Banking on change

New banks could inject vitality and vigour in a stressed yet critical sector

The level of gross non-performing assets or bad loans in the banking system is expected to spike to 4.4 per cent by the financial year 2014-15, from the current 3.9 per cent, according to an analysis by Standards & Poor's. At the same time, the additional funding requirement for the sector is expected to rise to Rs 2,80,000 crore in another five years. The aggregate profitability of the sector has correspondingly dipped below the long-term trend. Taken together, the numbers mean the sector would be stressed for funds to shore up its capital base and lending books.

While the default by borrowers, both in the corporate and retail sectors, in the repayment of loans has hurt the banks, the nature of the ownership of the public sector banks has also played a crucial role in leading the sector to its present predicament. The weak capital base of government-owned banks has hurt their ability to lend more. The weakness is because the government, their principal shareholder and itself fiscally challenged, has found it tough to add to or even retain their capital at current levels. In this context, the announcement by the Reserve Bank of India on Friday to invite fresh applications to set up new banks is enormously welcome. The new banks will take at least a year to be up and running. But what they would do is introduce a sense of urgency to the operations in a sector that forms the fulcrum for a possible revival of the growth story.

With their capital unconstrained, unlike the existing banks, the new banks will be able to finance projects far more aggressively. For instance, banks decide on their lending quota for each sector for each year as a percentage of their previous year's balance sheet. But because of the NPAs, their relatively low capital base and existing exposure, they often finish their quota within a week of the beginning of the new financial year. This means applicants have to ride out the year in wait, unless they queue up early. In this scenario, new banks can provide the headroom for lending that existing banks cannot. While the bank stocks have taken a battering, the enthusiasm for new licences remains. The developments in the sector promise to reset the board, and bring about a structural change in the long term.

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