Bank and the Covid Pain

Context: Indian economy must resist shortism and must persist with a multi-year five-pillar strategy for sustainably raising its Credit to GDP ratio.

Credit Expansion and Credit Repaid Nexus

• A modern economy grows by credit expansion/lending and a modern welfare state indirectly supports non-payment of credit.
• Credit expansion without credit repaid would mock the very concept of development and elimination of poverty.
• Fiscal constraints or natural disasters often create temptations to misrepresent spending as lending.
•  COVID induced economic crisis has raised requests of credit expansion like interest waivers, moratorium extensions, blanket one-time restructurings, fudging accounting, reducing capital adequacy, IBC suspension, etc. 

Lessons from Past Financial Scenario

• Giving loans is easier than getting them back: corporate credit growth gave rise to bad loan problems.
• Disallowing accounting fudging and restructuring: would have saved Rs 7 lakh crore because banks would have run out of capital.
• PSBs need more than capital: as their risk-weighted assets are lower despite capital infusion.
• Bank nationalisation idealism: by Hazari Committee (nationalizing banks to democratize credit) and Avadi Resolution (controlling a myopic private sector) has failed to solve the problem of credit to GDP ratio and bad loan.

Multi-Year Five-Pillar Strategy 

• Bank competition : competition-driven innovation approach is a must for credit expansion and lowering its price.

• • • Socialism is essentially capitalism without competition hence the Indian economy is in the dire need of more banks.

• Private bank governance: must move from a jagir (perpetual private fiefdom) to Amanat (trustees that hand over in better condition to the next generation).

• Private banks are only 30% of deposits but 80% of bank market capitalisation, 77% of incremental deposits, and 77% incremental loans. 
• Government bank governance: Government banks and companies rely on the wrong notion that return on equity and market capitalisation doesn’t matter. 
• Government banks reflect the decline of PSUs market capitalisation (from 30% to 6% in 10 years): i.e 70% bank deposit share translates to only 20% bank market capitalisation share. 
• Many PSBs have irrational employee costs to market capitalisation ratios.
• India needs only four PSBs with strong governance and no tax access for capital.
• RBI’s regulation and supervision: must be reinforced by re-imagining its current mandate, structure, and technology.
• Statutory auditors, ethical conduct, shareholder self-interest, risk management and first-principles review raise the need for the RBI’s regulation and supervision game. 
• Non-bank regulatory space: and supervision with progress in payments, MSME lending, and consumer credit is a must for financial inclusion.
• Regulatory apartheid traditionally existed between banks and non-banks.

Ongoing Progress in Indian Financial Sector

• Forex reserves are at a high and interest rates at a low. 
• Borrower rate transmission is improving. 
• Billion digital mobile payments target has met.
• RBI is creating a specialised cadre for supervision and has proposed licencing competitors to the NPCI.
• It is revamping its supervisory technology investments and early warning models. 
• It is calibrating an exit strategy for emergency COVID measures.
• Deposit insurance limits have been raised with a risk-based premium framework proposed. 

Conclusion: Indian economy requires balancing financial inclusion (migrants, self-employed, and MSMEs) and stability by persisting with a five-pillar strategy.

Quotes

• Warren Buffet,” equity markets may be voting machines in the short run but they are weighing machines in the long run”. 
• “Breaking the thermometer doesn’t help the fever”
• “Socialism is essentially capitalism without competition”