Introduction
The banking sector is the backbone of any modern economy, playing a crucial role in financial intermediation, credit creation, and facilitating economic growth. India's banking sector has undergone significant transformations since independence, particularly after the economic liberalization of 1991. These reforms aimed to enhance efficiency, competitiveness, and stability. However, the sector continues to grapple with challenges, most notably Non-Performing Assets (NPAs), governance issues in Public Sector Banks (PSBs), and the need for greater financial inclusion and adaptation to technological disruptions. This note delves into the historical reforms, current challenges, and the ongoing efforts to strengthen India's banking landscape.
5.4.1. Historical Reforms: The Narasimham Legacy
The Narasimham Committee I (1991), appointed in the backdrop of the Balance of Payments crisis, laid the foundation for banking sector reforms. The Narasimham Committee II (1998) reviewed the progress and suggested further measures.
Narasimham Committee I (1991)
Laying the Foundation for Reforms
- Reduction in SLR & CRR: To increase lendable resources.
- Phasing out Directed Credit: Gradually reducing priority sector lending scope.
- Interest Rate Deregulation: More freedom for banks.
- Capital Adequacy Norms: Adopting Basel norms (Basel I).
- Entry of New Private Banks: To foster competition.
- Establishment of ARFs: Precursor to ARCs for bad debts.
- Operational Autonomy for PSBs: Reducing government intervention.
- Phased reduction in Govt Equity: Below 51% in PSBs.
- Strengthening Bank Supervision: Quasi-autonomous body under RBI.
Narasimham Committee II (1998)
Review & Further Measures
- Strengthening the Banking System: Mergers of strong banks, closure of weak banks.
- Narrow Banking Concept: For weak banks to restrict activities to risk-free assets.
- Capital Adequacy: Increase in Capital Adequacy Ratio (CAR).
- Review of Banking Laws: Amendments to Banking Regulation Act.
- Asset Reconstruction Companies (ARCs): Creation to deal with NPAs.
- Faster Computerization & Modernization: Enhancing efficiency.
- Review of Directed Credit: Further rationalization.
- Universal Banking: DFIs to convert into banks.
- Strengthening Corporate Governance: In PSBs.
5.4.2. Non-Performing Assets (NPAs) / Bad Loans
Definition & Classification
An NPA is a loan or advance for which the principal or interest payment remained overdue for a period of 90 days.
| Asset Class | Criteria |
|---|---|
| Standard Assets | Do not disclose any problem and do not carry more than normal risk. |
| Sub-standard Assets | Remained NPA for a period less than or equal to 12 months. |
| Doubtful Assets | Remained in the sub-standard category for a period of 12 months. |
| Loss Assets | Considered uncollectible; identified by bank, auditors, or RBI inspection. |
Causes of NPAs
Sectoral & Economic Issues
Economic slowdown in specific sectors (infra, power, telecom, steel), cyclical downturns, global slowdown impacting exports.
Policy Paralysis & Governance
Delays in project approvals, land acquisition, environmental clearances, corruption, crony capitalism.
Flawed Lending Practices
Aggressive lending, poor credit appraisal, risk management, wilful defaults, diversion of funds.
Legal & Administrative Hurdles
Delays in Debt Recovery Tribunals (DRTs) and other legal processes.
Consequences of NPAs
Impact on Bank Profitability
Reduced net profit due to provisioning, lower interest income.
Reduced Credit Growth
Banks become risk-averse, curtail lending, affecting investment.
Broader Economic Impact
Higher credit cost, reduced capital formation, potential systemic risk, erosion of public trust.
Moral Hazard
Lenient resolution mechanisms can encourage wilful defaults.
Resolution Mechanisms
SARFAESI Act, 2002
Empowers banks to recover NPAs by auctioning properties of defaulters without court intervention for secured loans above ₹1 lakh (not applicable to agricultural land).
Facilitates the creation of Asset Reconstruction Companies (ARCs).
Asset Reconstruction Companies (ARCs)
Specialized financial institutions that buy NPAs from banks, allowing banks to clean up balance sheets. ARCs then try to recover dues. Regulated by RBI under SARFAESI.
Challenges: Capital constraints, valuation difficulties, legal delays, lack of secondary market.
SDR & S4A (Phased Out)
SDR: Allowed banks to convert debt into equity, potentially taking management control. S4A: Aimed at resolving large stressed accounts by bifurcating debt into sustainable/unsustainable parts. Largely subsumed under IBC.
Challenges: Limited success due to operational complexities and delays.
Insolvency and Bankruptcy Code (IBC) 2016
Consolidates laws for time-bound insolvency resolution, maximizing asset value and promoting entrepreneurship.
IBC Process (CIRP) - Simplified Flow
Successes: Improved credit discipline, significant recoveries. Challenges: Delays, low recovery in some cases, substantial haircuts.
