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he Banking Sector in India: Emerging Issues and Challenges

OR

TOP CHALLENGES FOR BANKS IN INDIA / SOLUTIONS FOR FUTURE BANK PROBLEMS

1. Background / Current Scenario of Indian Banking Industry :

1.1 Thrust of Banking Sector Reforms :

The banking system in India has undergone significant transformation following financial sector reforms since the early 1990s. The thrust of the banking sector reforms was on

·         increasing operational efficiency,

·         strengthening the prudential and supervisory norms,

·          removing external constraints,

·         creating competitive conditions; and

·         developing the technological and institutional infrastructure.

1.2 Impact of Reforms on Indian Banking Industry :

The impact of the reform measures is reflected in banking sector in the shape of

·         an improvement in profitability,

·         an improvement in financial health,

·         soundness and overall efficiency

·         ability to  maintain or increase their capital adequacy ratio, despite the sharp increase in their risk-weighted assets.

Moreover, with the entry of new private sector banks and increased presence of foreign banks,

·          Indian banking sector has become more competitive.

·          Public sector banks have also been raising capital from the market and are subject to market discipline.

·          Efficiency, productivity and soundness of the banking sector improved significantly in the post-reform phase.

·          Banks have increasingly diversified into non-traditional activities, as a result of which several financial conglomerates have emerged.

All the above has posed several regulatory and supervisory challenges. Thus, while deregulation has opened up new avenues for banks to augment incomes, it has also entailed greater risks. The banking sector has witnessed the emergence of new banks, new instruments, new windows, new opportunities and, along with all these, there have been new challenges

2. Recent Economic Developments

3. Evolution of Banking in India

Banking in India has a long history and it has evolved over the years passing through various phases. A brief evaluation of Indian Banking Industry can be encapsulated as follows:

·         Pre  Independence Phase : (1930s and 1940s) : The period leading up to Independence was a difficult period for Indian banks. A large number of small banks sprang up with low capital base. This period saw the two World Wars and the Great Depression of the 1930s. Many banks failed during the period. Apart from global factors, several other factors were also at play. Partly to address the problem of bank failure, the Reserve Bank of India was set up in 1935.

·         After independence (1947-1967) , the entire banking was in the private sector. The banking scenario in the early independence phase raised three main concerns: (i) bank failures had raised concern regarding the soundness and stability of the banking sector; (ii) there was large concentration of resources in a few business families; and (iii) the share of agriculture in total bank credit was miniscule. Although the issue of bank failure was addressed, two of three major issues at the time of independence continued to raise concern even after 20 years of independence.

·         Nationalization of Banks (1967-1991) : Accordingly, with a view to aligning the banking system to the needs of planning and economic policy, the policy of social control over the banking sector was adopted in 1967, which marked the beginning of the next phase. Fourteen major banks were nationalised in 1969 and six in 1980. With this, the major segment of the banking sector came under the control of the Government. Some other social controls were also implemented such as priority sector lending targets. Massive expansion of branch network that followed improved the banking access considerably, especially in rural areas. This helped in mobilising the deposits and stepping up the overall savings rate of the economy. The share of credit to agriculture, which constituted a small portion for a long time, improved significantly by the end of this phase in 1991-92. However, the objective to provide credit at concessional rate led to the administered structure of interest rates and other micro controls. Large fiscal deficit by the Government necessitated pre-emption of resources by way of CRR and SLR. These factors and the increased focus on priority sector targets led to decline in profitability of the banking sector, high NPAs and weakening of the capital base. With a view to overcoming several weaknesses that had crept into the system over the years and with a view to creating a strong, competitive and vibrant banking system, financial sector reform were initiated in the early 1990s, which marked the beginning of the current phase.

·         Current Phase / Banking Reforms Phase (1991-Till now):  Various reform measures resulted in an improvement in profitability, financial health, soundness and overall efficiency of the banking sector. With the entry of new private sector banks and increased presence of foreign banks, competition in the Indian banking sector also intensified. Another major achievement of this phase was the sharp increase in credit to agriculture from 2003-04 onwards; credit to agriculture had decelerated in the 1990s. Regional rural banks were also strengthened by way of restructuring to improve the rural credit delivery system. In this phase, financial inclusion emerged as a major policy objective and a significant progress was made in a short span of two years. The problem of dual control in respect of urban co-operative banks, which had impeded the effective regulation by the Reserve Bank for a long time, was overcome by a mechanism of Task Force on Urban Co-operative Banks (TAFCUB). So far 19 State Governments have signed MOU with the Reserve Bank constituting the TAFCUBs. The use of technology has improved significantly in the current phase