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Dikshu C. Kukreja
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Indian Banking Sector: Navigating Reforms and NPA Challenges

Indian Banking Sector: Navigating Reforms and NPA Challenges

The banking industry affects us in ways that we might not be aware of. By safeguarding our money, offering loans, and ensuring smooth transactions, it plays an essential part in our everyday lives. Additionally, it is a cornerstone of the Indian economy, contributing significantly to investment activities, consumption, and the overall growth of the nation. In recent times, India has also seen massive strides in banking, with advanced technology being implemented on such a large scale and quickly replacing traditional slower methods, making it one of the most cutting-edge sectors in the world.

It is amazing how this transformation has been driven by government initiatives, surging consumer demand, enhanced asset quality, and technological advances. This blog will discuss the evolution of the Indian banking sector over time, with a special focus on reforms and measures taken towards Non-Performing Assets (NPAs) at Indian banks.

Banking sector in India

India's well-established banking system, developed over decades, efficiently satisfies the economy's credit and banking needs. It fuels economic growth by addressing diverse financial requirements. Various segments across the country receive banking services and lending support through 137 scheduled commercial banks alongside co-operative and local area banks, 9,516 non-banking financial companies and five All India Financial Institutions: EXIM Bank, NABARD, NaFID, NHB and SIDBI. These institutions play a crucial role in intermediating resources from depositors to lenders, promoting economic growth through efficient resource allocation.

The Department of Financial Services (DFS) classifies banks into scheduled and co-operative banks. A

scheduled bank refers to a bank that has been listed in the Second Schedule of the Reserve Bank of India Act, 1934. Non-scheduled banks are those banks that are not listed in this schedule. Scheduled banks encompass nationalised banks, foreign banks, SBI and its associates, regional rural banks, and other Indian private sector banks.

Source: Department of Financial Services

Banking reforms

Banking sector reforms in India comprise different policy measures and actions directed to make the domestic banking industry more effective, stable, and competitive. These reforms are driven by governance and risk management practices as well as the development of the financial system, which contribute to financial inclusion and support economic growth. In the history of Indian banking, there have been great transformations because of major reforms that took place mostly during the 1990s as an effort to liberalize it. The need for these reforms was due to modernization and liberalization of the banking sector in order to promote competition and efficiency.

In addition, the introduction of capital adequacy standards called Basel I, II, and III has had a significant impact on the improved soundness and stability of the Indian banks. These standards have helped to reinforce the regulation system so that banks are kept supplied with enough capital to survive any financial shocks and to ensure smooth development. Besides, corporate governance and risk management have taken the centre stage in the banking reforms that foster transparency, accountability, and effective risk mitigation measures for protecting depositors’ rights as well as stakeholders’ interest while promoting financial stability.

The initiatives taken by DFS have been successful in keeping the reform momentum going and even enhancing it with a foundation of the earlier EASE Reform agenda. This movement cuts across several dimensions such as risk EASE was set to fortify risk appraisal, reduction in NPAs, extending financial access to vulnerable sections, improving customer service quality, enforcing technology-driven reforms, fostering the growth of retail and MSME credit off-take, building analytical capabilities, improving HR processes, and governance reform measures.

Enhanced Access and Service Excellence (EASE) Reforms (launched in January 2018):

  • EASE was conceived to enhance risk assessment, manage NPAs, deepen financial inclusion, improve customer service, drive digital transformation, increase retail and MSME credit off-take, promote analytical capabilities, transform HR practices, and improve governance.
  • The EASE Steering Committee, part of the Indian Banks' Association, is responsible for overseeing EASE Reforms. Its objective is to comprehensively revamp and enhance the capabilities of public sector banks (PSBs) to adapt to the evolving banking model. This initiative provides a unified platform for mid-sized and large banks to establish and enhance industry best practices, leading to improved services and experiences for PSB customers on a large scale.
  • It emphasizes collaborative development across PSBs through regular knowledge series and best practice workshops conducted by leading banks and industry experts. The reform objectives are publicly reported, independently measured, benchmarked, and reviewed quarterly by the bank boards, emphasizing on the performance appraisals of whole-time directors (WTDs).
  • The EASE Reforms Agenda has become deeply ingrained in all PSBs, prioritised by bank leadership since FY19. While the initial versions of EASE focused on addressing key operational and capability gaps, EASE 3.0 (FY21) and EASE 4.0 (FY22) concentrated on building new-age capabilities driven by digital innovations and analytics insights, accelerating PSB performance through data-driven technological initiatives.
  • After four years of successful implementation of EASE and with all 12 PSBs turning profitable, a brainstorming event called PSB Manthan 2.0 was held in April 2022, gathering the entire leadership of PSBs under the guidance of the DFS to elevate EASE to the next level. The EASENext programme emerged as a result, with a significantly broader scope consisting of two pillars:

a. Pillar 1 - The EASE Common Reform Agenda remains influential in driving EASE reform initiatives in its existing format.

b. Pillar 2 - Banks are encouraged to establish their own bank-specific three-year strategic roadmap, focusing on transformational reforms extending beyond the common EASE reform agenda.

