Strengthening financial sector | Business Standard Editorials

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Governance in the banking system needs to be improved

The Reserve Bank of India (RBI) intervened at various levels to contain the impact of Covid-induced disruption in the economy. Although the recovery is far from complete, and the impact of the pandemic will be felt for years to come, policy interventions will have to be recalibrated and the central bank would need to guide the economy towards normalcy. In terms of monetary policy management, the central bank has started the unwinding process in a calibrated manner. In the context of financial sector oversight, RBI Governor Shaktikanta Das touched upon several interdependent issues in his remarks at an event recently, and these need more attention.

The impact of the pandemic on asset quality in the banking sector has been far lower than initially anticipated. Asset quality and capital levels improved for the banking system in the September quarter compared to the previous one. Several banks have reported better than expected profits. However, as the governor highlighted, it must be recognised that improved parameters are partly a result of regulatory relief provided by the central bank along with the support extended by the government. As regulatory support is withdrawn, some of the accounts that have been restructured may not remain solvent, and the banking system will have to get those resolved. The RBI will need to ensure that lenders don’t delay the resolution of such accounts as has been the case in the past.

The governor further noted that the RBI had started taking a closer look at the business models of banks as some are following a high risk-high return strategy with the objective of serving the interests of shareholders. It is encouraging that the regulator is closely following the functioning of banks as it will help intervene in time to avoid any build-up of risk and ensure stability in the banking system. The need for close monitoring of banks and non-banking financial companies (NBFCs) cannot perhaps be overemphasised. Lack of appropriate regulatory oversight in recent years resulted in the failure of large NBFCs, which choked the credit market. A bank also had to be rescued. However, it’s not the banks only in the private sector that can give priority to shareholders’ interests. Public sector banks (PSBs) have been used for a long time to fulfil the government’s objectives. The government, for instance, has been nudging PSBs to push lending, including through outreach programmes. The idea is that pushing credit through PSBs will help increase consumption and investment demand. But it is important to recognise that overall economic growth depends on a variety of factors and pushing demand through the extension of credit may not be sustainable.

In terms of operations, Mr Das rightly noted that good governance was necessary for a well-functioning and resilient financial institution. The RBI, however, does not have adequate powers to regulate PSBs, which often function with vacancies in the board and top management. Since the condition of PSBs is important for the flow of credit in the Indian economy, it makes sense to bring them on a par with private banks in terms of regulation. This will help improve the overall health of the banking system in the long run. However, in the short to medium term, the RBI’s aim should be to ensure that banks and NBFCs deal with the overall impact of the pandemic transparently, and have adequate capital to facilitate economic recovery.

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