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Posted by on Nov 25, 2015 in Banking |


Issues or Problems

The problems in the Indian banking system lie elsewhere and fall into two categories: policy and structure.

  1. Policy Challenge: The policy challenge relates to financial repression. The Indian banking system is afflicted by what might be called “double financial repression”. Financial repression on the asset side of the balance sheet is created by the statutory liquidity ratio (SLR) and PSL. Financial repression on the liability side has arisen from high inflation since 2007.


  1. Structure Problem: First, there appears to be a lack of competition, reflected in the private sector banks inability to increase their presence. Second is Ownership, there is wide variation in the performance of the public sector banks measured in terms of prudence and profitability. Overall, the best public sector banks perform well below private sector banks on average, recognising of course that PSBs may be burdened with greater social obligations.


Way Forward: 4D’s Policy


  1. Deregulate: As the banking sector exits the financial repression on the liability side, aided by the fall in inflation, this is a good opportunity to consider relaxing the asset side repression. One is Easing SLR requirements and other is PSL norms too can be re-assessed.                                                                                                                                                              There are two options: one is indirect reform bringing more sectors into the ambit of PSL, until in the limit every sector is a priority sector; and the other is to redefine the norms to slowly make PSL more targeted, smaller, and need-driven.
  1. Differentiate: There must be differentiation between the PSBs. One size fits all approaches such as governance reform cannot be the most appropriate. Differentiation will allow a full menu of options such as selective recapitalization, diluted government ownership, and exit.
  1. Diversify: It implies that there must be greater competition within the banking system, including liberal licensing of more banks and different types of banks. There must also be greater competition from capital markets, especially bond markets.
  2. Disinter: It implies that exit procedures must become more efficient. Debt Recovery Tribunals are over-burdened and under-resourced. The ownership structure and efficacy of Asset Restructuring Companies, in which banks themselves have significant stakes of banks, creates misaligned incentives.
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