What are the challenges to the Indian banking sector?

Lets have an overview of challenges to the Indian banking sector.

The government has been using recapitalisation bonds to infuse capital into public sector banks (PSBs) in the last four years. The bond route includes PSBs subscribing to bonds issued by the government, which in turn, gets routed back to banks as capital. So far, the government has provided the capital of over Rs 2.70 lakh crores via these bonds. The estimates of quantum of capital for PSBs range from Rs 25,000 crores to Rs 50,000 crores, but the actual allocation depends on a host of factors that challenge the Indian banking sector. Now we will share with you some challenges that the Indian banking sector faces.

1. Regulatory forbearance inflates capital levels

The current capital adequacy levels in PSBs do not look too bad, but the current regulatory forbearance post-Covid hides the real picture. Last year, the Reserve Bank of India (RBI) had decided to defer the implementation of the last tranche of 0.625 per cent of the capital conservation buffer for a year till September 2021. Similarly, the Supreme Court declared that loan accounts were not classified as NPAs till further notice. Such relaxations will provide a picture of ease capital levels in the banking system, but a realistic assessment of the forbearance will increase capital requirements of the banks including PSBs. The private sector banks have aggressively raised capital from the market since the outbreak of the pandemic.

2. Capital for supporting recovery

When PSBs play a leading role, the capital levels of banks are very important for increasing lending activities or taking the risk. Covid affected businesses and sectors like services, MSMEs needs funds for restarting businesses. Currently, the PSBs do not have any internal generation of capital. For example, the PSBs as a pack have continued their losses at Rs 26,015 crores in 2019-20 as against a total income of Rs 8.34 lakh crores. The PSBs valuation in the stock market is also too low to raise equity capital at current levels which means a very high dependence on the government for capital. The limited capital also affects the risk-taking ability of banks.

3. New NPA (Non-Performing Assets) cycle on the horizon

After COVId prevails, banks are facing fresh NPAs in unsecured loans, MSMEs and services sector. The moratorium on loans and the two-year restructuring announced by the RBI  have protected weak borrowers, but the situation could slip for the worse once the restricting period ends. The RBI said that if the macro environment deteriorates, the ratio may escalate to 14.8 per cent under the severe stress scenario. Such a scenario would require a large capital infusion from the government in PSBs. But if the government decides to set up a bad bank, the burden may cause more.

4. IBC suspension delaying recovery

The slowdown in bad loan recovery is also creating capital shortages. A lot of bad loans or restructuring cases are a hurdle as the government has suspended fresh proceedings post the pandemic. The corporate sector is also not very keen to buy troubled assets as there are chances to buy good businesses post the COVID disruption. A lot of corporates are focusing on operational efficiencies and digitising the operations.

5. Privatisation of banks led to PSB consolidation

The government has left out half a dozen PSBs from the merger exercise. Such banks are Bank of India, Central bank of India, Bank of Maharashtra, UCO Bank, Indian Overseas Bank, and Punjab & Sindh Bank. These banks are not in fine condition. Due to a large number of private banks, consolidated PSBs and Small Finance Banks (SFBs) will find it difficult to survive.


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