Some urgent and bold reforms needed in the Indian banking sector

The increasing level of non-performing assets (NPAs) has become one of the major concerns for the banking industry in India – more so for the public sector banks (PSBs). For instance, in the nine months ending December 2013, gross NPAs of United Bank of India (UBI) nearly tripled and grew at an appalling rate of 297% on an annualized basis and touched a staggering 10.82% of the total advances.

During the same period, NPAs in all PSBs grew at an average rate of 75%. The gross NPA levels in India’s largest bank, the State Bank of India, stood at 5.73% as on December 31, 2013. Other major public sector banks such as the Punjab National Bank and the Central Bank of India also have high levels of gross NPAs at 5.40% and 6.48% respectively. Amongst the bigstate-run banks, only Canara Bank has gross NPA level of less than 3%. Bank of Baroda is on the borderline with gross NPA ratio of 3.3%.

Clearly, the SBI group and the PSBs have made some poor lending decisions and probably have ineffective monitoring mechanisms. In this context, it is worth mentioning that the new private sector banks have managed their balance sheets very effectively over the same period and their average gross NPAs are at 1.96%. At 0.3%, the net NPA ratio of HDFC Bank is the lowest among all large banks.

NPAs directly mirror the performance of banks. A high level of NPAs reflects high probability of a large number of credit defaults that adversely affect the profits and net-worth of banks and also erodes the value of their assets. NPA growth involves the necessity of provisions, which reduces the overall profitability and shareholder value.

As the NPA-related problem not only affects the banks, but also the overall health of the Indian economy, there is an urgent need to redress this issue on a fast-track as well as a top-priority basis. And it would be prudent, if this issue of NPAs can be tackled at the level of prevention rather than cure. To be able to do that, we have to first understand that the causes for an account becoming an NPA are of three types: (i) Causes attributable to the borrower; (ii) Causes attributable to the economy and environment in which the borrower and bank operates; and (iii) Causes attributable to banks.

The first set of causes that are attributable to the borrower may encompass lack of expertise, mismanagement, willful default, fraud, disputes, diversion of funds, lack of proper planning, dependence on single customer, imbalance of inventories, poor quality management and lack of quality control. Similarly, the second set of causes may comprise government policies, taxation laws, civil commotion, industrial recession, political hostility, sluggish legal system, changes in consumer preference, lack of infrastructure, etc. As the banking sector has very little influence on these factors, we shall not elaborate them here.

However, the third set of causes are attributable to banks and may include wrong selection of borrower, poor credit appraisal, tough stand on issues by banks, inflexible attitude of banks, non-inspection of units, delay in sanction, lack of trained staff and technical expertise, inadequate commitment for recovery of loans, lack of accountability, etc.

To be able to monitor, curb or eliminate some of the above causes that tend to increase the NPAs in the banking sector and lead to further erosion of values of a number of state-run banks, the Indian government should expeditiously muster the will to push through some of the bold reforms enumerated below.


First and foremost, there is an urgent need to implement the governance reform roadmap articulated in the P J Nayak Committee report submitted to the Reserve Bank of India (RBI) in May 2014. The said committee has suggested reduction of government capital in PSBs and proportionate increase of private capital, merger of nationalized banks, transfer of ownership of PSBs to investment companies, repeal of the bank nationalization act and coverage of banks under the Companies Act. The report also wants the government to refrain from issuing any regulatory instructions to banks.

The governance reforms agenda outlined in the said report should be implemented by the Government of India in right earnest as it already aligns well with the BJP’s economic policy of smaller role for government in running businesses as well as maximum governance and minimum government.

The advantage of this policy is that PSBs will get more autonomy and they will learn to function like private business houses in a competitive environment. Once that happens, no politician or minister or powerful business tycoon will pressurize banks to roll over credit lines to troubled, but well-connected big firms, that most private banks steer clear of. This in turn will ensure that PSBs don’t allow cronyism to creep in while making lending decisions. This will enhance the quality of loans and definitely bring down the levels of NPAs in public sector banks and make them more profitable. This in turn, will create much higher value for the government’s equity holdings in state-owned banks, which can eventually be sold off or diluted for better value.

