Streamlining Banking Systems

The past one and a half years probably saw more changes taking place in the banking industry than the previous decade and a half. Many of those changes were initiated and pushed through by Reserve Bank of India (RBI) Governor Raghuram Rajan. The central bank chief always had a reputation for speaking his mind, and for his fine understanding of the global financial markets. He is also developing a reputation for pulling a fairly reluctant banking system in India to change, though many bankers and bureaucrats are trying to slow down the process.

Among the big changes the banking system in the country saw last year was the 10 licenses given out to small finance banks and the in-principle approval given to 11 players for setting up payments banks. If the small finance banks work the way the RBI governor is thinking, they will essentially take over the role that microfinance institutions in the country have currently - but under much better regulation and with a more transparent way of functioning. The payments banks should finally solve the problem of money transfer of small amounts - something that is a big hurdle in financial inclusion currently.

Rajan's other big push throughout his tenure has been to sort out the worrisome bad loans problem in the banking system. He has pushed banks to clean up their balance sheets, sell bad assets to asset reconstruction companies - and recently even defaulting bonds to vulture funds - and even take over companies directly through the new strategic debt restructuring route, so that they can be revived or sold off to recover at least part of the money.

It will take some time, though, before the bank's big non-performing assets (NPA) problem is solved. For one, the public sector banks (PSBs) have over the years accumulated a truly staggering amount of NPA - roughly 80-85 per cent of the total NPA of all banks combined, in fact. Some of the PSBs would have been on the verge of collapsing if they were not owned by the government.

The issue is that the PSBs have two sets of problems that lead to an accumulation of bad loans. First, many of the PSB executives in charge of loans are not trained to assess risks properly. Two, many PSBs often come under tremendous pressure from politicians to lend to companies and groups that are perceived to be administration-friendly.

It is not easy to solve the problem, though the Modi government is also trying to do its bit to reduce the bad loans in the books of the banks it owns. One proposal that has recently been mooted is to create a special 'bad bank' - which can take over the bad loans of all PSBs, and will have specially trained staff who can figure out how to get money back from these defaulting borrowers. Another big step the government is taking is to create a proper bankruptcy law, which will make it easier for a company to fail, and in a more efficient manner than the current system allows.

Meanwhile, as our 20th Best Banks survey shows, private banks keep gaining in strength. This year, we changed our methodology to have both a quantitative survey that allows a pure numbers comparison, and a qualitative round that takes into account factors that cannot be boiled down to numerical ratios. As expected, private banks swept most of the top spots, though India's largest public sector bank, State Bank of India, won an award for being the most financially inclusive bank.

State Bank of India's chief Arundhati Bhattacharya has also gained a reputation for thinking out of the box and for being an extremely good, hard-nosed banker. The problem, though, is that all PSB chiefs have fairly limited tenures - less than five years in almost all cases. And five years is just too little to bring about substantial change in a bank where problems have built up over decades. The government would do well to think of that when it looks at reforming the banks it owns.