When the National Democratic Alliance (NDA) government assumed office in 2014, it inherited an extremely fragile banking sector. Banks were burdened with bad loans, while millions of Indians lacked access to basic financial services. Today, most households in the country have access to banking but the overall health of the banking system is still fragile.

The pile of bad loans in India’s banking system trace their origins to the last economic boom, and it is partly because of regulatory forbearance that the extent of the problem was hidden from public view for so long. The huge scale of India’s bad loan problem started becoming apparent only after the Reserve Bank of India’s asset quality review in 2015, which showed that the bulk of the problem lay in India’s state-owned banks.

By this time, the P J Nayak committee on banking sector reforms had submitted its report on reforming state-owned banks. The Nayak committee had recommended diluting the stake of the government in state-owned banks below 50%, so that banks could be freed from external vigilance emanating from the Central Vigilance Commission, the Right to Information Act, and from government constraints on employee compensation. It also proposed creation of a Bank Investment Company to act as the holding company for various state-owned banks.

However, the government chose to largely ignore these recommendations. A Banks Board Bureau was indeed instituted but it failed to make much of an impact .

The government however did manage to empower banks to take action against errant promoters of indebted companies and ‘wilful defaulters’ by amending existing laws and putting in place new laws such as the Insolvency and Bankruptcy Code (IBC) in 2016 which sought to establish a speedy resolution process for insolvency (see timeline).

New laws and the withdrawal of regulatory forbearance meant that the non-performing assets ratio spiked up in the first half of NDA-II’s tenure before stabilizing now. Gross NPA rose four-fold between fiscal 2014 and fiscal 2018 to 10.4 trillion (11.6 % of aggregate bank assets). While there has some improvement in this ratio over the past fiscal year, with gross NPAs projected to reach 10.3% in March 2019, India’s NPA ratio is still one of the worst among the largest economies of the world that constitute the G-20 grouping.

Greater recognition of NPAs has also meant that banks are increasingly writing off loans. State-owned banks have written off 3.4 trillion worth of NPAs between fiscal 2014 and fiscal 2018, the data shows.

Writing off loans can reduce NPAs but they also hurt banks because they are rarely recovered and add to bank losses.

The greater recognition of bad assets and rising write-offs has dented profitability. In 2014, Indian banks return on assets (RoA), the common measure for bank profitability, stood at 0.67% but this has since plummeted to a negative return (-0.1%) in 2018 and has made Indian banks among the least profitable in the world.

The impact of the banking crisis was felt most on bank balance sheets with bank capital eroding fast. To shore up the capital base of state owned banks, a recapitalization program was put in place because of which banks look healthier today than they did a couple of years ago. The capital to risk weighted assets ratio (CRAR) of India’s banking system --- a measure of its ability to withstand shocks --- has grown from 12.5% in 2014 to 16% in 2018. Compared to G-20 economies, India’s CRAR puts it among the middle, IMF data shows.

Overall, the NDA government’s record in restoring the health of the banking system appears mixed. While the government eschewed some structural reforms relating to governance of banks, it initiated other reforms that changed the lender-promoter relationship, the impact of which will be felt over the long run.

On the financial inclusion front, the government’s efforts have led to some immediate results although here too, the results are mixed. While the government’s flagship scheme to boost financial inclusion, the Jan Dhan Yojana (JDY), has provided a big boost to banking access, it has not led to a significant surge in use of those accounts yet.

While the proportion of Indians with a bank account increased from 53% in 2014 to 80% in 2017, according to World Bank’s Findex report, the share of inactive bank accounts also surged.

According to the government’s own data, of all the JDY accounts, only 25.7 crore or 76.5% of the accounts were functional accounts as of December 2018. A 2018 study by the economists Dipa Sinha and Rohit Azad published in the Economic and Political Weekly argues that opening of accounts alone has not led to financial inclusion. They showed that credit-deposit ratio in rural areas remains low and small-ticket loans have remained stagnant even with increasing bank account coverage. They also show that only 1% of Jan Dhan beneficiaries availed the overdraft facility, which was advertised as an integral component of the scheme.

“If people are only opening bank accounts but neither have the money to save nor find actively operating bank accounts a viable option, then the claims of financial inclusion only remain superficial," Sinha and Azad wrote.

Nonetheless, it is a testament to the efficacy of JDY in creating new accounts for the unbanked that politicians cutting across party lines are able to contemplate different kinds of cash transfer (or basic income) schemes involving bank payments for India’s poor today.

*This is the second of a 12-part report card series on NDA-II.

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