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The Economic Survey has prescribed a '4-D model' for the banking sector to face competition in the changed environment.
"Banking is hobbled by policy, which creates double financial repression, and by structural factors, which impede competition," the Economic Survey 2014-15, tabled in Parliament by Finance Minister Arun Jaitley, said.
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"The solution lies in the 4 Ds of deregulation (addressing the statutory liquidity ratio (SLR) and priority sector lending (PSL), differentiation (within the public sector banks in relation to recapitalisation, shrinking balance sheets and ownership), diversification (of source of funding within and outside banking), and disinterring (by improving exit mechanisms)," it said.
The Survey has recommended SLR, a portion of deposits mandatorily invested in government securities, requirements can be gradually relaxed.
This will provide liquidity to the banks, depth to the government bond market, and also encourage the development of the corporate bond market, it said.
The right sequence would be to gradually reduce SLR and then provide incentives for a deeper bond market, it added.
Recently, the RBI has taken commendable and gradual steps in lowering the SLR from 25 per cent to 21.5 per cent. Earlier this month, RBI slashed the SLR by 50 basis points to 21.5 per cent.
"PSL norms can be re-assessed. There are two options: one is indirect reform, bringing more sectors into the ambit of the PSL, until in the limit every sector is a priority sector; the other is to redefine the norms to slowly make priority sector more targeted, smaller, and need-driven," it said.
The dual responsibility of building a modern economy and lifting the standard of living at the lowest percentiles of income demand creativity, including more evidence-based policy making especially in relation to PSL, it said.
The Survey further said that the analysis suggests that there is sufficient variation in the performance of public sector banks. The policy implication is that a one-size-fits-all approaches to governance reforms, public ownership, exit and recapitalisation should cede to a more selective approach.
It also suggested that more banks and more diversified ones must be encouraged.
Healthy competition from capital markets is essential too which will require policy support, it said.
Besides, better bankruptcy procedures for the future is essential.