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The Look at Indian financial structure

 

 

The Look at Indian financial structure

 

Why a part of D.N.A.-The Reserve Bank of India (RBI) has said in its latest Financial Stability Report that Indian banks will continue to be under pressure because of their bad loans. Stress tests conducted by the central bank show that bad loans will continue to increase in the current financial year while capital adequacy will decline.

 

Current Scenario - Most of the current policy attention has quite naturally been focused on the first three of four components of a recovery in financial sector health—what has been described with alliterative flourish as

  1. recognition,
  2.  resolution,
  3. recapitalization and
  4. reform.

Background:

 

1st Phase

The first came up during the era of planned industrialization. The government of the day set up specialist financial institutions—Industrial Finance Corporation of India, Industrial Credit and Investment Corporation of India and Industrial Development Bank of India—to provide funds to new projects at a time when local financial markets were not developed enough to provide long-term finance for new industrial projects. These financial institutions focused on project finance while the commercial banks provided working capital.

2nd Phase

The second era in the Indian financial structure began after the radical economic reforms of 1991. The two committees headed by former RBI governor M. Narasimham produced seminal reports, in 1991 and 1998, which provided a road map for a complete overhaul of the Indian financial system. The underlying logic was that a financial system that had evolved within a system of credit planning would be out of sync with a market economy. The two Narasimham committees pushed India in the direction of universal banking, as the specialist financial institutions either converted themselves into commercial banks or withered into insignificance.

Problem ?

The commercial banks  weighed down with soured loans to steel, telecom, power and infrastructure projects. One part of the problem is that public sector banks were forced to lend to these projects during the previous credit bubble, as fiscal constraints meant that infrastructure could not be built using budgetary resources.

What next? Creating a new generation of development finance institutions is easier said than done. The old financial institutions could lend cheaply because they had access to subsidized capital—either from international agencies or directly from RBI.

Way Forward :

  1. What India perhaps needs is a newer generation of financial agencies that can help build national infrastructure without landing in a balance sheet mess. The other alternative is deeper bond markets to provide finance to large projects. In fact, one possibility that is often discussed is a financial structure in which large companies borrow from the bond markets while smaller companies get their funding from commercial banks.
  2. The ongoing problems in the banking sector mean that much of the policy focus is on the trio of recognition, resolution and recapitalization. The reform debate is largely stuck on the issue of who should own banks—the government or private investors? There is a more profound problem that needs to be addressed. What financial structure is needed over the next two or three decades?
  3. The recent moves by RBI to give differentiated licences to payment banks, small finance banks and local banks should be seen as a move away from the earlier commitment to universal banking.
  4. The Indian central bank has also, in an April 2017 discussion paper, floated the idea of specialist wholesale and long-term finance banks that would largely fund infrastructure projects. They would not only lend directly but also securitize priority sector loans originated by other banks as well as do takeout financing. The funds for these specialist lenders would come from wholesale deposits, long-term deposits, debt/equity capital raised from primary market issues or private placements, and term borrowings from banks and other financial institutions.

 

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