Moving Towards Financial Sector Reforms

RBI has been trying to get more money in the system by slashing SLR

It is not even a question whether India needs a financial overhaul or not. The prescription is written all over the wall. Among the few immediate steps that the government needs to take are to deepen the equity and money markets while protecting smaller investors, the public sector banks have to be reformed in a major way and the insurance sector has to be strengthened to increase the flow of capital and protection of investment.

The latest Economic Survey 2014- 15 also repeated what needs to be done with the banking sector. It gave a four-pronged solution – deregulation, differentiation, diversification and disinterring. The survey called for  gradual reduction in the statutory liquidity ratio (SLR) or the chunk of money banks need to mandatorily invest in government securities and the other liquid assets such as gold, to make available liquidity for lending for productive sectors. The amount, thus released from the shackles of the forced-government security investment, could be used freely by the public and private sector banks at their discretion.

The Reserve bank of India under the Governor Raghuram Rajan has also been steadily attempting this. After the former International Monetary Fund economist Rajan took the helms of the India’s central bank, SLR has been reduced thrice by 150 basis points to 21.50 per cent. With the sector afflicted to double financial repression and misallocates capital to investors, the Survey sought correction in assetside repression. Asset-side repression is created by SLR requirement, while liability side is due to high inflation.

The survey also highlighted the need for a proper Bankruptcy law in the country so as to help lenders recover some of their losses if a corporation runs out of business.

Currently, the country does not have a proper bankruptcy law and the banks have to resort to either Corporate Debt Restructuring Cell – a place where the consortium of lenders discuss the feasibility of a sick company and study the case for moratorium on the loan repayment, or to the Board for Industrial & Financial Reconstruction (BIFR) – a government body to revive bankrupt companies. Both the units have failed to offer quick solutions for banks struggling with bad loan problems or in even reviving the companies from their plight.

Currently, toxic assets are over 10 per cent of the total loans given by banks, impacting their profitability. As the survey notes, “distressed assets hang like a Damocles sword over the economy and require creative solution.” Hence, a bankruptcy law is urgently required in the country. On the increase in the non-performing assets (NPA), the economic survey notes that as on June 2014, five subsectors – infrastructure, textiles, iron and steel, mining and aviation hold 54 per cent of the total stressed advances of government owned banks.

The survey prescribes to do away with the one size-fits-all approach of the government when it comes to treating public sector banks and asked the authorities to look at differentiated solutions for differently sized state-backed banks. Currently, all the state-banks are treated the same way in appointing bankers, compensating policies, distribution of capital, or employee performance.

These solutions have been harped by various central bankers and economists over the years, so Arvind Subramanian, chief economic adviser to Arun Jaitley, has just reinforced what has been said over the last one decade. It’s the government which needs to take action. The latest Union Budget did promise a Bankruptcy Law along with reforms in the financial sector, but it is yet to be seen how soon the government can bring about these changes.

The government has moved forward in some respects in the financial sector reforms by allowing state-backed banks to dilute government stake to 52 per
cent and making sure amendment of Insurance Bill is passed in the Parliament. The new insurance law allows the foreign partners to hold 49 per cent stake in their Indian partnerships up from 26 per cent allowed according to old law. The passage of the new law will definitely get in some relief to the cashstrapped Indian insurance sector but the government still needs to completely free this sector to see a sharp rise. According to Minister of State for Finance Jayant Sinha, the move is estimated to rack in USD10 billion in the sector. While the statebacked banks can tap in markets to raise funds and improve their capital adequacy ratios especially when the stricter norms of capital adequacy under the Basel 3 norms will kick in fully by 2018-19. According to Reserve Bank of India estimates, the banking sector will then require Rs. 2.4 trillion rupees.

The Reserve bank of India has also been actively promoting granting of new license for banks following two applicants got approval in April, 2014 to set-up new banks in the private sector within 18 months. The  RBI released guidelines and invited applications for setting up payments banks and local area banks as well.

The government is also looking for ways to deepen the debt market and attempting to increase domestic flow into the Indian markets. To win small investor confidence, Jaitley has announced setting up of a task force to establish a sector-neutral Financial Redressal Agency that will address consumer grievances against all financial service providers. The government is also aiming to remove unnecessary restrictions in the currency derivative markets, and has formed a committee on Indian Financial Sector that will submit a report to the government on proposal to revamp this segment. These steps would make the system internally more strong.

The government is moving forward with a lot of proposals that are progressive and might be able to achieve the reforms that are required. The problem, however, for this government has been its inability to get laws passed in the upper house, where it does not enjoy a majority. Case in point has been the Land Acquisition Bill that the government has been unable to get through and has decided to reissue the ordinance for its continuation. The government has not been able to even table the Goods and Services Tax bill that look at unifying various taxes in the country under one umbrella. The question with the present government is no more the intent but the capacity to convert proposals into laws. There is serious need for tougher reforms in the financial sector, which would ensure sufficient money supply to the economy.