In view of what is stated above, the P J Nayak Committee recommendations seem to align perfectly well with the BJP-led NDA government’s reforms policy aimed at repairing public finances and putting the economy on a higher growth trajectory by providing managerial autonomy to PSUs to compete globally.


In the present scenario, a major factor that is instrumental for high NPAs in PSBs is absolute lack of accountability among officials who have the power to take decisions, grant loans and effect recoveries. Currently, no one is held accountable for the increasing levels of NPAs in state-run banks, nor is the responsibility for the deteriorating asset quality fixed on any specific person or position. Because of this, no one in particular bothers to take the right decision in a timely manner or to avert delays in sanctioning or releasing the loans, or for ensuring that efforts to recover the outstanding loans are initiated at the right time and in an appropriate manner.

In view of this, a culture of accountability has to be introduced, responsibility has to be fixed on the concerned officials, time-limit for all important decision and functions should be preset and punitive action should be initiated against officials responsible for red tapism and bureaucratic delays as well as for arrogance, non-cooperative attitude, shirking of responsibility and corrupt practices. This measure will bring in the much-needed attitudinal change among the staff and management, which in turn will drastically improve the work culture in PSBs.


Currently, PSB customers don’t have access to a proper and effective grievance redressal mechanism for expeditious resolution of complaints. There is also no tangible structure to ensure that senior bankers don’t shirk their responsibility. Moreover, there is an absolute lack of transparency in the functioning of PSBs and also an absence of fixed or predetermined time-frame for project appraisal, disposal of loan applications and release of loans. Since all these tend to adversely affect the performance of the banking sector and also contribute to increasing NPAs, the Union government needs to create a suitable grievance redressal mechanism with the required structure and efficacy and an appropriate timeframe for prompt disposal of complaints, including thelast escalation point within that timeframe.


The Union government should also separate the post of chairman and managing director/CEOs in state-run banks and give them a fixed term of three or five years so as to bring in more accountability. Furthermore, their selection should be made in a timely, transparent and professional manner, and the prevailing practice where ministers or politicians can influence such decisions has to be scrapped. To improve corporate governance, government should also specify eligibility criteria such as professional qualifications and experience for independent directors appointed to bank boards. Also, the remuneration offered to top-level executives of state-run banks should be revised to narrow down the huge difference between the compensation levels of executives holding the same ranks in public sector and private sector banks.


To curb corruption and keep the state-run banks sound, stable and profitable, the scope of receiving bribery for approving loans to undeserving business entities by violating prudential norms, needs to be totally abolished. A robust and transparent decision making process, which is effectively monitored by the bank’s Board of Directors, should be put in place. This will tremendously reduce the discretionary powers andcorresponding opportunities for arbitrary action and corrupt practices, which are currently enjoyed by senior bank officials.



An RBI-appointed working group under the then executive director, Anand Sinha, had in 2007 ruled out Islamic banking in the country, saying current regulations don’t permit the model. Moreover, immediate past Governor of RBI, D Subbarao, had explicitly stated in May 2013 that implementing Islamic banking model in India would be impossible because it is inconsistent with our country’s banking regulatory set-up where interest is charged and given.

It is really surprising that despite the assertions of two top RBI officials (Anand Sinha retired as RBI Deputy Governor and Subbarao as Governor) that implementing Islamic banking would be impossible in India, the then UPA government gave a go-ahead in August 2013 to a Kerala government’s proposal to launch a financial institution named Cheraman Financial Services Ltd (CFSL) based on the principles of Islamic banking.

