Banking Crisis in India: Failure of Governance and Regulation?

The 2008 financial crisis is the worst economic disaster since the Great Depression of 1929. In 2008, the crisis showed its impact the world over, all major economics effected, and growth rated declined, housing prices fell by more than 30%, inflation doubled, unemployment increased. But its impact on India was not much significant. There are two main reasons behind it. The first one was a strong & fortified banking sector and another reason was welfare schemes like MGNREGA (Mahatma Gandhi National Rural Employment Guarantee Act). MGNREGA absorbs the employment voids and fortified banking system supported economy not to stall. Asian and European economic crisis happened in past whose main reason was the failure of the Banking system. Greece’s economic crisis is the best example to support it.

No doubt banking is directly related to the economy of any country and the impact of the economy is very versatile in nature. The banking system is the lifeline of any economy. It looks very simple process like collecting money from the people and giving credit to other people and people get interested in return for putting money in Banks. But banking does many more functions beyond it. It regulates financial inclusion and lends loans to agriculture, renewable energy, MSME (Micro Small Medium Enterprises), other private companies, issuing bonds, and many more. People also feel safe in putting their money in banks and in return they get something. People’s savings goes to the banks and that saving turns into an investment which leads to business expansion. More business expansion leads to good growth of the country and employs the people.

Past experience shows that for the economic crisis, failure of the Banking system is the main cause of it. The Great Depression 1929 is one of the best examples of it. It was the worst economic downturn in the history of the industrialized world. Throughout the 1930s over 9000 banks failed. Bank deposits were uninsured and thus as banks failed people simply lost their savings. Surviving banks, unsure of the economic situation and concerned for their own survival, stopped being as willing to create new loans. This exacerbated the situation leading to less and fewer expenditures. Another good example is the recent Greece economic crisis of Europe. It was supposed by many thinkers that banking failure was one of the major causes of Greece’s economic crisis where so-called bail-out was designed to serve the interests of private bankers and those of dominant countries in the Eurozone. People were restricted to banking access.

The third example is the 2008 economic crisis. Failure of banking was also one of the main causes of that crisis. Banks had allowed people to take out loans for 100 percent or more of the value of their new homes. Many blamed the Community Reinvestment Act. It pushed banks to make investments in subprime areas, but that wasn’t the underlying cause. The Gramm-Rudman Act was the real villain. It allowed banks to engage in trading profitable derivatives that they sold to investors. The banks had chopped up the original mortgages and resold them in tranches. That made the derivatives impossible to price. So, the crisis in the banking system in India is not a good sign for our country’s growth. However, recent incidents like Vijay Mallya evasion of bank loans, Nirav Modi Scan, ICICI loan to Videocon have adversely affected the credential of the Banking sector.

India understood the importance of the banking sector. To make banking more inclusive, secure, and face, nationalization of banks was done. Although there are some disadvantages, it helped in enhancing financial inclusion through banks. Later on, the Indian government take Narasimhan recommendations into consideration. It allowed private sector to participate and can hold 74% stake. These steps increased competition among banks which helped in increase in productivity of the bank. After that substantial reform was done by the RBI which reduces much conflict of interest between central and commercial banks. Urjit Patel commission came into the picture which emphasized to ensure transparency and accountability in central banking. Monetary policy committee is compelled to become responsible of derailed plan. Due to that reform inflation was in controlled.

However, at present banking sector in crisis due to many reasons. First problem is NPA (Non-Profit Asset) due to defaulters. The gross NPAs of all the banks in the country amounted to more than Rs 8 lakhs crore, led by industry loans followed by services and agriculture sectors. The highest amount of gross NPAs was for country’s largest lender SBI about Rs 2 lakhs crore. There were about thousands of projects with an anticipated investment of Rs 13 lakh crore that had been marked as ‘implementation stalled’ on Private Economic Databases. It is a small child of NPA which can later become NPA.  NPAs have become a grave concern for the banking sector in couple of years and impacted credit delivery of banks to a great extent. As per a survey, net NPAs amount to only 2.36 percent of the total loans in the banking system. As per the International Monetary Fund (IMF), around 37 percent of the total debt in India is at risk.

