Bring banks on track

Credit market ecosystem needs better governance and oversight

The banking sector is showing signs of a turnaround, though challenges remain. The latest Financial Stability Report (FSR) of the Reserve Bank of India (RBI) says that gross non-performing assets (GNPA) of scheduled commercial banks could rise from 9.3 per cent in September 2019 to 9.9 per cent in September 2020, largely due to change in macroeconomic conditions, marginal rise in slippages, and declining credit growth. Slower economic growth is a risk for both the banking and non-banking financial sectors. Nominal growth in the Indian economy slipped to 6.1 per cent in the second quarter of the current fiscal year — the lowest in about two decades. Lower nominal growth will affect revenues of businesses, which will have a bearing on their ability to service debt. 

Apart from NPAs, the macroeconomic and policy environment can make things difficult for banks, especially those in the public sector. Credit growth is now lagging deposit growth. While part of the banking system is not in a position to expand its balance sheet, Indian companies are increasingly borrowing from abroad. As a recent report in this newspaper showed, fundraising through dollar bonds jumped nearly five-fold to $23.6 billion in 2019. Monetary policy accommodation in advanced economies has eased conditions in global financial markets. The slower pace of transmission in the Indian banking system, which has not allowed companies to fully benefit from lower policy rates of the RBI, also made borrowing from abroad more attractive. The rise in foreign currency borrowing, apart from affecting the banking system, could also complicate policy management for the central bank.

Even though the macro environment is not favourable, a good deal can still be done to improve the resilience of the banking and financial system. RBI Governor Shaktikanta Das has rightly emphasised the need for improving governance, including in private banks, in the foreword to the FSR. In fact, there is a need to review governance standards in the entire credit market ecosystem. For instance, as the FSB has highlighted, it has been noticed that credit-rating agencies provided indicative ratings without written agreements. As these indicative ratings are not disclosed by rating agencies, it is difficult to track the possibility of rating shopping. However, the pattern of withdrawal of ratings by one agency and provided by another does indicate the possibility of rating shopping because the new ratings are often the same or better than the earlier ratings. Since ratings play an important role in credit screening, compromised evaluation by rating agencies could affect lending decisions. The Securities and Exchange Board of India recently fined rating agencies in the IL&FS issues. This should help send a message about the importance of following regulations. 

Nonetheless, rating agencies are only one part of the ecosystem. The health of the banking system, to a large extent, also depends on the government and the central bank itself. The RBI has not been able to detect governance failure in several cases, both in banks and non-banking financial companies. Again, IL&FS is a case in point. Improvement in the oversight capacity of the regulator will help strengthen financial stability. Further, the government needs to implement governance reform in public sector banks to improve efficiency, so that they are not a drag on the financial system and overall economic growth.