A vibrant banking sector needs the ‘4-D’ approach

Subramanian has advocated the gradual reduction of SLR that currently stands at 21.5 per cent, which would free up capital.

Exisiting policies and structural factors are responsible for the current mess in the banking sector, says the Economic Survey.

The country’s public sector banks are plagued with non-performing assets, while having to meet the challenge of raising their capital buffer to comply with the Basel III regime. Even as the Survey highlighted the current compliance needs that are a hindrance, it has offered solutions such as deregulating the sector, creating more banks and preparing the banking system to withstand boom-bust cycles.

The finance ministry’s chief economic adviser Arvind Subramanian, the lead author of the report, was critical of the high SLR (statutory liquidity ratio) requirement of banks, and the priority sector classification that absorbs a large proportion of a bank’s lendable resources.

Subramanian has advocated the gradual reduction of SLR that currently stands at 21.5 per cent, which would free up capital. This would make the market for government bonds more liquid. SLR is the proportion of reserves that banks have to park in mandated forms including government securities. The survey has also raised concerns over the trend over the last decade where almost 60 per cent of household savings are parked in physical assets as opposed to financial assets, and has flagged the negative real return on bank deposits due to the high levels of inflation.

Among the solutions on offer is what Subramanian calls the ‘4D’ policy: Deregulation (addressing SLR and priority sector lending ), Differentiation (within the public sector banks in relation to recapitalisation, shrinking balance sheets, and ownership), Diversification (of source of funding within and outside banking), and Disinterring (by improving exit mechanisms).

Calling for relaxation of SLR requirement on a gradual basis, the survey said, “This will provide liquidity to the banks, depth to the government bond market, and encourage the development of the corporate bond market.”

On the priority sector lending, Subramanian has called for a reassessment of the same and stated that either more sectors have to be brought into its ambit or the norms can be slowly redefined to make priority sector more targeted, smaller, and need-driven.

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While the Survey called for selective policy approach for banks of different sizes, it also suggested that more diversity is required within the sector — more banks and more kinds of banks.

The survey also proposed to appoint an Independent Renegotiation Commission with political authority and integrity that will aim to resolve big and difficult cases as it felt that India needs to be better prepared for the next boom and bust.

“India needs to be better prepared to distribute pain between promoters, creditors, consumers, and taxpayers. Being prepared for the cleanup is as important as the being prudent in the run-up,” said Subramanian in the Survey.