14 Jun 2019 20:01 IST

Why India’s beleaguered financial sector needs a big boost

The rate cut has duly arrived but the financial sector is crying out for long-term reforms

There is a growing body of opinion that believes real interest rates in the country are among the highest in the world. This, in turn, is hurting the country’s growth prospects, and so there has been a rising clamour to trim the rates. The RBI’s Monetary Policy Committee duly obliged when it cut policy rates by 25 basis points last week in a highly anticipated move. But some commentators, who had hoped for more decisive action, felt the rate cut was far too anaemic, given the headwinds the economy faces.

And the success of even the moderate rate cut will depend on whether the banks transmit it by pruning lending rates to spur the economy. So far, we have seen very little evidence of that. In fact, a recent BusinessLine news report showed that instead of cutting lending rates, some banks actually raised them during the last rate cut cycle.

Woes in the sector

Among the host of economic issues confronting the new NDA government — a slowing economy, anaemic private investment and consumption, the agrarian crisis, mounting bank NPAs, and trade turbulence — the financial sector’s woes seem the most pressing. Finance minister Nirmala Sitharaman, in her first Budget to be presented on July 5, will surely have a package for the beleaguered financial sector.

Earlier, it was only the bad loans, especially in public sector banks, that used to haunt the sector. But ever since IL&FS went belly-up last year, (Bloomberg columnist Andy Mukherjee called it “India’s mini-Lehman Brothers moment”), the NBFC, or shadow banking, sector is also facing immense stress with serious liquidity issues. The recent default by Dewan Housing Finance Ltd (DHFL), a major housing finance player, has only compounded the problem. This also led to the NAVs of various mutual funds with having exposure to DHFL paper, plummeting.

Mukherjee, in a recent Bloomberg column, argues for a ‘Troubled Asset Relief Programme’ similar to the one created in the US in the aftermath of the 2008 meltdown to restore faith in the system. He goes on to list five policy initiatives to prevent the problem from assuming ‘systemic’ proportions. These include a RBI-funded special purpose vehicle, which will help carve out the more stable assets of the troubled NBFC and sell them to prospective buyers. The remaining assets will be bought by the RBI-funded SPV.

Mukherjee says this will help the creditors, including mutual funds. The other suggestions include creating a government-mandated land bank, refinancing maturing loans, capital infusion into banks and more stringent regulatory monitoring of the NBFC segment by the RBI.

Is privatisation the solution?

But what about the banking sector and its huge bad loans mess? Some of the earlier suggestions were large-scale privatisation of PSU banks as their public holding was seen as a major impediment to professional governance. Among its main proponents is former Chief Economic Advisor Arvind Subramanian. It is argued that excessive political interference is what led to this mess and freeing banks from government and political control would lead to more professional governance norms and risk assessment.

But this argument has its fair share of critics. Former RBI Governor C Rangarajan and TT IIM-A professor Ram Mohan have, in a recent column, argued that massive privatisation is too simplistic and won’t work. They use RBI data to show that the private banks too were afflicted with bad loan problems, pointing out that the NPA/gross advances ratio of ICICI Bank and Standard Chartered Bank are similar to that of SBI. However SBI’s share of lending to the stressed sectors such as power and real-estate is higher than that of the private banks.

Government reforms

Another former RBI Governor, Raghuram Rajan, also says that “simple solutions like privatising all public sector banks may be no panacea”. In an article in the recently published book What the economy needs now, Rajan argues that privatisation could be tried out as an experiment in one or two mid-sized public sector banks, while for other major banks, governance reforms is the answer. He is extremely critical of farm loan waivers and calls for an all-party agreement to avoid them in the national interest.

Rangarajan, Ram Mohan and Rajan are clear about boosting governance norms in public sector banks and raising risk assessment norms. Rajan argues for a viable out-of-court mechanism to settle bankruptcy issues as it is simply impossible for the NCLT to handle all the cases. Banks may also have to brace for some hair-cuts.

The problems besetting India’s financial sector are structural and deep-rooted; hence, there can’t be any quick-fix solutions. But the new Finance Minister can show intent in her first Budget. The BJP, with its brute majority in Parliament, is in a strong position to put in place long-term reforms that the economy is in dire need of.