The Bank of America has offered a $17 billion settlement to the US government to stop investigations into the sale of 17,600 defective mortgage loans prior to the 2008 financial crisis. The settlement offer, the largest in the history of corporate America, ends the main remaining legal issue from the 2008 financial crisis. It also brings a moment for us to examine the vulnerabilities of the Indian financial system and the existing regulatory framework. Though Indian banks and financial companies did not collapse in the wake of the financial crisis, there are many signs of vulnerability within the current financial system.
The US stimulus programme that bailed out distressed financial firms after 2008 was opposed for using taxpayer money to aid firms that had made risky investments. In India, there has been no such debate on the heavy doses of stimulus to inject liquidity into the financial system post-2008. Some argue that the Indian stimulus overheated the economy, and is one of the causes for the current stagflationary situation. Be that as it may, it is a fact that Indian banks today are saddled with a large number of non-performing assets, and this is beginning to affect the health of the financial system. The nature of financial regulation has exacerbated the moral hazard problem in India — there is an implicit assurance of unlimited bailouts due to government ownership. The RBI has also been only too happy to oblige distressed banks by tweaking norms and rules. Banks, therefore, do not suffer the harsh consequences of making bad investments. Almost 40 per cent of India that has no access to the organised financial system subsidises bank bailouts by paying indirect taxes.
Much of this is due to the mandate-driven approach to regulation in India. Banks are under pressure to meet multiple targets on priority sector lending, financial inclusion etc. These requirements reduce the scope for financial innovation, and distort sound business judgement. Government ownership and interference create incentives to please political masters. The government and regulators are therefore only too happy to oblige banks complaining of suffering under an oppressive regulatory regime. If the Indian financial system is to become truly competitive and accessible to all, there is a need to re-orient the regulatory regime in a manner that reduces unnecessary regulation.