Shaktikanta Das: Indian banking at crossroads - some reflections
Speech by Mr Shaktikanta Das, Governor of the Reserve Bank of India, at the First Annual
Economics Conference, Amrut Mody School of Management, Ahmedabad University,
Ahmedabad, 16 November 2019.
* * *
I am very happy to be amongst you today to address the first Annual Economics Conference
being organised by the Amrut Mody School of Management, Ahmedabad University. The theme
of the conference - "50 years of Bank Nationalisation: Indian Banking at Crossroads" - provides
the perfect backdrop for a discussion on the evolution of Public Sector Banks(PSBs), their
journey over the last 50 years and a vision for their future. The banking system has played a
critical role in the upliftment of our country, especially in the recent decades which saw
unprecedented economic growth. However, the banking system, especially the public sector
banks, has experienced a large churn after the Global Financial Crisis(GFC) as it tries to grapple
with multiple challenges, including high non-performing loans (NPLs), global and domestic
economic downturns, adaptation of technology and competition from new age fintech
companies. In my address today, I shall attempt to discuss the challenges that lay ahead for the
broader banking sector and what we expect of them going forward. I shall also briefly touch upon
our approach to tackling the issues in the non-banking finance companies and urban
cooperative banks, which are important segments of the financial sector.
2. Many a time, to see through to the future, looking back at the past provides insights that are of
much help. With that limited objective, I shall wade back a little to the past for the sake of
contextualising our discussion. In 1967, credit to agriculture constituted only 2.2 per cent of the
total advances of the Scheduled Commercial Banks in sharp contrast to industry which
constituted 64.3 per cent. Five cities in the country, viz., Ahmedabad, Mumbai, Delhi, Kolkata and
Chennai accounted for around 44 per cent of the bank deposits and 60 per cent of the
outstanding bank credit in1969. This led to the widespread political perception that, left to
themselves, the private sector banks were not sufficiently aware of their larger responsibilities
towards society. The solutions that the policy makers thought of at that time included exerting
various degrees of control over the banking system, which ultimately culminated in the decision
to nationalise 14 private sector banks in 1969, followed by the nationalisation of six more private
sector banks in 1980. The impact of the decision to nationalise banks has been succinctly
summarised in the History of RBI, Volume III: "....at the time of nationalisation as many as 617
towns out of 2,700 in the country were not covered by commercial banks. And, even worse, out
of about 600,000 villages, hardly 5,000 had banks. The spread, too, was uneven......"
Current Challenges and the Role of Exogenous Factors
3. Against this historical detour, let me come to the challenges faced by the banks today, many of
which are a result of how various exogenous factors have played out over the years. Everyone
concerned should realise that banks are in the business of taking bonafide risks. This means that
out of a host of exposures which a bank chooses to take, a few may go bad. The PSBs, which
have been used as vehicles to further the development agenda of the Government, had to
achieve and maximise multiple objectives. The high growth phase prior to the GFC (2008) was
aided by bank credit to a large extent, mostly by PSBs, leading to risk build ups in the balance
sheet of the lenders. In particular, bank credit to infrastructure sector increased at an
unprecedented rate. This exposed the PSBs to the travails of the infrastructure sector, which
materialised significantly in the post-crisis years.
4. Further, the tail end of the above high growth period in advances to infrastructure coincided
with a period of slowdown in economic growth and tightening of environmental clearances. Also,
the transformation of major term lending institutions into universal banks/NBFCs led to
commercial banks becoming the primary source of long-term debt financing to projects in
infrastructure and core industries. An immediate consequence of these circumstances was that
it led to a spurt in the level of 'restructured standard assets', i.e., assets which were restructured
without being downgraded as non-performing assets (NPAs). Eventually, most of the
restructured assets which were allowed to be classified as 'standard' became NPAs as the
restructuring packages proved to be unviable. Inadequate credit assessment by banks and
governance issues also played their due part in the risk build-up.
