bank capital it has set aside to provision for losses on its assets, i. e., on its non - performing loans, made primarily to the industrial sector. 3 what does it mean to have little bank capital as provision for losses? i like the following analogy. a bank not keeping adequate capital buffer to absorb losses on its loans that are more or less 4 / 7 bis central bankers'speeches known to be arriving soon is akin to not preparing to rescue with emergency a person who has slipped off the terrace of a skyscraper, and instead in the midst of his almost surely fatal descent, hoping that the laws of gravity would somehow freeze and work differently this time. while such under - provisioning problem extends to some of the private banks too, the scale of the problem is three to four times magnified in case of public sector banks. by and large, this scenario meets the adverse conditions of the narrative i provided about banking and banking panics. but in our context, several questions immediately come to mind : why should i worry about whether i can bank upon my bank when my deposit is insured by the government? more so, if my deposits are with a state - owned bank? why should i bother about my bank ’ s asset quality? the double - edged sword of deposit insurance and state ownership of banks answering these questions is crucial to understanding how our banking sector problems are likely to play out. a moment of reflection reveals that as long as i trust the deposit insurance and the guarantee of the state behind the public sector banks, i have no good reason to run and pull my deposit out of an insured deposit or a state - owned bank. the catch is this. when banks are in poor health, it does affect the potential borrowers. once a bank ’ s asset quality is adequately impaired, the bank does not grow its lending book much with fresh loans. bank management of a thinly capitalized bank is interested in primarily making two kinds of loans. first, ever - greening of existing bad debt – throwing more money after the bad, so as to help the borrower repay past loan, not acknowledge its true quality, and simply kick the can down the road. second, risky loans that give banks high returns so that it can make a last - ditch effort to rebuild capital quickly – doubling up bets in a casino when first round of gambling has all gone sour. faced with such borrowing prospects, healthy borrowers who have access to alternate forms of finance may be able to switch

out of their savings, but they do own a property against which they would like to borrow. these potential borrowers can visit the bank branch to meet such financing needs. the bank makes loans to these individuals and families, assessing their ability to repay the loans, signing appropriate agreements to claim repayments in due course, and attaching the property and other assets as collateral that it can have access to in case the repayments fall through for some reason. such loans are bank ’ s assets. they typically earn a higher rate of interest than bank deposits and make banking activity an attractive proposition. demand deposits are short - term ; bank loans are long - term this way, a bank takes shape. it has liabilities, the right - hand side of its balance - sheet, in the form of deposits that must be repaid when depositors so demand ; it has assets, the left - hand side of its balance - sheet, in the form of bank loans that have some fixed points of time at which the bank can command repayments. by being so organized, the bank is performing the economic function of maturity transformation. a deposit, which is potentially demandable at any instance, has effectively been lent out through financial intermediation in the form of a longer - term bank loan that is not making repayments at each instance. and yet … the beauty of the arrangement is that most of the time, this works out. the day my health expenses arise and i take out money from the bank, my neighbor and others have likely received monthly paycheques, a part of which remain deposited in the bank, or that same day some loan repayments have been made, extending the savings pool of the bank and allowing it to meet my deposit withdrawals. in background, financing has been made available to new entrepreneurs, first - time home buyers and aging parents. their undertakings are creating a whole second - round of economic activity, in the form of job creation at new enterprises, construction and cement industry, and medical services and hospitals. those involved in these activities have their own saving and borrowing needs, and will in turn deal with their banks. banking, in this manner is the life - blood of an economy, channels savings in the form of demand deposits into borrowings in the form of bank loans or bank credit, fuels and lubricates growth, and improves everyone ’ s welfare. 2 / 7 bis central bankers'speeches all of our lives would be easy, including of central bankers, if