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What’s The Root Cause Of Indian Banking Failure?

The reasons for such failures are quite transparent. In essence, the sloppy regulatory oversights, weak supervision, absence of accountability, susceptibility to misuse by prominent figures and the ineptitude to learn from past mistakes keep adding to the woes of the financial system.

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The finance and banking sector of the country appears to be controversy’s favourite child. With the PMC crisis, the country’s financial system already took a big hit in November, and the next big blow comes in the form of Yes Bank collapse hinting that Indian economy might be hanging by the cliff.

Presently, Yes Bank is put under a moratorium by the RBI, announcing that the depositors can’t withdraw more than Rs 50,000 excluding exceptional circumstances. To revive the bank which had a loan book of 3 Lakh crore, SBI will invest at least Rs 2,500 Crore. If the government and RBI don’t come up in support, these could lead to a full-blown crisis as approximately one-third of the financial system is in a state of plight.

The reasons for such failures are quite transparent. In essence, the sloppy regulatory oversights, weak supervision, absence of accountability, susceptibility to misuse by prominent figures and the ineptitude to learn from past mistakes keep adding to the woes of the financial system.

Why Doesn’t The Banking Sector Learn?

Banking crisis is not a new development in the Indian financial history; the failures in the past didn’t have severe implications due to the relatively small size of the banks. The impact was limited to the distinct local areas the cooperative banks served, and the news would often be immune to public attention, unlike today.

The banking slumps date back to the 1900s when the Indian banking sector was rapidly soaring up. The overwhelming entrepreneurial growth saw the prominent banks granting large loans to influential business tycoons. The same problems of overextended balance sheets, accounting frauds saw the mushrooming banks head to a sad fate.

In November 2019, PMC (Punjab and Maharashtra Co-operative bank), a bank with a legacy of more than three decades in meeting the financial requirements of small and middle-class merchants, came down with a loud thud due to corrupt lending.

Inadequacy in detecting of suspicious transactions, deceitful practices, dummy account operations, violation of standard operating systems and procedures by the board of committee appointed, the bank’s management are compelling reasons behind a scam of this magnitude.

India’s central bank, despite being in constant touch with the management of Yes Bank in finding a solution for improving the balance sheet and liquidity, couldn’t determine the impending disaster. The bank indicated they are likely to be successful and gave false hopes assuring the situation was under control. It struggled to acquire serious investors ready to infuse their capital. Besides, it witnessed a regular outflow of liquidity that further deteriorated their financial position.

Requirement of a Rapid Resolution Scheme

To ensure other commercial or government-undertaking banks don’t meet the same fate like PMC or Yes Bank and the economy doesn’t pay a heavy price, a robust legal framework for resolution is crucial.

The lenders must try to maintain a balance between corporate and retail lending. This will prove to be a big step in administering the bad loans. To avoid collapse, the banks must voluntarily refrain from drawing out to one or a few large borrowers to minimize the chances of potential defaults.

To guarantee the consumers, taxpayers and borrowers don’t suffer and pay for such collapses; the government should see that new bank licences are given to those emerging public or private sector banks which are coupled with a mechanism to exit in case things go sour. 

Economic growth is indispensable, but to encourage this, the government shouldn’t pressurize banks to overlend. Banks must not grow their loans faster than their deposits.

If these checks are implemented, and the government confirms stringent penalties for mishaps by auditors and rating agencies, India will be able to resolve and control a fair number of crises.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


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Rakesh Tulsiani

Rakesh Tulsiani is the COO at Digitalabs. He has worked across industries, including Banking, Automobile, E-commerce, Government, Hospitality, Retail, Telecommunication, Health Care, Electronics, Insurance, Media, FMCG, and Education.

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