31st December – Indian Banking – Challenges

The Reserve Bank of India (RBI) is planning to conduct the second phase of Operation Twist by simultaneous buying and selling of government securities.

What it means?

  • It will buy long tenure bonds and sell short-term ones to bring down the bond yields and flatten the curve, narrowing the term premium.
  • The 10-year bond yield, which rose to 6.8 per cent in the recent past fearing higher government borrowing to bridge the widening fiscal deficit, is now hovering at 6.5 per cent.

What is ‘Operation Twist’?

  • Operation Twist “manages” bond yields, brings down the cost of borrowing for the government and saves banks from treasury losses.
  • Banks can make money trading bonds but nobody knows how long the RBI would continue the exercise and how much it would buy. Therein lies the challenge for the banks.

How has the economy been growing?

  • In 2000, it was Rs 20.13 trillion and in 2010, Rs 64.78 trillion (both 2004-05 series). The estimated size of the Indian economy in 2020 is Rs 211 trillion (2011-12 series).
  • In March 2019, the gross non-performing assets (NPAS) of the Indian banking sector was 9.1 per cent of the loans, the highest among emerging markets. It may rise to 9.9 per cent next year.

What brought NPA crisis?

  • The current decade started with enormous fiscal and monetary stimulus to ward off the feared impact of the collapse of US investment bank Lehman Brothers Holdings Inc.
  • The government went all out spending money and the RBI followed an ultra-loose monetary policy, flooding the system with liquidity and bringing down the policy rate to its historic low.
  • All of this sowed the seeds of the problems that plagued the financial sector for an entire decade, threatening to spill over to the next.

The current issue –

In the current decade, there has been partial opening up but that is not the reason for the enormous pain that the Indian financial sector has been experiencing. Unlike in the past when only the banking sector bore the brunt, the problem has spread across the financial system — to non-banking finance companies, mutual funds and rating agencies. There is a clamour for fiscal stimulus even as monetary easing continues.

Reasons behind the economic mess –

  • Few economists blame the abolition of development financial institutions (DFIS) in the 1990s that forced banks to lend for projects without the core competence.
  • A few are holding the RBI Governor YV Reddy’s regime responsible for the current troubles as the economy grew at over 9 per cent for three successive years then and the credit growth was phenomenal, leading to overheating. Then, of course, there was the exaggerated response to the global crisis in the aftermath of the Lehman collapse.
  • The endgame in the politician banker-corporate house nexus has not played out yet. Banks have kept on changing their assets — from steel to infrastructure to telecom to retail — and corporate India kept on leveraging up even as the regulator was generous in offering forbearance to banks.

What comes next?

In the new decade, we will see the emergence of large banks through consolidation; probably better-governed public sector banks with a smaller market share; the entry of many small banks; and even the return of DFIS in some form. Let’s hope and pray that we also see the closure of the bad loan saga.

SourceBusiness Standard

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