5. As documented, the increase in NPAs was significantly higher in PSBs as compared to their
private and foreign counterparts. PSBs, probably to fulfil the additional social objective of their
mandate, had taken higher exposure in some of the critical sectors of the economy such as
mining, iron and steel, and infrastructure. NPA levels in these sectors shot up as all these
sectors suffered external shocks leading to the respective stress - mining and energy was hit by
the cancellation of allocation of coal blocks; iron and steel sector faced cost pressures due to
dumping of cheaper steel from China; telecommunications sector underwent a disruption in the
form of cancellation of 2G spectrum allotment; and the construction sector was marred by
delays in obtaining necessary government approvals, in particular environmental clearances.
6. To add to these issues, shocks in the form of debt waivers/moratoriums and payment issues
of DISCOMs also meant significant costs to the fisc and also affected the health of the banking
sector as well as the credit culture. Interestingly, data put together by the Indian Banks
Association shows that of the 10 states that announced debt waiver schemes since 2017, only
three states have reimbursed almost completely as promised. Thus, it is imperative that write-off
amounts are reimbursed to the banks and DISCOM payments are made in a time bound
manner, so as to improve the health of banks and their capacity to lend in subsequent years.
Corporate Governance - The Elephant in the Room
7. This brings me to some of the internal challenges faced by the PSBs, and their governance
could easily be identified as a central concern. In fact, many of the problems that currently seem
to affect the PSBs such as the elevated levels of NPA, capital shortfalls, frauds and inadequate
risk management can mostly be attributed to the manifestation of underlying corporate
governance issues. The role of independent Boards in fostering a compliance culture by
establishing the proper systems of control, audit and distinct reporting of business and risk
management has been found wanting in some PSBs leading to build-up of NPAs. Also, the
understanding of risks from a business perspective by the Boards in some banks has been
inadequate due to skill gap and, competency issues. The fact remains that a strong corporate
governance culture, with a focus on transparency and accountability, has to percolate from a
strong Board which sets the example by leading.
8. Let me also touch upon governance issues in private sector banks (PVBs) which originate
from altogether different set of concerns. The issues here mainly relate to incentive structure of
their managements, quality of audits and compliance and also functioning of Audit and Risk
Management Committees. The Reserve Bank has recently issued guidelines for compensation
in private sector banks which include specification of minimum variable pay component and
clawback arrangements, among others.
Resolution of Stressed Assets
9. Apart from governance, one of the biggest challenges faced by the PSBs, and the banking
system in general, is the resolution of stressed assets. For a long time, India did not have a
bankruptcy law in place, and hence the Reserve Bank introduced various restructuring
frameworks which were designed to emulate the desirable attributes of a bankruptcy law. The
enactment of the Insolvency and Bankruptcy Code, 2016 (IBC) has been a game changer in this
regard. Despite the impression that IBC has been marred with numerous litigations leading to
delays in resolution, I am optimistic that these are teething problems in a new law. Majority of the
companies that went through insolvency proceedings under IBC and ended in liquidation so far
were already stressed entities for a long time whose value had been eroded significantly and
were pending before the Board for Industrial and Financial Reconstruction (BIFR). The real
impact of the IBC is to be seen in the fresh cases where I expect the law to provide an efficient
avenue to effect a resolution.
10. To complement these efforts, the Reserve Bank has put in place a framework for resolution
of stressed assets through a circular dated June 7, 2019 which envisages a time bound
implementation of a resolution plan, failing which disincentives in the form of additional provisions
will kick in.
11. While these provisions are available for real sector firms, the situation is entirely different
when it comes to resolution of financial firms. In this regard, the Government, on November 15,
2019 has notified the rules containing a framework for resolution of financial services providers
(FSPs) under the IBC. The applicability of these rules would be limited to certain financial
services providers to be separately notified by the Government in consultation with regulators.
12. Our resolute efforts towards recognition, repair and resolution have resulted in
nonperforming assets (NPAs) of the banking system declining for the first time in March 2019 after a
gap of 7 years. Fresh slippages declined and the system-level provision coverage ratio jumped to
60.5 per cent from 48.3 per cent a year ago. The capital adequacy ratio of the banking system
has increased to 14.3 per cent, much higher than the Basel norms. This has benefited from the
recapitalisation of PSBs in the order of ₹ 2.9 lakh crore by the Government in the recent period.
