Nifty PSB index in a free fall: Time to initiate last of 4 'R's in banking

The Nifty PSU Bank index declined 3.57% on Wednesday with Andhra Bank, Canara Bank and Allahabad Bank sustaining the maximum damage.

Indian equity markets registered yet another day of decline — the sixth one in a row — with the Sensex and the Nifty at the year’s lowest level. While some of it can be attributed to weak global clues, thanks to apprehensions of a trade war brewing in the West, the key concern in the domestic market is the nervousness over the banking sector, particularly public sector banks. The Nifty PSU Bank index declined 3.57 per cent on Wednesday with Andhra Bank, Canara Bank and Allahabad Bank sustaining the maximum damage. A big part of the worry surrounding banking stocks has originated from the growing uncertainty in the wake of the Rs 127-billion Nirav Modi-Punjab National Bank scam amid apprehensions that there might be more skeletons in the cupboard.

 
The timing of this scam could not have been worse. For one, the Indian banking system, especially public sector banks, has barely come to terms with high levels of bad loans or non-performing assets on its books. Fresh concerns over corruption and fraud will further erode the already low level of credibility they enjoy. Moreover, economic growth is finally looking up. The latest national income data shows a sharp rebound taking place in investment expenditure in the economy. This is the time when investors need healthy banks to come forward and finance economic activity. However, the current mess in the banking system, especially in public sector banks, which account for around 70 per cent of all banking, makes it difficult for fresh lending to take place efficiently.

 
It is time now to pay heed to the advice given in this year’s Economic Survey, which stated that the banking sector needed the 4 ‘R’s — recognition, recapitalisation, resolution and reform. Over the past four years, the government, along with the Reserve Bank of India, has tried to move ahead in this direction. There is now a clear path laid out for prompt recognition of bad loans, the government has already provided an over Rs 2 trillion recapitalisation package for public sector banks and with the Insolvency and Bankruptcy Code in place, resolution, too, is streamlined. However, the fourth R of reform has not received adequate attention, even though the government has taken some steps in the last few days. These include asking public sector banks to inspect all bad loan accounts above Rs 500 million and proposing a new law for fugitive economic offenders. The RBI has also formed an expert committee to look into rising instances of fraud.

 

But the fact of the matter is that without urgently reforming the way banks go about lending money, all the other ‘R’s  will not amount to much. Indian public sector banks suffer from excessive political interference and have weak governance norms. Decision makers are confused about their objectives as banks are subject to dual regulation by the government and the RBI. There is no dearth of suggestions — the P J Nayak Committee (2014) being the most recent one — on how to improve the functioning of Indian banks. It is generally considered that India has a strong consensus for weak reforms. The current crisis in the banking setup provides the government with a great opportunity to bite the bullet and aggressively push reforms in public sector banks, including steps such as shrinking unviable banks and allowing greater private sector participation.