Banking reforms in India is needed because resilient banking sector is a sine qua non for a strong economy. A Country’s capacity to the internal as well as external shocks depends largely on maintaining a robust banking infrastructure. Banking sector has so long been strategic for supporting India’ service sector led growth. However, as the country plans to shift its gear to create a robust manufacturing base to augment job creation and exports, the role of banks has become all the more critical.
The Indian banking sector after independence was insulated from the global economy due to the policies followed by the government during 1960’s to 1980’s. These policies later contributed into Balance of Payment crisis of 1991 and hence the reforms were undertaken. Since, then Indian economy has grown with leaps and bounds and so has its banking sector. In 1998 an expert committee was set up under the chairmanship of M Narsimahan with the task of properly laying down recommendations for `the Indian banking sector and its regulation thereof. The suggestions by Narsimahan committee were breakthrough and the most
Nonetheless, post-2007 Public Sector Banks did face problems. These were instigated by many factors, like the sinking of economy even after surviving the recession. The other reason for worry was inflation, which stressed the monetary situation further. Part of the mayhem was contributed by bureaucratic delays like permit delay for land acquisition that directly stalled many big projects concerning infrastructure. This affected the banks credit negatively, led due to increased defaults of loans, mounting NPA’s and lowering of gross profitability of the PSB’s.
Banking and Capital Adequacy
Capital or credit profile defines the success of bank. It highlights the strength of the bank to withstand shocks and failures. This is because credit is core component of banking and therefore the most crucial risk factor. Credit Risk means that a bank’s borrower or customer is unable or shows unwillingness to meet its obligation towards the bank especially in relation to lending, trading and other transactions. For a bank this inability or unwillingness on part of the other party would accrue as a loss on its portfolio. Loans advanced by most of the banks are largest contributor of credit risk although there are other activities as well like inter-bank transactions, equities, foreign exchange transactions, swaps and other settlements of financial transactions.
The issue was addressed globally through the Basel Accord. These norms were passed after various round of deliberation between the countries. Basel I norms came into being in 1988 and talked about provisions regarding minimum capital requirement and risk weighted assets for banks. The major role of these norms has been to standardize banking practice across nations. Due to a few shortcomings in definition of earlier norms, Basel II were adopted which further laid guidelines for capital adequacy, disclosure requirements and risk management etc.
Despite these measures, the US Subprime Financial Crisis of 2008 brought to fore the deficiencies of financial regulation in Basel II norms. The norms allowed banks to take on certain other kind of risks that resulted into financial meltdown. Subsequently the Basel III norms were adopted in 2010. They create a voluntary global framework and were adopted to strengthen bank capital requirements, market risk etc. the implementation of these has been extended to March 31, 2019
Tier I and II Capital
Basel Accord creates primarily two category of capital for supervisory purpose in banking i.e. Tier I, II. They form part of Capital Adequacy Framework meaning thereby that a bank has sufficient and stable resources to absorb losses arising due to risks. The Tier I capital is the core capital; this is the highest form of capital and normally consists of equity or share capital and disclosed reserves. Core capital is necessary for purposes of lending, trading etc.it also reflects the financial strength of the bank because it is easily available to cover losses fully. Tier II or supplementary capital consists of certain reserves and types of subordinated debt. The capacity of Tier II to absorb losses is lower than that of Tier I capital
Indradhanush and its salient feature
Therefore, in Indian context, considering all these issues alongside recommendation of multiple committees important being Narsimhan (1998), Nayak (2014) Committee, measures were due. Stating, “For some years now, banks are facing challenging time but no cause of Panic” the Finance Minister launched the ‘Indradhanush Scheme’ for revamping the current state of affairs in public banking sector.
Touted as the most comprehensive Reform since 1970s that saw nationalization of major banks, the indradhanush scheme focuses upon bringing about a marked shift in the banking industry in realm of public sector banks. ‘Indradhanush’ stands for seven areas mainly, Appointment, Bank Board Bureau, Capitalization, De-stressing PSB, Empowerment, Framework of Accountability and Governance Reforms. The sector specific attention, aligning it with the global best practices, would ensure health of a bank and its working in safe zone, safeguarding it against any possible fallout of loopholes.
A Brief outline of the scheme and measures undertaken are as follows:
1.The Appointment stresses upon delinking of the position of Chairman and Managing Director in the banks. This reform was prompted partly due to the need for betterment of managerial efficiency, improved transparency, added expertise and to avoid situations of headless operating of institution in case of delay. As per the reform, the subsequent vacancy will be filled up, the CEO will get the designation of MD & CEO, and there would be another person who would be appointed as non-Executive Chairman of PSBs. The criteria for selection stands altered made more meticulous and vacancies are open for the private sector individuals too.
2.Bank Board of Bureau will look into the administrative operation of public sector banks. Replacing the Appointment Board, the Whole Time Directors and Non executive Chairman will be appointed by Bureau. Bank Board of Bureau will constantly engage with the Board of Directors of all the PSBs to formulate appropriate strategies for their growth and development. It will commence its function with the coming fiscal April 1, 2016.
