DMPQ-Discuss how India’s banking sector needs next generation reforms.

The government recently announced new banking reforms, involving the establishment of a Development Finance Institution (DFI) for infrastructure, creation of a Bad Bank to address the problem of chronic non-performing assets (NPAs), and privatisation of public sector banks (PSBs) to ease its burden in terms of mobilising additional capital.

The Indian banking sector has been evolving on a continuous basis, and it will be interesting to trace its journey. The Indian economy has diversified quite significantly and been growing rapidly since 1991, and getting increasingly integrated with the global economy. Therefore, the fourth generation (1991-2014) of Indian banking saw landmark reforms such as issue of fresh licences to private and foreign banks to infuse competition, thereby enhancing productivity as well as efficiency by leveraging technology; introduction of prudential norms; providing operational flexibility coupled with functional autonomy; focus on implementation of best corporate governance practices; and strengthening of capital base as per the Basel norms.

Since 2014, the banking sector has witnessed the adoption of the JAM (Jan-Dhan, Aadhaar, and Mobile) trinity, and issuance of licences to Payments Banks and Small Finance Banks (SFBs) to achieve last-mile connectivity in the financial inclusion drive. For instance, SFBs had mobilised deposits of ₹82,488 crore and extended credit of ₹90,576 crore to small and marginal farmers, and MSMEs (micro small & medium enterprises) by the end of FY 2019-20.

Given the current challenges of a burgeoning population, the ongoing Covid-19 pandemic, and the West’s intention to shift its manufacturing base as well as supply/value chains from China to India and elsewhere, it is essential to say ‘yes’ to fifth generation (2014 and beyond) banking reforms. This calls for a paradigm shift in the banking sector to improve its resilience and maintain financial stability.

While promoting niche banks, the government should tighten the loose ends by allowing them to build diversified loan portfolios and have cross-holdings to mitigate concentration/market risks, establishing sector-wise regulators, bestowing more powers to deal effectively with wilful defaulters, and paving the way for the corporate bond market (shift from bank-led economy) to create a responsive banking system in a dynamic real economy.

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