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AIR spotlight summary on “Banking Reforms”.

AIR spotlight summary on “Banking Reforms”.



  • The government announced the major banking reforms process, linking Rs 88,000 crore of capital infusion in ailing public sector banks. The strategy is to provide a lifeline to banks struggling under the legacy of bad loans so that they can once again resume commercial lending and revive the investment cycle in the economy.

Bank Recapitalisation

  • The capital infusion plans for 2017-18 include Rs 80,000 crore through recapitalisation bonds and Rs 8,139 crore as budgetary support. In addition, the banks will raise Rs 10,312 crore through share sales.
  • Bank recapitalisation bonds are issued by the government to which banks can subscribe and they are specifically aimed at banks that have a lot of deposits on hand which flowed due to demonetisation. It is these excess deposits that the banks use to buy the recapitalisation bonds. The government will use the money raised by the sale of these bonds to increase the number of shares it holds in the banks. This will give the banks more capital, making it easier for them to offset the effect of writing off bad loans. The bonds are fiscal deficit neutral.These bonds will carry a maturity of 10-15 years and will be treated as non-SLR bonds.

Need for Bank Recapitalisation

  • The public-sector banks (PSBs) are falling short of capital. We have Basel III norms in place and it asks for higher capital adequacy which is the amount of capital required compared to the amount of money lent. There are high rates of NPAs which are hurting these banks. The ability to raise money from the stock market is limited because their share valuations have fallen. So it was duty of the government to recapitalise the banks.
  • The previous bank recapitalisation was done in 1990s. Once banks are recapitalised and they are on a healthier platform, the need for a bailout or a bail-in reduces. For economic growth and for employment generation we need a financially healthy banking sector which is able to lend. MSMEs can create many jobs but they need capital from banks. Earlier banks were unable to lend them because of shortage of adequate capital.
  • There are 21 PSBs in the country which constitutes 70% of the banking sector. According to RBI financial stability report the banking system’s gross bad loan ratio was 9.6% in March 2017.
  • The recapitalisation and reform agenda is sharply focused on strengthening PSBs, increasing lending to MSMEs and making it easier for MSMEs and retail customers to transact as well as significantly increasing access to banking services. Asking public sector banks to become more MSME-friendly is an important step, given the footprint and role of small enterprises.

Reform Agenda

  • Banks have been asked to tie up with specialized monitoring agencies for credit exposure above Rs250 crore. Proper due diligence has also been suggested while sanctioning loans. They have also been asked to scrutinize balance sheets, ensure strict mechanism and ring-fence while giving loans.
  • Banks have been asked to create a separate stressed asset management vertical to focus on recovery of loans.
  • India still needs public sector banks, but not so many. If some PSBs cannot mobilize the required resources for their profitable growth, they should be merged.
  • PSBs will have to revamp their lending practices, especially in advancing loans to big businesses, monetize non-core assets, rationalize overseas branches, embrace technology and move to recover loans that have turned bad. The strategy is to provide a lifeline to banks struggling under the legacy of bad loans so that they can once again resume commercial lending—and revive the investment cycle in the economy.