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Should distressed private banks be saved by PSBs? Do you agree to the fact that larger PSBs are being made more fragile by involving them in bailouts of their public sector or private peers? Discuss.

Topic:  Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

6. Should distressed private banks be saved by PSBs? Do you agree to the fact that larger PSBs are being made more fragile by involving them in bailouts of their public sector or private peers? Discuss. (250 words)

Reference: The Hindu

Why this question:

A day after the government imposed a moratorium on the financially troubled Yes Bank last week; the Reserve Bank of India announced a draft restructuring plan that entails the State Bank of India acquiring a 49% stake in the private lender. Thus the question.

Key demand of the question:

The answer needs to explain why the private banks need to be saved by the public sector banks, what are the issues and challenges involved and what an optimal solution to address such a situation is.

Directive:

Discuss – This is an all-encompassing directive – you have to debate on paper by going through the details of the issues concerned by examining each one of them. You have to give reasons for both for and against arguments.

Structure of the answer:

Introduction:

In short present the background of the context in question.

Body:

First explain why such banks should be saved; list the reasons. As per the Financial Stability Report of the RBI, the level of inter-connectedness within the financial services ecosystem is deep. While after the global financial crisis, the idea was always to have no bank which is too big to fail.

The systemically important banks are banks which are tracked more carefully and which are also subject to higher capital requirements under Basel III. But that is not to say that banks which are relatively smaller in size, such as Yes Bank, do not pose systemic risk and therefore, should not be rescued.

Then explain what should be done –

  • The first option should always be to have a private investor come in and infuse his capital into the private bank.
  • The next option then, the straightforward option, would be for the government to simply nationalize the stressed bank. It happened during the global financial crisis with innumerable private banks all over the world.

Suggest other solutions.

Conclusion:

Conclude with way forward.