NARCL / Bad Bank
A specialized ARC set up by the government to take over large bad loans (typically >₹500 crore) from commercial banks.
Progress: Incorporated in July 2021, started acquiring assets. Challenges: Finalizing valuations, swift resolution by IDRCL, avoiding moral hazard.
Strengthening the Banking Sector: Key Initiatives
5.4.3. PSB Recapitalization
Infusion of capital to meet regulatory norms (Basel), strengthen balance sheets (weakened by NPAs), and support credit growth.
- Methods: Budgetary allocations, Recapitalization Bonds, Market borrowings.
- Indradhanush Plan (2015): 7-pronged approach including appointments, capital, de-stressing, governance.
5.4.4. Bank Consolidation
Creating larger, stronger banks with better scale, efficiency, and risk appetite.
- Rationale: Fund large projects, global competitiveness, cost savings.
- Impact: Increased capital, operational efficiency, but HR/IT integration challenges.
- Recent: SBI with associates (2017), Mega-mergers (2020) reduced PSBs from 27 to 12.
5.4.5. Financial Inclusion
Delivery of affordable financial services to disadvantaged and low-income segments.
- PMJDY (2014): Zero-balance accounts, RuPay card, OD. (51.5 cr+ accounts by Jan 2024).
- JAM Trinity: Jan Dhan, Aadhaar, Mobile for DBT.
- Business Correspondents (BCs): Last-mile connectivity.
- Micro-finance: Small loans to low-income groups.
5.4.6. Deposit Insurance (DICGC)
Wholly-owned RBI subsidiary providing deposit insurance to protect depositors in case of bank failure.
- Covers all bank deposits.
- Limit: ₹5 lakh per depositor per bank (increased in 2020).
- 2021 Act: Payout within 90 days of moratorium.
5.4.7. PSB Governance Reforms
Crucial for efficient functioning and stability of banks.
- PJ Nayak Committee (2014): Reduce govt share to <50%, Bank Investment Company (BIC), autonomy for boards.
- FSIB (2022): Replaced BBB, recommends appointments for PSBs, FIs, PSU insurers.
- Emphasis on risk-based internal audit, stronger board committees.
5.4.8. Digital Banking & Fintech
Transforming the banking landscape with technology.
- UPI: Instant P2P & P2M payments, explosive growth (>131 bn transactions in FY24).
- AEPS: Aadhaar-enabled payments via BCs.
- Fintech & Neo-banks: Digital lending, payments, wealth management. RBI's regulatory sandboxes.
- CBDC (e₹): RBI's digital currency pilots.
- RBI-DPI: Digital Payments Index (Sept 2023: 418.77).
UPSC Prep Corner
Prelims-ready Notes
- Narasimham Committee I (1991): Reduce SLR/CRR, interest rate deregulation, entry of private banks, capital adequacy.
- Narasimham Committee II (1998): Stronger banks via mergers, ARCs, narrow banking, universal banking.
- NPA: Loan overdue for >90 days.
- NPA Classification: Standard, Sub-standard (NPA ≤12 months), Doubtful (>12 months as sub-standard), Loss (uncollectible).
- SARFAESI Act, 2002: Enforce security interest without court for loans >₹1 lakh (not agri land).
- ARCs: Buy NPAs from banks; regulated by RBI.
- IBC, 2016: Time-bound insolvency resolution (180+90 days, max 330 incl. litigation). Adjudicators: NCLT (companies), DRT (individuals). Regulator: IBBI.
- NARCL (Bad Bank): Acquires large NPAs (₹500 cr+). Govt guarantee for SRs (₹30,600 cr). 15% cash, 85% SRs. IDRCL manages assets.
- Recapitalization: Infusion of capital into PSBs to meet norms & support lending. Indradhanush Plan (7 components: A,B,C,D,E,F,G).
- Bank Mergers (2020): Reduced PSBs to 12. Aim: larger, stronger banks.
- PMJDY (2014): Basic savings account, RuPay card (₹2 lakh accident cover), overdraft (₹10,000). Over 51.5 cr accounts (Jan 2024).
- JAM Trinity: Jan Dhan, Aadhaar, Mobile for DBT.
- DICGC: RBI subsidiary. Insures bank deposits up to ₹5 lakh per depositor per bank. Payout within 90 days of moratorium.
- FSIB (2022): Replaced Bank Board Bureau. Recommends PSB heads, FI heads, PSU insurer heads.
- UPI: NPCI product for instant P2P & P2M payments.
- AEPS: Aadhaar-based payments via BCs.
- CBDC (e₹): RBI's digital currency (Retail & Wholesale pilots ongoing).
- RBI-DPI (Digital Payments Index): Tracks digital payment adoption. Base: March 2018=100. Sept 2023 = 418.77.
