Economic Survey does a Raghuram Rajan, hits bull’s eye on banking reforms

The Economic Survey 2014-15 offers an excellent prescription to bring in some of the long-pending, much-needed reforms for India’s ailing banks — something if accepted in its entirety by the government and the regulator, can do wonders to salvage these entities.

The survey outlines four critical reforms to be taken up by the banking regulator and the government, which is the majority owner in state-run banks.

One, the survey calls for gradual reduction in the statutory liquidity ratio (SLR) or the chunk of money banks need to mandatorily invest in government securities and the other liquid assets such as gold, to make available liquidity for lending for productive sectors.

As Firstpost has noted earlier , this amounts to taking the economy out of the so-called financial repression or a form of directed lending employed by governments using central banks to channelise funds from commercial banks of a country to themselves and denying fund flow to the private sector.

To be sure, this is something Reserve Bank of India (RBI) Governor Raghuram Rajan has been attempting. Ever since Rajan took office, SLR has been reduced thrice by a cumulative 150 basis points (bps) to 21.50 percent. One bps is one-hundredth of a percentage point. Releasing money stuck at SLR requirement would also help the development of a deeper bond market, the survey notes.

At present, banks are required to invest 21.5 percent of their total deposits in SLR.

Second, the survey suggests revamping the priority sector lending (PSL) basket. Under PSL norms, banks are required to lend 40 percent of their total loans to agriculture, exports, micro-credit and other economically weaker sections.

Observing that PSL loans often do not reach the intended beneficiaries, survey suggests reforming the PSL either by including more sector or by reassessing the targeted segments on a need-based model.

The survey calls for closer monitoring of the end-use of the money to ensure the money isn’t misused. This is a highly critical recommendation as 40 percent of the bank total loans are locked under this requirement and the money often doesn’t reach intended beneficiaries.

Three, the survey argues for doing away with the one size-fits-all approach of the government when it comes to treating public sector banks. This is a much critical suggestion and something the central governments, both the UPA and NDA, have so far refused to accept.

At present, all state-run banks are treated at par, regardless of their size, when in all areas ranging from the appointment process, compensation policies, distribution of capital, or employee performance. The survey also calls for licensing of more banks to bring in healthy competition.

Four, the survey highlights the need for bankruptcy rules that allows banks to recover their assets from failed companies before it is too late.

As Firstpost has noted many times before banks struggle to recover assets as promoters drag lenders to court rooms to delay the process of loan repayment.

Delay in loan recovery is one of the reasons behind the pile-up of stressed assets in the banking system. Currently, such assets constitute over 10 percent of the total loans given by banks, impacting their profitability. As the survey notes, “distressed assets hang like a Damocles sword over the economy and require creative solution.”

To be sure, some of these recommendations — such as doing away with financial repression, revision in PSL rules — broadly follow the reform path followed by Rajan since he took charge at Mint street.

But the responsibility of acting on other recommendations — reforming state-run banks and bringing in much-need bankruptcy laws — surely rests with the government.