Banking Sector Reforms

[oped of the day] The current crisis at PMC Bank serves the country a warning

Note4Students

From UPSC perspective, the following things are important :

Prelims level : Nothing much

Mains level : Cooperative banks; PMC issue

Op-ed of the day is the most important editorial of the day. This will cover a key issue that came in the news and for which students must pay attention. This will also take care of certain key issues students have to cover in respective GS papers.

Context

The crisis unfolding at PMC Bank is a tip of the iceberg of larger, unresolved problems in India’s banking sector. 

Roots of the cause

    • The roots of the crisis in the banking sector go back to the unresolved problem of non-performing assets (NPAs).
    • These are magnified in the case of cooperative banks due to lax governance and a dicey business model.

Problems with RBI’s approach

    • By imposing severe withdrawal restrictions on depositors, those who suffer are largely the poor who prefer the higher deposit rates that cooperative banks offer.

Other problems with the cooperative sector

    • Bad loans and poor governance.
    • The business model offers depositors high-interest rates and lends money to borrowers of dubious credentials at low interests.
    • It can easily run into difficulty due to the resultant wafer-thin profit margins.
    • Poor regulatory response – it has so far been symptomatic and shows little understanding of the underlying disease. 
    • The government does not have a coherent and well-thought-out overarching strategy for economic policy. The policy seems reactive rather than forward-looking.

Way ahead for cooperative banks

    • Fundamentally reformed governance so that a crisis such as this one does not occur in the future. 
    • The long-run health of the banking sector requires short-run transitional costs. This dichotomy—between long-run and short-run cost—is at the root of many deferred or unfinished reforms.
    • Rationalizing taxes is a good start. But it cannot serve as a fix to the sort of problems that we are seeing at PMC Bank and other troubled banks. 
    • They need a more stringent regulatory process and, more fundamentally, legislative reform that overhauls the governance of cooperative banks as well as of the larger public banking sector. 

Conclusion

The fundamental political economy problem is that public sector banks serve multiple masters and, as a consequence, loan decisions are not always based on economic and financial logic. 

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