Summary Tables/Charts
Table 1: NPA Classification & Provisioning (Simplified)
| Asset Class | Criteria |
|---|---|
| Standard | No overdue, normal risk |
| Sub-standard | NPA for a period ≤ 12 months |
| Doubtful | Remained sub-standard for 12 months |
| Loss | Uncollectible, identified by bank/auditor/RBI |
Table 2: Key NPA Resolution Mechanisms
| Mechanism | Key Feature | Focus |
|---|---|---|
| SARFAESI Act, 2002 | Enforcement of security interest without court | Secured creditors |
| ARCs | Purchase & resolution of NPAs | Specialized NPA management |
| IBC, 2016 | Time-bound resolution/liquidation, CoC driven | Stressed companies (holistic) |
| NARCL | Aggregation & resolution of large NPAs from PSBs | Large legacy NPAs |
Table 3: Financial Inclusion - Key Schemes
| Initiative | Launched | Key Feature |
|---|---|---|
| PMJDY | 2014 | Zero-balance account, RuPay card, OD facility |
| JAM Trinity | - | Jan Dhan, Aadhaar, Mobile for Direct Benefit Transfers |
| Digital Payments | Ongoing | UPI, AEPS, IMPS, Mobile Wallets, QR Codes |
Mains-ready Analytical Notes
Major Debates/Discussions
-
Privatization of PSBs:
- Pros: Improved efficiency, reduced political interference, market discipline.
- Cons: Neglect of social objectives, job losses, systemic risk, public trust.
- Govt. Stance: Gradual approach, maintaining strategic presence.
-
Bad Bank (NARCL) - Efficacy:
- Pros: Clears bank balance sheets, allows banks to focus on lending.
- Cons: Moral hazard, low recovery rates, taxpayer money for guarantee, operational inefficiencies.
-
IBC - Successes vs. Challenges:
- Successes: Improved credit culture, time-bound (in principle), significant resolutions.
- Challenges: Delays in NCLT, large haircuts, low liquidation value, gaming by promoters.
-
Digital Divide & Financial Inclusion:
- Opportunities: Efficiency, outreach.
- Risks: Exclusion of non-digitally literate, cyber risks.
Historical/Long-term Trends, Continuity & Changes
- Continuity: Dominance of PSBs (though declining), focus on financial inclusion, recurring issue of NPAs.
- Changes: Shift from directed lending to market-oriented reforms, increased competition, emphasis on prudential norms, rapid tech adoption, structured NPA resolution (IBC), PSB consolidation.
Contemporary Relevance/Significance/Impact
- Healthy banking sector is critical for India's $5 trillion economy ambition.
- Efficient credit disbursal fuels investment, consumption, job creation.
- NPAs: Situation improved from peak (Gross NPAs of PSBs 14.6% in Mar 2018 to 3.9% by Mar 2023).
- Digital transformation: Enhancing efficiency & outreach, new risks (cybersecurity).
- PMJDY & JAM: Empowered millions, improved governance via DBT (World Bank lauded).
- IBC: Fundamentally changed creditor-debtor relationship.
Real-world/Data-backed Recent Examples & Integration
- India: IBC Success (Essar Steel, Bhushan Steel). NARCL acquired/received offers for ~₹1 lakh cr assets. UPI processed 11.37 bn transactions in Oct 2023. Bank frauds (PNB, Yes Bank).
- World: GFC 2008 (systemic risks), Bad Banks (Ireland NAMA, Spain SAREB).
- Value-added: Economic Survey, RBI FSR, Basel Accords, MUDRA Yojana, FSB, World Bank.
UPSC Previous Year Questions (PYQs)
Prelims MCQs:
-
With reference to the governance of public sector banking in India, consider the following statements: (UPSC 2018)
- Capital infusion into public sector banks by the Government of India has steadily increased in the last decade.
- To put the public sector banks in order, the merger of associate banks with the parent State Bank of India has been affected.
Which of the statements given above is/are correct?
(a) 1 only (b) 2 only (c) Both 1 and 2 (d) Neither 1 nor 2
Answer: (b)
Explanation: Capital infusion has been variable, not steadily increasing. The merger of SBI associates did occur.
-
The establishment of ‘Payment Banks’ is being allowed in India to promote financial inclusion. Which of the following statements is/are correct in this context? (UPSC 2016)
- Mobile telephone companies and supermarket chains that are owned and controlled by residents are eligible to be promoters of Payment Banks.
- Payment Banks can issue both credit cards and debit cards.
- Payment Banks cannot undertake lending activities.
Select the correct answer using the code given below.
(a) 1 and 2 only (b) 1 and 3 only (c) 2 only (d) 1, 2 and 3
Answer: (b)
Explanation: Payment Banks can issue debit cards but not credit cards. They cannot undertake direct lending activities.
