Strengthening financial sector

News: For a swift economic recovery of India, the central bank would need to guide the economy towards normalcy. In terms of monetary policy management, the central bank has started the unwinding process.

In the context of financial sector oversight, RBI Governor Shaktikanta Das touched upon several interdependent issues in his remarks at an event recently, and these require more attention.

What is the present situation of the financial sector?

The impact of the pandemic on asset quality in the banking sector has been far lower than initially anticipated.

Asset quality and capital levels improved for the banking system in the September quarter compared to the previous one.

Various banks have reported better than expected profits.

What are some issues with the financial sector that merit attention?

Improved parameters are partly a result of regulatory relief provided by the central bank along with the support extended by the government. As regulatory support is withdrawn, some of the accounts that have been restructured may not remain solvent, and the banking system will have to get those resolved.

The RBI, however, does not have adequate powers to regulate PSBs, which often function with vacancies in the board and top management.

The government has been encouraging PSBs to push lending, including through outreach programmes. The idea is that pushing credit through PSBs will help increase consumption and investment demand. But it is important to recognise that overall economic growth depends on a variety of factors and pushing demand through the extension of credit may not be sustainable.

What steps are being taken?

RBI has started taking a closer look at the business models of banks as some are following a high risk-high return strategy with the objective of serving the interests of shareholders. Closely following the functioning of banks as will help RBI intervene in time to avoid any build-up of risk and ensure stability in the banking system

What is the way forward?

The RBI will need to ensure that lenders don’t delay the resolution of restructured accounts, as has been the case in the past.

Since the condition of PSBs is significant for the flow of credit in the Indian economy, it makes sense to bring them at level with private banks in terms of regulation. This will help improve the overall health of the banking system in the long run.

In the short to medium term, the RBI should ensure that banks and NBFCs deal with the overall impact of the pandemic transparently, and have adequate capital to facilitate economic recovery.

Good governance is also necessary for a well-functioning and resilient financial institution.

Source: This post is based on the article “Strengthening financial sector” published in Business Standard on 18th Nov 2021.