Current status of Banking sector

Today lets discuss and understand in depth the various committees that were set up by the Government of India from time to time to strengthen the banking sector. Let us also look at the concept of NBFCs and further also try to analyse the various problems faced by the banking sector in India these days. This is the third chapter in our preparation.
– This is in continuation with the article published on 12th, June 2019, in these columns.

Damodaran Committee (2011):
– The Reserve Bank of India constituted a Committee in 2011 to look into banking services rendered to retail and small customers, including pensioners and also to look into the system of grievance redressal mechanism prevalent in banks, its structure and efficacy and suggest measures for expeditious resolution of complaints.
Some of the important reforms suggested:
– A guaranteed payment of up to Rs 5 lakh (raised from Rs 1 lakh) under deposit insurance to an account holder if a bank fails.
– No liability on customer for losses in ATM and online transactions
– Instant blocking of ATM card through SMS for lost/misused cards
– Pensioners to be allowed to submit life certificate in any bank branch
– A third-party Know Your Customer data bank
– Compensation for delayed return or loss of title deeds in the custody of banks
– Prepaid instruments worth up to Rs 50,000 for frequent travellers
– Compensation for delayed return or loss of title deeds in the custody of banks

Urjit Patel Committee (2013):
– An expert committee was appointed to examine the current monetary policy framework of the Reserve Bank of India. It was Headed by Urjit Patel, the then Deputy Governor of the Reserve Bank of India (RBI). Its Objective was to strengthen Monetary Policy Framework of RBI.
– The MPC (Monetary Policy Committee) that is in working now, is a recommendation of this committee.

What is the difference between a Bank and NBFC?
– NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few differences as given below:
– NBFC cannot accept demand deposits;
– NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself;
– Deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to depositors of NBFCs, unlike in case of banks.

Current status of Banking sector at a glance
– The Indian banking system consists of 26 public sector banks, 20 private sector banks, 43 foreign banks, 56 regional rural banks, 1589 urban cooperative banks and 93550 rural cooperative banks.

Issues and challenges in the Banking sector
– Amidst signs of progress, the Indian Banking sector has been facing multiple challenges in recent times. Few of them are:
Reduced profits
Non-performing Assets
Corruption
Crisis in management

1. Reduced Profits:
– The banking sector recorded slowdown in balance sheet growth for the fourth year in a row in 2015-16. Profitability remained depressed with the return on assets (RoA) continuing to linger below 1 percent. Further, though PSBs account for 72 percent of the total banking sector assets, in terms of profits it has only 42 percent share in overall profits.

2. Non-Performing Assets (NPAs)– A non performing asset (NPA) is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days. These are the assets of the banks which dont bring any return.

Types of NPAs
– Sub-standard: remaining as NPAs for less than or equal to 18 months.
– Doubtful: remaining as NPAs for more than 18 months
– Loss assets: where loss has been identified by the bank or internal/external auditors or the RBI inspection, but the amount has not been written-off.

Reasons for Growth of NPAs
– Due diligence not done in initial disbursement of loans. Eg: loans given to road sector even before acquisition of land by the contractors.
– Inefficiencies in post disbursement monitoring of the problem
– Diversion of funds by companies for purposes other than for which loans were taken
– Restructuring of loans done by banks earlier, to avoid provisioning. Post crackdown by RBI, banks are forced to clear their asset books which has led to sudden spurt in NPAs
– Economic downturn seen since 2008
– Global demand is still low due to which exports across all sector has shown a declining trend for a long while now
– Economic Survey 2015 mentioned over leveraging by corporate as one of the reasons behind rising bad loans
– Policy Paralysis seen during UPA 2 regime affected several PPP projects and key economic decisions were delayed which affected the macroeconomic stability leading to poorer corporate performance
– Crony capitalism is also to be blamed. Under political pressure banks are compelled to provide loans for certain sectors which are mostly stressed
– In the absence of a proper bankruptcy law, corporates faced exit barriers which led to piling up of bad loans

3. Corruption
– Scams in the erstwhile Global Trust Bank (GBT) and the Bank of Baroda show how few officials misuse the freedom they are granted under the guise of liberalization, for their personal benefit. These scams have badly damaged the image of banks and consequently their profitability.

4. Crisis in Management
– Public sector banks are seeing more employees retire these days. So, younger employees are replacing the elder, more-experienced employees. This however, happens at junior levels. As a result, there would be a virtual vacuum at the middle and senior level. The absence of middle management could lead to adverse impact on banks decision making process.

What is an NBFC?
– A Non Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 of India, engaged in the business of loans and advances, acquisition of shares, stock, bonds hire-purchase, insurance business or chit business but does not include any institution whose principal business includes agriculture, industrial activity or the sale, purchase or construction of immovable property.

Impact of NPAs
– Banks have to adhere to the provisioning norms set by RBI for the bad loans, which eats into their profitability. This leads to banks having lesser capital to deploy, shareholders losing money and banks finding it tough to survive in the market.
– Rising NPAs will lead to a crisis of confidence in the market. The price of loans, i.e. the interest rates will shoot up. Shooting of interest rates will directly impact the investors who wish to take loans for setting up infrastructural, industrial projects etc.
– If banks do not classify an asset as NPA, they naturally have more money to advance, so that they earn interest income on it. If large NPAs go unreported, the bank could reach a situation, where it has advanced more money than it has available, leading to a situation of technical bankruptcy.
– It will also impact the retail consumers like us, who will have to shell out a higher interest rate for a loan. This will hurt the overall demand in the Indian economy which will lead to lower growth rates and of course higher inflation because of the higher cost of capital. The trend may continue in a vicious circle and deepen the crisis.
– In light of attaining the Basel norms, the burden on maintaining Capital Adequacy Ratio increases.
– For economy, NPAs are disadvantageous, as banks become more suspicious and unwilling in giving loans which affect the credit offtake in economy.