Mains Questions:
-
The Public Sector Banks (PSBs) in India are facing the challenge of Non-Performing Assets (NPAs). What are the causes of this problem? Discuss the measures taken by the Government and the Reserve Bank of India (RBI) to tackle this issue. (UPSC 2018, Similar themes earlier too)
-
Pradhan Mantri Jan Dhan Yojana (PMJDY) is necessary for bringing unbanked to the institutional finance fold. Do you agree with this for financial inclusion of the poor section of the Indian society? Give arguments to justify your opinion. (UPSC 2016)
Trend Analysis (Past 10 Years)
Prelims:
- Conceptual Understanding: NPAs, types of banks (Payment Banks, SFBs), financial inclusion tools.
- Schemes & Policies: Direct questions on PMJDY, Indradhanush, regulatory bodies (DICGC, IBC, SARFAESI).
- Current Developments: Bank mergers, recapitalization.
- Shift: From basic concepts to applied aspects like financial inclusion mechanisms and NPA resolution.
Mains:
- NPAs: Dominant theme - causes, consequences, resolution (IBC, SARFAESI, Bad Bank).
- Financial Inclusion: PMJDY, technology role, challenges.
- Banking Reforms: Need for reforms, PSB governance, privatization debate.
- Bank Consolidation: Rationale and impact.
- Digital Banking: Emerging theme, opportunities and risks.
- Analytical Depth: Requires analysis, pros/cons, challenges, way forward. IBC is a very frequent topic.
- Shift: From descriptive to problem-solving and evaluative questions on reforms.
Original MCQs for Prelims
-
Consider the following statements regarding the National Asset Reconstruction Company Limited (NARCL):
- NARCL will acquire stressed assets from banks by paying 100% of the agreed value in cash.
- The India Debt Resolution Company Ltd (IDRCL) is an Asset Management Company (AMC) that will manage and dispose of assets acquired by NARCL.
- The government has provided a sovereign guarantee for the Security Receipts (SRs) issued by NARCL.
Which of the statements given above is/are correct?
(a) 1 and 2 only (b) 2 and 3 only (c) 3 only (d) 1, 2 and 3
Answer: (b)
Explanation: Statement 1 is incorrect (15% cash, 85% SRs). Statements 2 and 3 are correct.
-
Which of the following were key recommendations of the Narasimham Committee II (1998) on banking sector reforms?
- Introduction of Narrow Banking for weak banks.
- Reduction of Statutory Liquidity Ratio (SLR) and Cash Reserve Ratio (CRR).
- Establishment of Asset Reconstruction Companies (ARCs).
- Entry of new private sector banks.
Select the correct answer using the code given below:
(a) 1 and 3 only (b) 2 and 4 only (c) 1, 2 and 3 only (d) 1, 3 and 4 only
Answer: (a)
Explanation: Narrow Banking and establishment of ARCs were key recommendations of Narasimham Committee II (1998). Reduction of SLR/CRR and entry of new private banks were primarily from Committee I (1991).
Original Descriptive Questions for Mains
-
The Insolvency and Bankruptcy Code (IBC), 2016, marked a paradigm shift in resolving insolvencies in India. Critically evaluate its performance in addressing the Non-Performing Asset (NPA) crisis, highlighting its successes, persistent challenges, and the impact of recent amendments. (250 words)
-
"While digital banking and Fintech innovations are rapidly transforming India's financial landscape and promoting inclusion, they also present new regulatory and consumer protection challenges." Discuss this statement in the context of recent developments. (250 words)
Conclusion & Way Forward
The Indian banking sector has demonstrated resilience and adaptability, navigating complex reforms and economic shocks. The IBC, recapitalization, and consolidation measures have started yielding positive results in terms of improved asset quality and stronger bank balance sheets. Digital transformation is revolutionizing service delivery and financial inclusion.
Key Steps for the Way Forward:
- Strengthening Governance in PSBs: Implementing remaining PJ Nayak Committee recommendations, minimizing political interference.
- Effective NPA Resolution: Ensuring NARCL functions efficiently and IBC processes are further streamlined to reduce delays and improve recovery rates.
- Robust Risk Management: Adopting strong credit appraisal and risk management practices to prevent future NPA build-up.
- Enhanced Cybersecurity: Investing in advanced infrastructure to combat growing digital risks.
- Financial Literacy & Consumer Protection: Empowering users and safeguarding them from fraud in the digital realm.
- Integrating Climate Risk: Incorporating climate-related financial risks into banking supervision.
- Adapting to Fintech & AI: Exploring new technologies and differentiated bank licenses.
- Sustaining Credit Growth: Ensuring adequate flow to productive sectors for economic recovery and growth.
A robust, efficient, and inclusive banking sector is indispensable for achieving India's socio-economic objectives, including sustained economic growth, poverty reduction, and improved living standards. Continuous reforms and vigilance are necessary to maintain financial stability and foster a dynamic banking environment.