CFSL is a Kochi-based Islamic NBFC and is the latest incarnation of Al Baraka Financial Services. It clearly shows this was a political decision by the Congress-led UPA government to appease a particular community in Kerala with an eye on the fast-approaching 2014 Lok Sabha elections. And if the Kerala election results were any indication, this move seems to have paid rich dividends to the Congress party and its ally, the Indian Union Muslim League (IUML).

Furthermore, recent media reports say that RBI has lately become favorably inclined towards Islamic banking and has begun the process of reviewing its regulations and has set up an internal committee to examine how Islamic banking can be introduced in India. The Union government should immediately instruct the RBI to disband this committee as Islamic banking is not suitable for India for reasons enumerated below.

First and foremost, Islamic banking is bound by Islamic laws and the basic purpose of establishing an Islamic bank is to cater to the diverse economic and banking needs of the Muslim community while encouraging Islamic principles laid down by Shariah (religious laws based on the teachings of Koran). India being a secular country, communal and religious laws like Sharia should not be allowed to regulate our banking system.

Secondly, in the prevailing statutory and regulatory framework it would not be possible for banks in India to undertake Islamic banking activities because before allowing banks to do Islamic banking, drastic and appropriate amendments will have to be introduced in the Banking Regulations Act, 1949. Alternatively, a new law envisioning creation of a parallel banking system and a separate regulatory set-up will have to be formulated.

However, as India is a secular country there can’t be separate laws for its citizens based on religion. Our Constitution allows freedom to practice one’s faith, which is a personal matter. However, if religious laws and beliefs start intruding into areas like banking and other important aspects of oureconomy, it will go against the very concept and foundation of secularism, and India will no more be perceived as better than any Islamic country.

Furthermore, permitting Islamic banking in India has the potential to open up avenues for the inflow of terror funding and money laundering. So it would always be prudent and advisable to keep India outside this religious financial network by disallowing Islamic banking in our country.

While the above six recommendations are the most crucial and should be vigorously pursued and promptly implemented to safeguard the Indian banking sector as well as to boost its performance and profitability, at the individual level all the PSBs invariably need to focus on the following aspects in a bid to build the required capabilities to cope up with the emerging challenges of the dynamic banking environment, nationally and internationally.


Without adversely affecting the quality of their services, every state-run bank should design and pursue innovative strategies in a bid to cut down and control their costs, optimize resources, increase their presence across the value chain, renew focus on R&D and innovation and create adynamic and performance-oriented work culture. For instance, one of the future strategies of all PSBs should be to earn more of other income and reduce their dependence on interest income.


To render better customer service and to fulfill customer demands more effectively as well as to improve the profitability, efficiency and productivity of the bankingsector, all our state-owned banks should adopt the latest and the most cost-effective technologies and information systems. The best hope for PSBs is to embrace and promote low-cost mobile and internet banking with proper safeguards, including legal aspects and measures to enhance customer protection.


Another area that needs urgent attention of PSBs is improving the staff productivity. Most PSBs are saddled witha large number of inadequately trained or demotivated personnel. Such banks need to downsize staff and cut their costs. They also need to redistribute and train staff to strengthen the neglected areas of marketing and innovation, which are needed to retain and win over more customers.


Finally, the Union government and the RBI should put in place a Citizens’ Charter to ensure speedy, efficient, fair and courteous customer service in the banking industry. This step will not only check areas of deficiencies in customer service, but also make it easier to introduce measures for improvement of work culture, inculcate greater customer orientation among bank employees as well as identify and eliminate structural and operational rigidities and inadequacies that tend to adversely affect the working ofpublic sector banks.

99 thoughts on “Some urgent and bold reforms needed in the Indian banking sector

  1. Ramkumar moorthy

    Your article started from pin point approach and later diluted to social arena. Do you have solutions for specific NPA causes? A private audit firm should audit the causes and remedies for every npa. The solution should not be within the frame work of R B I guidelines. If it is so it is mechanised. Think beyond horizons. No borrower borrow to be a npa. Dilute norms of npa. Think positive. Hope the reply is admissible.
    Ramkumar moorthy

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