What could be the possible cause of above discussed concerns? There could be two main causes of this problem. First could be failure of governance or failure of regulation. From the government side two immediate big steps are taken one after another. First one is demonetization and other one is GST (Goods and Service tax) reforms. It could be the possible reason of overburden on banking along with principle works of lending and issuing bonds. Demonetisation was aimed to achieve the goal of digital India causes dissatisfaction in people minds. Mismanagement during demonetisation regarding delivery of new currencies causes crisis of credibility in the mind of people. Apart from it loan waving policy of political party put banks in tension. It has to be understood that loan waving is not the solution, but it makes banks more reluctant for giving loan from the next time.

It has also been claimed by analysts that political parties have been engaged with private companies to make sure that they would get loan at lower interest rate and in return political expect party’s funding. That kind of relation affect the banking system adversely. So, transparency needs to be built up. Employees believe that it is not their money and collude with corporates, corporates believe they are not looting people as govt recapitalize banks, ultimately tax payer’s money is using to compensate the scams. If taxpayer’s money is using for filling scams, will they pay taxes, that is why we have low tax to GDP ratio 11%. The people working in banks are needed to get good salaries so that they refrain themselves in getting clubbed with corporates like PNB scam.

Direct tax collection should be done properly, and stringent action should be taken against the defaulter. People won’t pay tax regularly and tax evasion is done in both direct and indirect tax system. Political interference is another major reason for crisis in banking. Major higher-level appointments done by govt, and many former RBI governors talked about finance minister interference in RBI functioning. NPA problem can’t be handled by banks alone, because many governance problems like environment clearance, delay in project approvals and export import policies also cause NPA. So here both banks and govt work together to resolve the NPA problem.

RBI is the regulatory power and monitor the banks functionality. However, there are many functions to RBI and it can’t check each transaction, so problem raised. There are many statutory audits, multiple checks and balances before do any transaction, however in PNB scam, many audits are bypassed. In the core banking solutions, bank must align with swift, but synchronization not happened. These kind of gap causes loopholes in regulatory system. Banking regulation restrict people to reach. Too many obstructions have been added for withdrawing. People put their savings in the bank by keeping in my mind the in need they can withdraw without hesitation. But the banking regulation does not allow them to withdraw without paying extra charges. These kinds of unusual charges make people reluctant toward banking system.

Apart from that there is huge disparity between rate of saving and lending. If a person put his saving money in bank, he/she gets only 4% in saving account and on the other hand when he goes to get educational loan for their children, he has to pay 14% in return. This difference is big. This difference can be reduced by reducing reserve ration. Presently 4% CRR (Cash reserve ration) along with 23% SLR (Statutory Liquidity Ration) are one fourth of amount which is not used properly for getting profit out of it. It should be decreased. If banks are making good differences in rates, then bank must not restrict people and collect different charges on the name of services.

There are some arguments that public sector banking is a major reason for crisis, however combination of public and private sector worked out well in western counties also, so instead of focussing on privatization of banking, reforming the public sector would help to resolve the crisis. So, failure of governance and regulation both are reasons for crisis in banking sector. There are some good steps like amendment in banking Regulation act can be taken to give more power to RBI to take decisions to reduce NPA.

In India banking is not simply an institution to save money, but a way of life, part of life. Any major activity like marriage, seeding, education, would not start without withdrawing money from bank. Although banks don’t offer big interest rates, people deposit money out of Nostalgia, safe venture or out of habit. We have seen the importance of fortified banking system. It works for economy behind the curtain. One more important thing is that Banking system stands upon the credibility of the people. So people’s credibility must be ensured by both regulation and governance collectively.

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