Union budget 2021: Creation of bad bank, additional demand stimulus measures key for banking sector

India’s banking sector has gone through a tough phase in 2020 ravaged by a deadly pandemic and general economic slowdown. However, an industry crisis was averted by the timely intervention of the RBI and the government through a series of measures to ensure liquidity and prevent an asset quality shock.

While the government announced a series of measures to make funds available to small and medium-sized companies and micro-entrepreneurs as part of its Rs 20 lakh crore economic package, the RBI announced a slew of liquidity measures totaling Rs12.7 lakh crore since February 2020.

As a result, the banking system is today flushed with liquidity. Given that most of the PSU banks have started raising from the market, there is no pressing demand for capital infusion. However, some PSBs may require capital support due to the tough business environment. The budget will need to give guidance on capital infusion plans for the sector.

But, what is really missing is the demand for credit. This is hurting the sector.

Bank credit growth remains depressingly slow due to poor demand in the economy and erosion in consumer confidence. As per the latest RBI data, the non-food bank credit growth decelerated to 5.6 per cent in October 2020 from 8.3 per cent in October 2019.

Of this, credit to industry contracted by 1.7 per cent in October 2020 as compared with 3.4 per cent growth in October 2019, mainly on the back of contraction in credit to large industries.

The banking sector, 60 per cent of which is dominated by the government, is in need of additional measures to stimulate the overall demand. To be sure, the government has been spending in recent quarters. However, given the deep contraction in the economy, more demand stimulating measures are in order.

On the larger reform front—the government needs to come with a solid roadmap to gradually exit the majority ownership in public sector banks and leave these institutions open for private participation. This is something the P J Nayak panel had recommended way back in 2014.

Although there have been repeated promises on PSB privatisation from the NDA-government and the erstwhile UPA regime, so far action is limited to merger of smaller state-run banks with bigger ones. This, however, was not really a game changer.

Experts have cited the government’s majority ownership in state-run banks as a hindrance to the banking sector’s development. State-control has acted as a drag on PSBs. The budget should lay out a roadmap on privatisation plan of PSBs.

Next is the creation of a bad bank. This is a long pending idea worth experimenting at this juncture. Indian banking system has around 8.5 per cent of gross NPAs. The RBI estimates this chunk to rise to 12.5 per cent by March 2021 and even to 14.7 per cent in a worst-case scenario.

A bad bank can act as an aggregator of all stressed assets in the system and work towards the resolution of these assets whereas banks can focus on business.

Since the banking system is dominated by the government, it is imperative that bad bank idea should be spearheaded by the government itself.

At a time when the banking system is staring at a fresh round of non-performing assets (NPAs), time is perhaps ripe for union finance minister, Nirmala Sitharaman to chart out the road map to build a bad bank.

The banking system is the backbone of the economy and is often called a proxy to the economy. Although it is unwise to expect the budget to offer solutions to all the problems of the sector in one go, it can certainly offer a blueprint for the industry.