Daily Editorials for UPSC IAS Exam Preparation

Agenda for Banking Sector Reforms




NDA government since coming to power has focussed on bringing several banking sector reforms (Jan Dhan Yojana, Measures to tackle the NPA, Bank Board Bureau etc.) but the agenda is unfinished. There are several measures that need to be taken. The top priority must be fixing the problems of public sector banks.

This requires action on three fronts according to Montek Singh Ahluwalia, the former deputy chairman of the Planning Commission.

  • accelerate recoveries from non-performing assets (NPAs),
  • recapitalize public sector banks to strengthen their ability to expand credit, and
  • introduce reforms that will increase the efficiency of these banks

Recoveries from NPAs

To deal with the non-performing assets over the last couple of years, RBI and government have tried many ideas like-

  • Flexible Refinancing of Infrastructure (5/25 scheme),
  • Asset Reconstruction (ARC),
  • Strategic Debt Restructuring (SDR),
  • Asset Quality Review (AQR) and
  • Sustainable Structuring of Stressed Assets (S4A).

Yet, with all the strategies we have only had limited success in countering the problem, India’s twin balance sheet problem still persists.

Strategic Debt Restructuring (SDR)

  • The Strategic Debt Restructuring Scheme allows banks to convert the debt into equity, take control of the project, remove the existing management, and induct new management. Ideally, the project should be auctioned off to the highest bidder and the existing management, if not suspected of malpractices, should also be allowed to bid. The difference between the amount paid for the equity and the value of the debt converted is a market-determined debt write-off.
  • The scheme has not worked for a variety of reasons;
    • problems of coordination among the different banks involved,
    • regulatory uncertainties (especially for infrastructure projects) which deter new investors,
    • the unwillingness of bankers to accept a sufficient write-down of the outstanding debt
    • the practical problem of running the projects taken over until a new management comes in. Banks are ill-equipped to do this.

Scheme for Sustainable Structuring of Stressed Assets (S4A)

  • It has the advantage of not having to look for a new management, but since the incumbent management remains in place, and the debt write-off is not competitively determined, there is a danger that the concessions given may attract the charge of cronyism and corruption.
  • Bankers worry about this since Section 13.1. d (iii) of the Prevention of Corruption Act (PoCA), 1988 makes a public servant liable to the charge of corruption if he/she, “while holding office as a public servant, obtains for any person any valuable thing or pecuniary advantage without any public interest
  • Some think that the problem can be overcome by setting up an independent “oversight body” to approve the debt reduction terms. But since the oversight body will also consist of public servants, the problem remains.

Solution is National Bad Bank

The best solution as suggested by Montek Singh is to create a new government institution—the so-called “bad bank”—to which the public sector banks transfer their large problem assets at a realistic price, leaving it to the new entity to handle recovery.

  • It should remain in the books of the banks, and can then be recapitalized appropriately.
  • Bankers will be much more willing to transfer their NPAs at a low price to a new public sector agency, than offer the same benefit to a private party.
  • The new entity can then offer realistic levels of debt reduction without making a loss on its books. It will also be much less vulnerable to the charge of corruption if the public interest and urgency involved in cleaning up NPAs is clearly spelt out in the mandate of the entity. Its proposals could also be vetted by a high-level oversight board.
  • It could work in partnership with private asset management companies specializing in particular areas to bring in new investors.
  • It could experiment with both approaches—a change in management in some cases, and retaining existing managements in others.

Recapitalization of public sector banks

The capital requirements of the banks have increased with increasing NPAs.

  • We need to lower the government equity below 51% in order to allow public sector banks to raise capital on favourable terms.
  • We can attract one or more strategic investors into some of the public sector banks. They need not be given any direct role in management, but could be given a seat on the board, as China has done.
  • The reduction in government equity below 51% may be resisted because it jeopardises reservations in employment. These fears can be addressed by building suitable provisions into the shareholder’s agreement, and announcing that the government, which will remain the dominant though not the majority shareholder, will ensure that reservations continue.
  • The budgetary funds for recapitalization should be allocated in a manner which favours the better-performing banks giving the incentives for the banks to perform better and to improve their performance.

Reforms in the banking sector


  • Reducing the government equity below 51%, and attracting some strategic investors, would be a very major step.
  • It will not only reduce the pressure on the budget to provide funds for recapitalization, it will also set the stage for a more commercial orientation for public sector banks. This is critical if public sector banks are to compete more effectively with private sector banks.
  • If that is contested we can use the recommendation as suggested by the J. Nayak committee, of vesting the government’s shareholdings in public sector banks in a separate holding company, and limiting the finance ministry to deal only with the holding company on policy issues.
  • The individual public sector banks should be free of finance ministry control and become board-managed entities.
  • The holding company should appoint a non-executive chairman and other representatives on the board. Top appointments in the banks, including those of the chief executive officer, should be made by the board of each bank, and not by the appointments committee of the cabinet.
  • The Bank Boards Bureau was initially seen as a step towards the establishment of a holding company, but it has not been empowered to play this role. Even in the matter of appointments, it only makes proposals to the appointments committee of the cabinet, which is not very different from the pre-existing position.

[su_box title=”Practice Questions” style=”bubbles” box_color=”#99bb41″ title_color=”#000000″ radius=”20″]

  1. NPA has been the biggest problem Indian financial sector is facing. Examine if creation of Bad Bank could be a solution to the crisis.
  2. Autonomy of the Public Sector Banks is the need of the hour. But our political class is still ambiguous about it. Discuss.


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