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Monday, October 16, 2017

Banking Sector at a Cross Roads!

With the announcement of quarter one GDP growth rate at 5.7%—the lowest in the last six quarters—and industrial growth rate for April-July being at 1.7%, down from 6.5% in the comparable period of last year, besides, current account deficit at 2.4% and inflation slowly inching forward to 3.4%, everyone is looking up to the forthcoming monetary policy announcement by the RBI eagerly.

The RBI Governor is thus caught in a complex situation: if he cuts the rate to support growth, and if inflation picks up, no one would spare him. On the other hand, staying put with his hawkish attitude towards containing inflation, if he does not cut the rate, and if growth continues to slide, he will be dubbed as a governor who is not for growth.

Given the fact that inflation is inching up owing to rise in food and fuel prices that are anyway outside the purview of monetary policy and that the RBI inflation models being good enough, that too, consistently to overestimate inflation growth, the Governor may, some opine, better take a chance to cut the policy interest rates.

And here rises the real issue: given the existence of excess capacities in the industry, will the rate cut create fresh demand for credit from the industry? It may not, more so in the light of the fact that lending to industry has shrunk in the last two years—for the first time in the last two decades—as against a growth rate of almost 30% recorded earlier.

Infrastructure projects are stalled at various stages of execution for quite some time for reasons galore, and those which were executed particularly from the sectors of power and telecom are in the doldrums. That aside, the overall poor consumer demand across the sectors has adversely affected the cash flows of companies. As a result, their balance sheets are saddled with huge burden of debts. This in turn is affecting the balance sheets of banks, for 20% of their loans have either turned bad or warranting restructuring. One estimate of likely losses that PSBs may incur owing to bad debts puts it at 1 tn. Its obvious impact is: slowdown in credit flow to industry—at least that is what some argue. Nevertheless, it is true that unless this ‘twin deficit’ problem is resolved, a mere cut in policy interest rate by 25 to 50 bps could hardly boost the growth in economy.

The government is, of course, aware of the scale of recapitalization needed and there is an indication too that it may resort to a tool like ‘recapitalization bonds’—the government will inject capital into banks and banks in turn will use the said capital to buy government bonds—but fearing that it may adversely impact fiscal-deficit, it appears to hold it back. The other alternative under consideration is: merger of bad banks with good banks to create robust balance sheets. But the question is: where are the good banks? For, all PSBs are equally infested with bad debts.

That said, we must also remember that mergers are essentially meant for leveraging on ‘synergies’ likely to emerge out of the merging units but not for creating big balance sheets. And so far as synergies are concerned, there are hardly any, for each bank has its own peculiar problem with balance sheet and style of operating—even their operating technologies widely differ. And when it comes to credit culture, the less said, the better. For, cyclical down-trends impacting the balance sheets of businesses is a recurring phenomenon. In the light of these realities, merging ailing banks without first setting right their balance sheets will only create new problems.

So, the only alternative is: under the contemplated fiscal stimulus, the government may infuse capital into banks, for it indirectly makes fresh capital available for industry to invest afresh. Or, the owner may take a call for privatizing, at least, some banks to begin with. This move shall also help banks to retain their existing network advantage in tact while effective and healthy competition is created among banks, which incidentally can result in the much desired effective management in the banking sector. But in one way or other act it must, for delay would only make things far worse.

Simultaneously must continue to pressurise the banks: one, to pursue recovery of bad debts through IBC with greater vigour and two, to build and nurture better  credit culture. 


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