YES Banking crisis: why the government must correct the vulnerabilities of the financial system


The Modi government faces a major problem. No, this has nothing to do with the Citizenship (Amendment) Act or the protests against it. Weak economy is a problem, as are fears about the spread of Covid-19. But the problem I’m talking about is the banking and financial system, which has been under a lot of stress over the past decade due to bad debts, mismanagement and lax regulation.

While there is no panic among the banks or a debilitating loss of confidence in the system, the government should be concerned about the growing vulnerability and unsustainability of key players in the financial system. Consider these facts: Over the past year and a half, two banks and one non-bank lender have gone bankrupt and had to be placed under an RBI moratorium. While Yes Bank is being saved, a solution to relaunch PMC Bank is not yet in place. Last year, DHFL became the first major non-bank lender to be placed under moratorium and is now in the process of being sold.

Some public sector banks are likely bankrupt if not for implicit sovereignty over their loans and deposits. One of them had to be saved at great expense with money from LIC policyholders.

Some other non-bank lenders are also struggling. Credit flows are a problem and with the big banks focusing on lending to large non-bank lenders, the smaller ones are being squeezed out. They are forced to save money, stop lending, and turn down opportunities.

Pressure from Finance Minister Nirmala Sitharaman to turn on the loan taps has eased the situation somewhat, but there is still a long way to go. The downturn in the economy hasn’t helped matters either.

These kinds of failures could easily have caused political nightmares. The success of Prime Minister Modi and the BJP in dealing with these potential landmines, combined with the weakness of the opposition, means that the party and government have yet to pay a heavy political price.

But that could change. If a large part of the public begins tomorrow to believe that their money in banks is dangerous, it could end up creating a panic of immense proportions.

India has not experienced a major financial system panic in decades thanks to the nationalization and skillful management of the RBI during past crises. Even the massive GNP fraud in 2018 did not lead to massive withdrawals.

But private banks have grown too big to fail. And with the growth of non-bank lenders, the explosion of financial market activity and the interconnection of all, the stage is set for mass convulsions, if things are not quickly brought under control.

None of these scenarios bode well for the BJP. They can point out that most of the banks’ problems started when the UPA was in power and that they have done a lot to strengthen the system. This is correct and one can cite the injection of capital into public sector banks and the launch of the Insolvency and Bankruptcy Code in support of this argument. Bankruptcy courts have succeeded not only in recovering money for the lenders, but also in putting the fear of God among the promoters. The banks have also managed to recover a decent amount of the cases settled so far.

But the problem is, the weakness of the banking system persists and the argument that Congress is solely responsible is becoming outdated. The BJP has had six years to study, understand, and act on the weakness, and its record on quick action has been less than stellar.

Summary obligations for public sector banks should have been completed in 2015, not 2017, and mergers could have been announced at any time over the past six years. This would have sped up reforms and given the banks enough time to absorb the mergers and use the money to fully cover the losses. Lots of market panic and losses

could also have been avoided.

Yes Bank is another classic example of deferred action. It was clear from last year that the bank is going to have a hard time raising funds. A quick bailout put in place over the weekend with markets closing could have made the government and the RBI appear strong, nimble and determined. Instead, the two are now repelling attacks and trying to take “strong actions” in an effort to change the narrative.

The government now has a fantastic opportunity ahead of it over the next few years. Falling oil prices could spur fiscal gains, and mistrust of supply chain concentration in China may lead to FDI inflows into India. Structural reforms, low corporate taxes and low interest rates can boost growth and drive the economy toward the $ 5,000 billion goal by 2024. The opportunity must not be wasted by lax regulation and delayed action in the banking and financial sector.

The opinions expressed are those of the author.


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