High-level committee on banking: What it should focus on to strengthen India’s financial system

It is nobody’s argument that banking reforms are not overdue. The sector’s health reflects the state of the broader economy and there are enough signs of it being misaligned with the national ambition of achieving ‘developed’ status by 2047.

There are problems in liquidity management, with liability management calling for a strategy revision. The gap in governance between public and private sector banks has widened. Human resource policies for hiring, training and retention are outdated. Perverse incentive structures have led to a pile-up of consumer grievances. And there are other issues that await redressal.

Finance ministry officials have indicated that among other things, the committee will re-examine bank licensing norms—including whether to let corporate houses get them—and the possibility of another round of mergers among public sector banks (PSBs).

Letting corporate houses run banks might be a bit premature at this stage, given the current volatility in geopolitics and geo-economics. There are other reasons for caution: it could plausibly worsen uncertainty in the liabilities market and amplify risks to systemic stability. The banking industry’s credit-deposit ratio recently crossed the 81% mark and set off alarm bells.

Banks are seeing a steady shift in deposits to alternate asset classes, with incremental deposit growth in a struggle to keep up with incremental credit.

This has already begun to cast a cloud on credit-expansion sustainability. Banks have had to rely on dearer sources of money—such as bonds or commercial paper—to fund their loans, which has affected margins adversely.

While new licences for private corporate players may step up competition in the sector, today’s scramble for deposits—what new entrants are likely to be eyeing—would suddenly intensify and drive up every bank’s cost of funds, which could slow loans down and spell instability as profits dry up (or assets sour—in a worse case).

The panel should instead examine how to align the sector’s liquidity-management framework with a new strategy for liabilities—the money that banks borrow to lend. The need for PSB mergers 2.0 seems to contradict the clamour for more banks to widen and deepen credit delivery. The panel should look closely at whether the system has enough credit-delivery platforms or the economy needs broader growth impulses to expand credit.

The new panel’s other focus should be on flawless customer service, linked as it is to resource mobilization for loans. Poor service and faulty mechanisms for grievance redressal afflict private sector banks even more than PSBs.

The problem can be traced to incentives for customer-facing officers to aggressively sell third-party insurance and mutual fund products; with hefty commissions involved, restraints on mis-selling these packages seem weak. Often, officers are set ‘stretch’ targets for credit-card issuances or unsecured retail loans, raising default hazards.

As Reserve Bank of India Governor Sanjay Malhotra had noted in the context of financial stability, inadequacies of grievance redressal need to be tackled. In sum, there are many ways in which the sector could let us down—but must not.