Photo: Pradeep Gaur/Mint
Photo: Pradeep Gaur/Mint

A heavy financial sector reform agenda

The one reform that will go a long way in improving the working environment for investors and lenders in the long run, is introduction of the Bankruptcy Code

No one can argue that the Narendra Modi-led government is shying away from difficult financial sector reforms. The government in its first two years has tried to improve access to financial services through its Jan Dhan Yojana; taken steps to improve governance among state-owned banks through the creation of a Banks Board Bureau (BBB); given the economy a Bankruptcy Code and is now attempting consolidation within the banking sector.

Some of this has started to show results. The rest is work in progress.

The Jan Dhan Yojana was formally launched on 26 January 2015, with the intention to provide a bank account to every Indian household. This wasn’t the first time an attempt was being made to improve the penetration of banking services but previous efforts, such as the one to introduce zero-balance and no-frill accounts, had limited success.

Eighteen months after the launch, there is reason to believe that this time may be different. Helped by the introduction of direct cash transfers, most Jan Dhan accounts are currently active. According to the scheme’s official website, 218.1 million accounts have been opened and these hold a total balance of 37,616 crore.

Equally important, the percentage of zero balance accounts is now just at about 26%. Bankers, who were once sceptical, are now hopeful that the experiment will help build a credit culture in rural areas, which will eventually allow lenders in the formal sector to make deeper inroads into these markets.

Efforts to strengthen and improve the functioning of state-owned banks have also been initiated but are, understandably, taking time to yield results.

To the government’s credit, interference in lending decisions from New Delhi has stopped. With this, bankers have a freer hand as they try to clean up their balance sheets. Industrialists, who once ran to North Block to prevent banks from pushing them too far in attempts to recover dues, now have nowhere to run.

As such, bankers are being able to push promoters into taking tough decisions including the sale of assets. Indian firms have announced more than 1 trillion in stressed asset sales since 2013, noted a report by Kotak Institutional Equities Research this month. While the government can’t take full credit for this, the tough stance it has taken towards errant borrowers has certainly allowed lenders to negotiate harder.

The government has also set up BBB which is intended to improve the functioning of public sector banks. The exact purpose of BBB is a little fuzzy. The bureau was set up to help find qualified top executives to lead the country’s state-owned banks and also help them with their strategic road map. But it is unclear whether BBB will go further and get involved in devising capital-raising plans for these banks, which is the real need of the hour.

The Reserve Bank of India has pushed banks into a much-delayed clean-up of their balance sheets. As a consequence of this, banks have reported heavy losses and are in need of capital to strengthen their balance sheets. India Ratings and Research Pvt. Ltd estimates that banks need a total of 3.7 trillion between fiscal year 2017 and fiscal year 2019 to meet Basel-III norms.

Where this capital will come from is not clear. This is one area where the government’s strategy has not really worked. While the government has committed to a 70,000 crore capital infusion into banks over three years (starting with last fiscal year), that amount is nowhere near enough. It has talked about potentially reducing stake in some banks like IDBI Bank Ltd but the pile of bad loans on the books of these lenders has meant that interest is muted and valuations are low.

A better strategy, if the government can find an out-of-the-box way to raise capital, would be to first recapitalize these banks and then attempt a reduction in the state’s holding. Consolidation, an effort worth pursuing to reduce redundancies in the banking sector, is not the answer to the shortage of capital.

The one reform that will go a long way in improving the working environment for investors and lenders, albeit in the long run, is the introduction of the Bankruptcy Code. While everyone agrees that the code was much needed, any tangible benefits from it are still at least a couple of years away.

The code will only work if the judicial infrastructure is strengthened to support it so as to prevent a build-up of pending cases.

The Debt Recovery Tribunals (DRTs), and the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, when introduced, were also thought to be significant steps in improving the resolution environment in India. But lack of adequate judicial infrastructure has meant that more than 4.5 trillion worth of cases are pending with DRTs.

Such issues must be resolved to ensure that the financial system gets the full benefit of the Bankruptcy Code.

To sum up, no one can question this government’s attempt to reform the Indian financial sector. It gets an “A" in that regard. The jury, however, is still out on its ability to see these reforms through to their logical end.

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