Banking Sector Will See Tectonic Shifts In Coming Years

The Indian economy is emerging from its cyclical nadir. While the macro environment has stabilized in the last six months, signs of strong revival are still elusive. I am confident that the new government’s thrust on infrastructure, as validated in the Budget, will be the stepping stone to stimulate growth. As the economy turns around, it is critical that the banking sector develops in tandem to support and finance this growth. Banks, aft er all, perform the crucial task of financial intermediation by pooling savings and channelizing them into investments through maturity and risk transformations.

The challenges that banks face at the current juncture are manifold. There has been an increase in stressed and nonperforming assets (NPAs), particularly among the public sector banks, which account for over 70 per cent of market share. Further, to support potential growth and to meet Basel III requirements, recapitalization of public sector banks assumes priority. Having said so, it is well known that stress in the banking sector has been particularly driven by the infrastructure sector. As such, policy measures nurturing a revival in this sector will be crucial. Revival of large-scale infra projects which have inherent economic viability but are facing temporary cash flow mismatches can take place if such assets can be taken over through transparent bidding process by corporates or joint ventures.

Further, recognizing the need for large-scale infra-financing, the government in the recent Budget adroitly balanced announcements of new infrastructure projects such as 16 new ports, ultra modern coal power plants, new airports in tier II cities, north-east highways, 100 smart-cities along with incentives for banks to raise long-term funds for infrastructure financing (exempted from CRR/SLR requirements) with flexible restructuring of infra loans. Such a move augments ability of banks to take greater exposure to incremental infrastructure financing sans further deterioration in asset-liability mismatches. Following the government’s announcement, the Reserve Bank of India (RBI) has been quick to notify the new norms.

Facilitating availability of credit for key sectors is critical for the revival of banking sector and the economy overall. A priority sector lending status to pre-shipment credit in foreign currency (PCFC) will sort out liquidity and pricing problems for exporters. Further, takeout financing for infra projects can be incentivized by allowing reasonable compensation to banks when they give up a good asset after the project is completed. Akin to infrastructure projects, a grace period of two years may be extended to non-infrastructure projects.

With an aim to channelize retail savings into financial sector, banks may be allowed to offer Gold Deposit Account (GDA) to defer gold imports thereby promoting financialization of gold and curbing pressure on current account deficit (CAD). The GDA will represent notional units of gold and provide gold price return in weight terms. The gold liability created with the GDA will have to be netted off at the economy-wide level with a body holding gold in the form of assets. The government and RBI could set up an apex body – The Gold Bank (GB), which can procure and retain gold abroad through off shore foreign currency borrowing. The banks can then act as an intermediary between retail customers and the Gold Bank.

From a structural perspective, the new government can make a difference by addressing the need for human capital in the public sector banking space, improve competition in the sector and enhance market value and eventually free itself from the burden of pumping in capital every year. In this context, the Nayak Committee recommendations can be implemented for improving systemic efficiency. With a conducive and stable policy environment, the banking sector will see tectonic shift s in the coming years.