a long awaited move that could be one of the most critical reforms in India in nearly three decades and puts our banks at the centre stage once again.
The direction and commitment that the current regime has shown towards long-term, path-breaking reforms has been encouraging. Financial inclusion too has been among the foremost development agendas. The efficacy of the welfare schemes depends on their presence in the formal banking system and banks will have to rise to the occasion to help our nation realise the full potential of these initiatives. Building operational capacity and developing key digital infrastructure is critical. But are the banks operationally robust enough to take on this challenge?
In dire straits
The Indian banking sector has been in dire straits since 2015, grappling with issues of capital adequacy and asset quality. While non-performing assets (NPA) account for a little over 2 per cent of the bank loans, viewing this in conjunction with other restructured and stressed assets paints a much darker picture. According to an IMF report, nearly 37 per cent of the total debt in India is at risk. Banks don’t have the capacity to handle even a third of the potential loss and this puts them in a position of tremendous weakness. Though the banks are now loaded with cash, India’s corporates are not in a position to borrow, given the weak economic outlook. Easing capital adequacy norms has not been enough to support the banks through these difficult times and the problems are exacerbated by forex volatility.
In August 2015, the Finance Ministry had introduced seven key reforms for the banking sector called the “Indradhanush Reforms”. One of the key measures proposed was the recapitalisation of banks with an estimated ₹180,000 crore till 2018-19, out of which Government agreed to put ₹70,000 crore in 4 years. In the upcoming Union Budget, we expect provisions for an additional infusion over and above the influx that had been planned initially. We also expect the government to take a strong stance against NPAs and incentivise a regime of greater discipline and responsibility among corporates. Striking the right balance between encouraging growth and maintaining operational stability is critical to the economy and to the health of our banks.
Piecing back the economy
During his address to the nation on New Year’s Eve, the Prime Minister had announced a concession on home loans for the rural and urban poor and a similar relief on the interest rate burden for farmers. It will be interesting to see how the Government supports the banks as they account for the lost spread on such loans. It will also be intriguing to see how the demonetisation story unfolds as the economy lurches back from the slowdown since Diwali. Given that we are in the midst of a global economic slowdown and most developed nations have policy regimes that are currently inward looking, building the consumer spending power is going to be critical. Exports have not looked up and this makes it imperative that growth is driven domestically. Cheaper, easier loans for personal consumption will have a big role to play.
A road map for consolidation of the public sector banks, as the Finance Minister had mentioned last time, does not look like a favourable option any more. The budget needs to instead focus on a divestment road map, striving to bring down the Government stake to 52 per cent. Not only will this reduce the pressure on exchequer, it will also help usher in capacity-building and digitisation that is going to be vital in the years to come.
(Gaurav Manoj Jha and Vinay Tiwari are students pursuing PGPM at the Indian School of Business. While Gaurav Manoj Jha is an economics and engineering graduate from BITS Pilani, Vinay Tiwari is a chartered accountant)