Banking Sector Reforms

First, Fix the Banks


Mains Paper 3: Government Budgeting, Indian Economy and issues relating to planning, mobilization of resources, growth and development, employment.


From UPSC perspective, the following things are important:

Prelims level: Tier 1 Capital in banks, Fiscal stimulus

Mains level:Steps to revive economy, Recapitalisation of banks





  1. The article bats for selective recapitalisation of public sector banks in order to ease financing and revive the economy.



  1. The economy has seen growth spiralling downwards for the last six quarters consecutively.
  2. And as some experts suggest, due to poor design and implementation of GST the growth might further fall in the next two quarters.
  3. Some have suggested initiating a fiscal stimulus in order to revive demand and consequently the economy. However, fiscal stimulus will not address the root cause of the problem i.e. shrinking credit disbursement by the banks.

Main reason for deceleration of growth is
The massive tightening of credit disbursement by the banks.


Why have the banks reduced credit disbursement?

  1. The Indian Public Sector Banks comprising 21 “nationalised banks” and six of the State Bank of India group, account for almost 70 per cent of the assets and liabilities of the system.
  2. Post global financial crisis of 2008, government initiated fiscal stimulus and at that time banks were also keen to lend (sometimes with inadequate evaluation). This is the time when big projects were undertaken in the power, ports and housing sectors. However, the coal and spectrum scandals withthe policy paralysis experienced at the top leadership led to squeeze in debt disbursement by the banks. From a growth of around 15 per cent four years ago, Public Sector Banks (PSB) advances grew by just 3 per cent in 2015-16.
  3. As of December 2016, gross NPAs for the 27 PSBs were Rs 6,47,800 crore, or 88 per cent of the total NPAs recorded across all banks.
  4. Today for the PSBs as a whole, gross NPAs are greater than their tier-1 capital (the one that really counts).
  5. Another major reason for downfall in credit disbursement is the provisioning for bad loans done on account of the Asset Quality Review by the Reserve Bank of India.



  1. The RBI has done the right things: Tightened income recognition and provisioning and forced banks to book losses on their balance sheet.
  2. The banks have also done the right things of going after major defaulters and initiating better bankruptcy resolution.

What should the government do?

  1. It should initiate selective recapitalisation of better banks so that these banks can get back to lending.
  2. In order to avoid the ‘’moral hazard’’ government can recover this cost by raising capital directly from the market by divesting some shares from these banks. This will strengthen the stressed balance sheets of the banks and give them a breathing space to re-start credit disbursement.



  1. NPA: Read in detail here.
  2. Tier 1 Capital: This includes common shares, preferential shares and all the assets which are highly liquid and can be used to ward off any sudden crisis.
  3. Fiscal Stimulus: Increasing government spending on infrastructure etc in order to lift investor sentiment, increase money supply in the market and increase demand in the economy.
  4. Moral hazard: The government believes that if it recapitalises the banks then it might cause a moral hazard. Moral hazard is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost. It arises when both the parties have incomplete information about each other.
  5. Asset Quality Review: The RBI periodically conducts review of the asset qualities of banks. However, in 2015-16 it clubbed the procedure for two quarters and reviewed them collectively. This review is conducted to make sure banks are provisioning sufficient amount for bad loans.

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