October 7, 2011 3:00:20 am
A downgrade of SBI bonds due to the poor asset quality of the bank should remind us of the need for better regulation of the banking sector. India has been thumping itself on its back for the banking sector escaping the global banking and financial crisis because of the good job that the bank supervisor did. In this story,we fail to remember the basic flaws of the Indian banking and financial system.
The corporate debt market in India is underdeveloped. A large share of domestic financing for big projects ends up as bank loans. Public-sector banks end up giving loans to well-connected,large corporations. A PSU bank chairman may,however,be reluctant to reveal the quality of the loans given by the bank during his tenure. During an economic slowdown,the quality of assets may also turn bad at a faster pace as businesses do badly. At present,unfortunately for the SBI,both these seem to have come together. However,the worrying part of the news is that it is not the banking supervisor that is telling us the bad news. The banking supervisor needs to have the competence to look at SBIs balance sheet and prevent it from taking higher risks. A new chairman or a rating agency should not be needed to do what is essentially a bank supervisors job. The supervisor should have alerted the public of the quality of SBI assets long before a rating agency that is not privy to all the information that the RBI is. The RBI,as the bank supervisor in India,has historically treated public-sector banks less like entities that need to be supervised and more like entities that need to be protected. The policy of recapitalisation of PSU banks means they can keep on giving bad loans,and remain unprofitable,in the expectation that when the need for capital arises,the government will fulfil this need. Not only does the banking supervisor not have the required skills and attitude,the sovereign guarantee for PSU banks makes it pointless. PSU banks can give as many bad loans as they like without the fear of going bankrupt.
When finance gets into trouble,this spills over to the exchequer. This is the last thing India needs today. In India,precisely because the fisc is a disaster,we need banking to function without needing capital from the government. At this time,we can ill-afford the luxury of incompetence on financial regulation.
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