Banking weakness affects financial stability

AN IMPORTANT insight that emerges from the developments in the financial sector in the 1990s is the need to treat financial stability as a dominant objective of macroeconomic management and as a necessary, if not sufficient, condition for accelerating economic growth.

Towards this end, it has become necessary not only to regulate and supervise the financial sector, but also encourage market participants to improve information flows, adopt transparency practices, manage a wide array of risks associated with the growth of business and eliminate asset-liability mismatches.

Financial stability without efficiency is not a workable proposition from the growth and development view. Competition for funds and the introduction of modern technologies based on IT and networking have been the distinct hallmarks of the 1990s, enabling freer competition.

But profitability and cost minimisation which enable freer competition and financial innovations have remained areas of concern.

The banking sector is still dominant in the overall financial system in India. Since the adoption of prudential standards in 1993-94 there has been a reduction in the non-performing assets (NPAs) in relation to the total assets, especially over the last five years.

The NPA-level remains unduly high, partly because of the NPAs carried over in certain sunset industries and the continued existence of weak internal control systems in banks, and partly because of the relatively weak legal support to the recovery mechanisms.

However, the large quantum of NPAs poses a major problem for a few banks, identified as weak banks, where the possibility of a return to profitability, without substantial restructuring, is doubtful. The Verma Committee, which looked into the problems of weak banks, made certain recommendations which are under the consideration of the Government and the Reserve Bank.

Any delay in the resolution of the NPA problem could act as a `drag' on the reforms process itself. It should be recognised that mere compliance to the internationally-accepted Core Principles of Banking Supervision will not eliminate the problem.

There is a need for not only banks and supervisory authorities to adopt best practices, but also for corporate entities to adopt greater accountability through disclosures and transparent practices and corporate governance principles.

The legal machinery, as reflected in the establishment of a larger number of Debt Recovery Tribunals (DRTs) and Settlement Advisory Committees (SACs) in banks, will need to be strongly activised to enable the expeditious recovery of the dues of banks and financial institutions.

The on-going initiatives such as the setting up of internal asset-liability management committees (ALCOs) in banks, the pursuit of risk-based supervision and the preparation for setting up of a Credit Information Bureau should be vigorously followed, together with upgradations in technology and payment and settlement systems.

Monetary policy has continued to place emphasis on the twin objectives of pursuing price stability and ensuring adequate availability of credit for the economy's productive activities. These objectives are fundamental not only because they are in line with the provisions of the Reserve Bank of India Act, but also because they reflect the country's economic priorities.

(Edited-extracts from the annual report of the Reserve Bank of India)