Mergers of Public Sector Banks
13. The government, with an objective to create strong and competitive banks, has announced
an amalgamation of PSBs in order to create stronger banks with global presence. This
consolidation is in the direction of the recommendations of the first report of the Narasimham
Committee in 1991, where the requirement for fewer but stronger banks for Indian economy had
been highlighted. The idea was to enable such banks to compete at the national and international
level. A well-executed merger generates synergies of workforce and capital, helps in streamlining
of operations and leads to significant improvements in efficiency. It can also entail diffusion of
best practices across the board between banks. The bigger and agile banks, in principle, could
reposition themselves with better branding exercises. I must, however, hasten to add that the
merger process has to be executed without creating any disruption in the normal functioning of
these banks.
Non-Bank Financial Companies (NBFC) Sector
14. It is well recognised that NBFCs play a prominent role in the Indian financial system by
catering to financial needs of a wide variety of customers and niche sectors, providing
complementarity and competition to banks. The NBFC sector largely depends on market and
bank borrowings, thereby creating a web of inter-linkages with banks and financial markets. As
Housing Finance Companies (HFCs) now fall under the regulatory purview of the Reserve Bank,
we are undertaking a review of extant regulations and are in the process of harmonising these
regulations for HFCs with applicable regulations for NBFCs.
15. In the aftermath of the IL&FS crisis and subsequent defaults by a few companies, asset
quality concerns have emerged, which imposes liquidity constraints on NBFCs. The Reserve
Bank has been proactive in taking several measures to address these concerns and strengthen
the regulatory and supervisory architecture of the NBFC sector, thereby ensuring that the sector
remains stable and robust. We have attached considerable importance to make them resilient
through harmonization of regulations and a robust liquidity framework. RBI on November 4, 2019
has come out with guidelines on liquidity risk management framework for NBFCs. Our objective
is to ensure proper governance and risk management structures in NBFCs.
Urban Co-operative Banks
16. Let me now turn to co-operative banks. They contribute significantly in credit delivery and in
bringing other financial services to the people. The performance of some of these institutions,
however, has been hampered due to operational and governance issues. The recent unearthing
of fraud in one of the urban co-operative banks (UCBs) has brought up issues relating to their
governance, prudent internal control mechanisms, and adequacy of checks and balances to the
forefront.
17. Turning back to history, the Urban Co-operative Banks were brought under the ambit of the
Banking Regulation (BR) Act, 1949 with effect from March 1, 1966. Certain provisions of the BR
Act, however, were not made applicable to them, limiting the scope of regulation and supervision
1
over them . Broadly speaking, banking-related functions of cooperative banks are regulated by
the Reserve Bank and management-related functions are controlled by the concerned State /
Central Government. The Reserve Bank's regulatory control over UCBs is affected due to this
duality of control. RBI has made concerted efforts in the past to mitigate the adverse impact of
dual regulation in the form of MoUs with State/ Central Governments and setting up of a
Statelevel Task Force for Co-operative Urban Banks (TAFCUB). However, challenges still persist. At
present, the Reserve Bank is working with the Government to amend the Act governing
cooperative banks. We have suggested several legislative changes to the Central Government for
better regulation and supervision of UCBs. On our part, we are reviewing the existing architecture
of regulation and supervision of UCBs and shall carry out necessary changes in sync with the
evolving requirements.
18. Going forward, UCBs are likely to increasingly face competition from players such as Small
Finance banks (SFBs), Payments Banks, NBFCs and Micro-Finance Institutions (MFIs). It is,
therefore, necessary for them to adopt robust technology to enable them to provide banking
services at lower costs and with adequate safeguards. The Reserve Bank has been taking
proactive steps to assist these institutions to adopt a robust IT infrastructure. The proposed
national level Umbrella Organisation (UO) is expected to provide liquidity and capital support to
member co-operative banks, and will therefore contribute to the strength and vibrancy of the
sector.