3.Capitalization will bring the industry as per standards of Basel Norms III and help maintain Capital Adequacy Ratio/Minimum capital requirement. This will cushion against any shocks and will reduce the vulnerabilities. The total infusion required is Rs 180000 Crore. Government on its part will infuse Rs. 70000 Crore in public sector bank until FY 2019. The remaining, banks will raise from the market on the basis of improved value productivity.
Capitalisation will be pursued on y-o-y basis. Of the total 70000 Crore to be supplemented, the government will contribute 25000 Crore in the present Financial Year, followed next by 25000 Crore, 10000 Crore and 10000 Crore till FY 2019 respectively. The estimates are on y-o-y analysis of credit growth and requirement by various sectors. Government’s first tranche disbursal of 40% of capital will be need based disbursal to the PSB’s. In the next tranche remaining 40% the capital will be distributed amongst the six big banks including SBI, BOI, PNB, BOB, Canara and IDBI, considering their role and capacity will be included and the third tranche of 20% be performance based incentive. This move is in tune with the capital structure adopted for the banks globally.
4.De-stressing is a mandatory component of banking sector. Prompted by enhanced exposure of the bank credit to NPA’s that had risen up to level of 6%, it became an alarming proposition. The buildup was due to bad performance of road, real estate, steel and power sectors. The core sectors were affected by permit delays, global markets etc. The major funding contribution in above areas was of PSB’s. Consequently it led to stress for banks coupled with restructuring and other mounting bad loans. Therefore, Sector specific intervention is sought to help relieve the banks of increasing financial burden.
In addition, government will beef up risk control measures, NPA disclosure norms and legal capacity of the banks. Along with the functioning of Debt Recovery Tribunal and SARFESI, the RBI guidelines for taking prompt action in situation of early red flags have been roped in. An intervention at this stage has twin benefit; rescuing the value of the asset and fair recovery for lenders. A new category of Non-cooperative borrowers is created. This covers those who are unwilling to make credit disclosures. The bank as a result will have to make tighter provisioning as applicable to sub standard asset. Finally, the Asset Reconstruction Companies need to increase their minimum investment in Security Receipt; encouraging thereby banks to clear off their balance sheet.
5.A high degree of government interference was considered a major obstacle in banks commercial capacity. Under the scheme, the government has given a major thrust to severe tight managerial controls and help the banks incorporate the commercial best practices. However, government will not water down its equity below 50%. The option of intervention to maintain check and balance shall be retained. Manpower addition and nominations to the Board for more informed decision-making is desirable by government. Banks are to constitute a Grievance Redressal Mechanism, to provide solutions to customer problems in a time bound manner, all adding to bank empowerment.
6.Framework of Accountability has introduced new bank performance indicator called Key performance Indicator (KPI). It is divided in two, quantifiable and qualitative categories with weightage of 80 and 20 respectively. Quantifiable indicators include efficiency of capital use, diversification of business/processes, NPA management and financial inclusion. Qualitative indicators focus strategic initiatives taken to improve asset quality, efforts made to conserve capital, HR initiatives and improvement in external credit rating. Alongside, the timeframe for reporting of financial frauds to CBI, vigilance for quick response time in case of staff connivance and day-to-day monitoring with CBI and constitution of Risk Management Group is mandatory. CVO will be the lead officer for frauds exceeding 50 Crores.
7.The scheme in total aims at achieving the overall governance reforms in the public sector banks. The initiation started by launch of “no interference policy” by government of India was to give banks a free hand in their commercial decision-making. As stated above, PSB’s were not able to compete in wholesome manner. Government will continue to engage with them on optimizing capital, digitizing processes, strengthening risk management, improving managerial performance and financial inclusion. Government will hold Gyan Sangam to strategize the functioning of the banks aimed towards helping economic growth and matching the changing financial landscape.
Indradhanush and Indian Economy
After 2007, not everything was pink. The sectors of the Indian economy started to slack, worsened with non-hedged ECB’s, increasing number of stalled projects, falling export and output in core areas. The Indian economy finally had to deal with recession spillovers. The worst liquidity profile was suffered by PSB’s, with huge exposure to the infrastructure projects. The total number of bad loans shot up, with increasing defaults, de valued restructuring and NPA’s hampering the credit scenario.
Slowing of corporate investments and reluctance of the banks to pass on the easy interest credit rates post NPA buildup, restrained the GDP of the country. Effects were visible, PPP lost its flavour and private sector started to lose interest in infrastructure projects. This further delayed acquisitions, implementation and completion of projects thus hampering Indian Economy at a global front. This was obvious as seen in credit agency ratings, flight of portfolio investment and not so enthusiastic FDI participation.
India is at cusp of a big world economic shift. Slump in Chinese economy and rise of other competitive nations warrants push to next level by India. Newer markets are opening up and older require new business solutions. To keep a sustained growth a healthy balance is essential i.e. of traditionally strong and competitive service and certain industrial sectors, with exploring and venturing into new. However, this momentum cannot be sustained till investments and funds are mobilised to critical infrastructure like roads, ports etc. and core sectors like coal, iron and steel, power generation. They are the framework to support the sustainable, consistent growth with enough flexibility to cater to changes.
India needs to fix these loopholes of credit, strong capital base demands and resilient banking profile. The scheme therefore with other measures taken by RBI aims at resolving both of these issues. Capital adequacy will reduce the risk associated to bank liquidity and meet aspirations of India.