  • Under Pillar 1, EASE 5.0 (FY23) centred on enhancing digital customer experience, with a focus on technology integration, including emerging cloud adoption, account aggregator, open APIs as well as data-driven, integrated, and inclusive banking solutions.
  • The current reform, EASE 6.0 (FY24), is conceptualised with 22 action points under four themes:
    • Achieving excellence in customer service through digital empowerment
    • Digital and analytics-driven business improvement
    • Technology and data-enabled capability building
    • Developing people and enhancing HR operations

Non-Performing Assets in Scheduled Commercial Banks

Source: RBI

Non-performing assets (NPAs) are loans or advances that no longer yield income for the lender. The NPA ratio refers to the percentage of total advances, which are not recoverable, and it is calculated by dividing NPA by total loans.

Slippages represent the new amount of loans that have deteriorated in quality within a year. A slippage arises when a bank’s loan becomes an NPA due to non-payment of interest by the borrower for more than 90 days. In turn, the slippage ratio refers to the rate at which healthy loans go bad and become non-performing into non-performing ones. The strategic interventions implemented by the DFS have contributed significantly to a major reduction of NPAs among SCBs.

The RBI data, on the other hand, indicates that the gross NPAs of SCBs fell from around US$ 112 billion (Rs. 9,33,779 crore), with a gross NPA ratio of 9.07%, as of March 31, 2019, to US$ 68.9 billion (Rs. 5,71,515 crore), with a gross NPA ratio of 3.87%, as of March 31, 2023. Moreover, fresh slippages related to SCBs decreased from US$ 36.4 billion (Rs. 3,01,795 crore), with a slippage ratio of 3.73%, from 2018 to 2019 to US$ 25.7 billion (Rs. 2,13,368 crore), with a slippage ratio of 1.78%, from 2022 to 2023.

The Government and RBI have taken a range of measures to recover bad debt resulting in SCBs recovering US$ 86.4 billion (Rs. 7.16 lakh crore) over the last five fiscal years (according to RBI provisional data for FY23).

The government's comprehensive policy response addressing stress recognition, resolution of stressed accounts, recapitalisation, and banking reforms have notably strengthened the financial health and resilience of the banking sector:

  • Asset quality considerably improved, with net NPAs of SCBs decreasing to US$ 16.4 billion (Rs. 1.36 lakh crore) in March 2023 from US$ 24.6 billion (Rs. 2.04 lakh crore) in March 2022.
  • Resilience had been ramped up, as shown by the provision coverage ratio (the percentage of funds that a bank reserves for losses due to bad debts) of SCBs rising from 86.9% in March 2022 to a robust 90.9% in March 2023.
  • PSBs mobilised capital totalling US$ 45.4 billion (Rs. 3,76,049 crore) from the market between 2014-15 and 2022-23.

Steps taken by RBI to improve NPA

The RBI launched the Asset Quality Review (AQR) in 2015, uncovering significant NPAs in banks. In response, the government implemented a comprehensive strategy focused on the 4Rs: Recognising NPAs transparently, Resolving and recovering, Recapitalising PSBs and Reforming the financial ecosystem. Over the past eight years, the government has executed major banking reforms aimed at enhancing credit discipline, promoting responsible lending, and strengthening governance. Reforms also included technology integration, bank mergers and sustaining of overall confidence within the banking sector.

In recent times, various policy initiatives have been implemented to help financial institutions better manage stressed assets on their balance sheets. The main focus of these measures was:

  • Addressing the resolution of long-standing stressed assets held by banks.
  • Promptly identifying and acknowledging stress upon default, followed by initiating corrective actions for mitigation.
  • Strengthening the regulatory framework for asset reconstruction companies (ARCs); and
  • Enabling market mechanisms of credit risk transfer for lending institutions to better manage their portfolios.

These measures equip institutions with the essential tools and incentives to facilitate timely and more efficient resolution of stressed assets on their balance sheets. Such measures, combined with the earnest efforts of the financial institutions, have enhanced the overall credit discipline in the country.

Government initiatives to enhance financial inclusion

Financial inclusion serves as a catalyst for expanding a bank's deposit base by incorporating previously underserved segments into the formal financial system. By gaining access to unbanked populations via clever products and all-encompassing policies, banks can tap into a rich resource pool with potential customers interested in banking services. Consequently, the number of new depositors increases, resulting in a total deposit base expansion with mutual benefit for both parties as financial firms extend their horizons and clients get reliable methods for saving and carrying out transactions.

In India, financial inclusion continues to be one of the main areas of concern and has been marked by efforts such as

  • Pradhan Mantri Jeevan Jyoti Bima Yojana
  • Atal Pension Yojana
  • Pradhan Mantri Suraksha Bima Yojana
  • Stand Up India
  • Pradhan Mantri Jan Dhan Yojana

Through the efforts of the DFS, millions of citizens, particularly those in the vulnerable segments, now have access to essential banking services, insurance, and pension schemes.

Looking forward

The banking sector is one of the most important sectors for India, which requires a conducive environment to grow and evolve. The introduction of measures such as the Insolvency and Bankruptcy Code (IBC), has established the growth and stability of the industry by increasing corporate governance standards, regulatory frameworks, and accountability. Apart from that, the government has been actively involved in promoting more public sector bank efficiency through consolidation and privatization endeavours. Similarly, financial inclusion activities are pivotal because they enable marginalized populations to get integrated into the formal banking system. This increased involvement in the banking sector has majorly contributed to its overall growth and expansion.

The recent reforms in India's banking sector, characterised by technological innovation, consolidation, and a shift toward digitalisation, are instrumental in leading the nation towards an Atmanirbhar Bharat.