New Frontiers of Banking
19. The emergence of new banking models, in the form of Payments Banks and Small Finance
Banks, have widened the horizons of banking in India. The Government and the Reserve Bank
2
have taken several initiatives to encourage greater use of electronic payments to achieve a 'less
3
cash' society. These measures have led to digital payments to GDP ratio rising to 8.6 per cent
at end-March 2019 from 6.7 per cent at end-March 2016. During the same period, the number of
per capita digital transactions rose from 4.6 to 17.6. Similarly, Fin-Tech is offering alternative
models of lending and capital raising. In this regard, crowd-funding, peer-to-peer lending, invoice
financing (Trade Receivables Discounting System (TReDs)) and digital lending have made their
presence felt. They have helped in improving the efficiency of intermediation by bringing down the
costs, sachetisation of products and services and in expanding the reach of financial services to
a greater number of people.
20. More recently, Artificial Intelligence (AI), Machine Learning (ML) and Big Data are becoming
central to financial services innovation. Analysis of vast amount of data, both structured and
unstructured, has been made possible using these techniques. Increasing levels of expectations
of compliance to regulations and a greater focus on data and reporting has brought RegTech and
SupTech into limelight. They are being applied in areas such as risk management, regulatory
reporting, data management, compliance, e-KYC / anti-money laundering (AML)/ Combating the
Financing of Terrorism (CFT), and fraud prevention.
21. In light of these developments, conventional banking is making way for next-generation
banking with focus on digitisation and modernisation. The need for brick and mortar branches is
being reviewed continuously as digitisation has brought banking to the fingertips of the people,
obviating the need to physically visit a bank branch. The transformation of the financial services
landscape caused by technological innovations can blur the difference between a bank and a
technology company, as technological giants are making rapid strides into areas such as
payments, traditionally the domain of banks. This will present testing grounds for the regulators to
delicately balance promotion of innovation and applying uniform supervisory and regulatory
framework.
Concluding Observations
22. Let me conclude by saying that banks have a critical role in the economy. The privilege of
raising unsecured liabilities from the society and generating revenue by deploying them in various
avenues and ventures necessitates prudent risk assessment of such deployment. In this
process, the banks do have a responsibility to shoulder when it comes to contributing to the
growth of productive sectors of the economy including infrastructure.
23. As we move forward, we at the RBI are focusing on governance, risk management, internal
audit and compliance functions in banks more closely. In a bid to strengthen oversight of
commercial banks, co-operative banks and NBFCs, we have created a unified department of
supervision (DoS) and a unified department of regulation (DoR) with effect from November 1,
2019. This move will enhance the efficacy of supervision and regulation as these entities operate
in an increasingly integrated environment with overlapping business domains. It is our endeavour
to update the knowledge and skill levels of supervisors on a continuous basis. We are adopting a
multi-pronged approach in this aspect. We are in the process of setting up a College of
Supervisors to augment and reinforce supervisory skills among regulatory and supervisory staff.
In addition, an internal supervisory research and analysis wing is being created to supplement
and support regulatory and supervisory activities. As indicated earlier, technology would continue
to play a vital role in enhancing the efficacy of regulation and supervision in a continual manner.
24. We are also addressing some of the long persisting issues in our regulatory and supervisory
framework in a systematic and time bound manner towards building a more efficient and robust
financial system.
25. I hope the participants of the conference would deliberate on some of the issues highlighted
in my remarks today in greater detail in the sessions that follow. I wish the conference all
success.
1
Co-operative banks are regulated under Section 56 of the BR Act, 1949 subject to certain modifications. As
Cooperative banks are exempted from certain provisions of the Act, the regulatory authority of the Reserve Bank
over UCBs is limited.
2
Such as Immediate Payments Service (IMPS), Unified Payments Interface (UPI), Bharat Interface for Money
(BHIM), Bharat Bill Pay System (BBPS), Aadhaar-enabled Payment System (AePS), Bharat QR code and mobile
wallets.
3
Digital payments include RTGS (customer transactions and inter-bank transactions), retail electronic payments
and card payments (credit and debit card transactions at point of sale (PoS) terminals, and payments made
through pre-paid payment instruments).