Recent reform efforts have focused too much on the symptoms of India’s banking crises, rather than on the sector’s underlying structural and operational weaknesses.
The Indian government’s relatively swift decision to implement a bank recapitalization plan in October 2017 was a first step in the right direction. However, it was discovered in February 2018 that one of India’s public-sector banks was defrauded of $ 1.8 billion over the course of seven years. This revelation confirmed what everyone suspected and feared— that the problems of India’s banking sector go much deeper than any recapitalization alone will be able to solve.
Unfortunately, most of the recent reform efforts have focused too much on the symptoms of India’s banking crises, rather than on the sector’s underlying structural and operational weaknesses. For instance, the Reserve Bank of India’s (RBI) undertook two previous projects. One was the July 2015 Asset Quality Review (AQR), which facilitated discovery and recognition of non-performing loans (NPL), and the other was the Insolvency and Bankruptcy Code of 2016, which accelerated the resolution of bad loans. The truth is that neither of these approaches corrected the underlying problems with risk controls, management, and supervision at public-sector banks. As a result, India has faced crisis after crisis in its banking sector, with no solution in sight.
In light of this, India has considered more radical proposals to shake up the banking sector, and many of these are debated ad nauseam. For example, observers contend that reducing the government’s ownership stake in public-sector banks would reduce conflicts of interest and pressure on banks to lend to politically-desirable projects. Alternatively, others have suggested that the government should merge some of the smaller public-sector banks to cut costs, centralize talent and best practices, and simplify regulatory oversight. In addition, others have advocated that the government should completely privatize the public-sector banks all at once.
While each of these proposals has merit, it is unlikely that any of these solutions will become feasible in the near term. This is because we have seen almost no progress on implementing any of these ideas due to India’s gridlocked political environment. Furthermore, the need to promote financial inclusion through state-directed lending and the complexity of operationalizing radical changes to a large banking sector ensure that the pace of change will be slow. In India’s search for practical solutions, leaders must not lose sight of such facts on the ground.