Banks will play a big role in transforming Indias political economy

Written by MK Venu | Updated: Mar 30 2011, 07:14am hrs
The true strength of Indias banking sector was evident after the global financial crises. Indias financial system withstood the contagion largely because banks were very well regulated at home and because they were lucky that they were not so well integrated with the western financial system. Last month ECB authorities said they were conducting fresh stress tests for banks, especially in EU economies, which are on the brink of a sovereign debt default. Indeed, much of the toxicity is still hidden in the system. In contrast, Indian banks have not only remained stable but have grown impressively since 2008. The banking sector led the stock market recovery after the global markets came in a bear grip late 2008. However, of late, there is some perceived macro risk to Indias banking sector emerging from higher government borrowings, tighter liquidity environment and persistent inflation. The Union budget has sought to address these concerns by keeping a tight control on budgeted expenditure. However, the outcome of such efforts would depend on some critical factors such as benign oil prices, good monsoons, etc, which the finance minister himself readily admits.

At present banks do face some challenges in the form of liquidity shortage in the system tending to become a structural issue. Liquidity problems combined with an inflationary environment could reduce credit growth and affect margins; in a rising interest rate environment, there could be losses in bond portfolios. And, of course, the threat of rising loan losses exacerbate because of the combination of the circumstances mentioned above. The problems are not insurmountable, though, and an economy growing at 8.5-9% would provide the way out of these incipient problems. Ultimately, steady GDP growth is a panacea for many of these ills. The banking sector reflects a growing economy like no other sector does. Typically, the RBIs credit growth target of 20% is linked to a nominal GDP growth assumption of about 14 -15%.

If credit grows at 20% a year, then the overall banking assets should nearly double every four years. That means banks will need additional capital of about Rs 4 lakh crore in the next five years.

The FE Best Banks Survey captures the dynamics of this process year after year. The FMs aggressive reform programme for the banking sector, including licences to new players, recognises the new paradigm of growth in Indias banking sector. The FM also wants to create 50 million new bank accounts in rural India by 2012 as part of its financial inclusion drive, a project aided by capital subsidy support to banks that will create these new accounts, to be serviced by banking correspondents. Banks are thus being made part of what the finance minister described as a transformation in the delivery of social sector expenditure. Banks will play a big role in the transformation of Indias political economy.