Banking Sector Reforms

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Note4Students

From UPSC perspective, the following things are important :

Prelims level : Banking Regulation Act

Mains level : Need for stringent banking regulation

Context

RBI imposed curbs on the activities of the Punjab and Maharashtra Cooperative Bank (PMC) for a period of six months. This came when certain irregularities in the bank were discovered, including the under-reporting of non-performing assets (NPAs).

Problem

    • The crux of the problem is the bank’s exposure to a real estate firm, which itself is currently undergoing insolvency proceedings. 
    • The bank’s financials for the year ended March 2019 does not provide any indication of financial stress. 

RBI’s response

    • Initially, RBI allowed depositors to withdraw only Rs 1,000 over a six-month period. 
    • After a public outcry, it revised this limit upwards to Rs 10,000. With this relaxation, more than 60% of depositors would be able to withdraw their entire account balance.
    • The restrictions imposed by RBI under section 35A of the Banking Regulation Act, are aimed at safeguarding depositors’ interest and preventing a run on the bank.
    • These measures are seen as penalising depositors. But they can end up having the opposite effect of denting trust in cooperative banks and increasing the risk of contagion.
    • RBI has appointed J B Bhoria as an administrator of the bank. 
    • A forensic audit could shed light on an asset-liability mismatch and reveal the true extent of the problem. 
    • RBI could also explore the option of merging PMC with another healthy cooperative bank to avoid any instability, as it has done so in the past.

Issues that arise

    • It raises questions not only on the governance structures at these cooperative banks but also on their supervision
    • Cooperative banks are under the joint supervision of the RBI and states. 
    • While the RBI has signed MoUs with state governments, unless state governments cooperate in effecting regulations, supervision is likely to be ineffective.
    • There were no early warning signs of trouble in this case.
    • It is likely to raise calls for reviewing this regulatory framework and giving more powers to the RBI to oversee these entities. 

Way ahead

The RBI should also examine the long-term feasibility of their business models in light of the rapid technological changes in the financial sector. The larger question over the absence of a framework for the timely resolution of financial firms remains.

 


Back2Basics

The Banking Regulation Act, 1949 is legislation in India that regulates all banking firms in India.

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