Fixing the rot in India’s financial ecosystem

The signs this could happen are there for all to see. Despite the government pumping in huge amounts into banks as capital, lending was just not happening.

The RBI’s latest warning that the burden of bad loans in India’s banking system is likely to go up is a timely red flag not only to get our financial system back on an even keel, but also to use the new year to try and resuscitate the entire economy. The central bank has warned that despite non-performing assets (NPAs) contracting in 2019, they are set to rise to nearly 10% of all loans by next September.

The signs this could happen are there for all to see. Despite the government pumping in huge amounts into banks as capital, lending was just not happening. A slowing economy and a series of spectacular shadow bank collapses means risks are multiplying. At greater than usual risk are the real estate, power and telecom sectors, besides the huge amounts of money lent by banks to shadow banks. RBI is expected to soon take up with the Centre the issue of fresh provisioning of risky loans that may amount to as much as Rs 3.8 lakh crore. The loans to shadow banks or non-banking finance companies (NBFCs), as they are called in India, remain suspect as, according to multiple reports including by RBI and CIBIL, NBFCs “remain under stress, with a recent portfolio shift to higher-risk unsecured credit”.

This shows the need for setting right not only India’s formal banking sector comprising scheduled commercial banks—both state-run and private—but also the larger financial ecosystem of NBFCs and cooperative banks. Neither RBI nor Central and state governments have any real idea of how deep the rot in the larger financial setup is. Fixing it will require hard decisions including shutting down or amalgamating many of these shadow banks and cooperative credit banks. At the same time, the government has to wake up to the fact that in bad times, everything may go from bad to worse. The need of the hour will remain putting right the basics of our economy on whose revival a lot depends, including greater credit offtake and improvement of the ability of firms and individuals to repay past loans.