Article

Banking Sector Indian Journal of Public

Administration
Regulation in India: 64(3) 1–14
© 2018 IIPA
SAGE Publications
Overview, Challenges sagepub.in/home.nav
DOI: 10.1177/0019556118783065
and Way Forward http://journals.sagepub.com/home/ipa

Geethanjali Nataraj1,2
Ashwani1,2

Abstract
The Indian banking industry is undergoing the rollout of innovative banking mod-
els in the form of more promotion to private banks for attaining the productivity
and efficiency. However, increase in the quantity of non-performing assets, poor
credit growth and low profitability of Indian banks cast doubt about the industry’s
resilience towards maintaining the country’s economic growth trajectory. While
taking lessons from global regulatory bodies and keeping in view the domestic
problem of the Indian banking industry, the dire need of the hour is to maintain
proper checks and balances on banking transactions. The article goes on to sum
up the various measures initiated by government to deal with banking-sector
challenges and how an attempt is made to adapt regulatory measures from global
best practices which could help the banking sector in India become more robust,
efficient and effective in preventing all fraudulent transactions and enhancing
the quality of its assets.

Keywords
Asset intermediation, capital management, market structure, profitability,
regulation

Introduction
The economics literature has well identified the multidimensional role of financial
system in economic growth under endogenous growth theories. Recently, the

1
Professor of Economics, IIPA, New Delhi, India.
2
Department of Economics, NIT, Kurukshetra, Haryana, India.

Corresponding author:
Geethanjali Nataraj, Professor of Economics, IIPA, New Delhi, India.
E-mail: geethanjali_n@yahoo.com
2 Indian Journal of Public Administration 64(3)

importance of financial sector has increased since the onset of financial and
sovereign debt crises. The sector has posed leading challenges before world
economies to understand the dimensions of operations, delivery and regulations in
banking industry. Across the globe, the role of the banking sector in an economy has
been identified on grounds of providing financial resources especially to
capital-intensive sectors such as infrastructure, automobiles, iron and steel, and
industrial and high-growth sectors such as pharmaceuticals and health care.
Nonetheless, banks carry the additional responsibility of achieving the govern-
ment’s social agenda too (PwC, 2014).
The growth experience of India—world’s tenth largest economy in terms of
nominal gross domestic product (GDP) and the third largest in purchasing power
parity—has been well attested by the literature. Indian financial system is mainly
composed of banking sector and its role has been observed from financing the
big ticket projects to make available finance and related services to masses of the
country. The sector has witnessed key reforms such as granting of operational
autonomy to public sector banks (PSBs), reduction of public ownership in PSBs
by allowing them to raise capital from equity market up to 49 per cent of paid-up
capital, transparent norms for entry of Indian private sector, foreign and joint
venture banks and insurance companies, permission for foreign investment in the
financial sector in the form of foreign direct investment (FDI) as well as portfolio
investment, permission to banks to diversify product portfolio and business
activities, roadmap for the presence of foreign banks and guidelines for mergers
and amalgamation of private sector banks and banks and non-banking financial
companies (NBFCs), guidelines on ownership and governance in private sector
banks and so on (Mohan, 2006).
With the continuous reforms taking place in the banking sector in India, the
banking structure was largely isolated from the adverse impact of the global finan-
cial crisis (GFC) which had its origin in 2007–2008 in the USA. Existing litera-
ture has given various reasons for such crises. To name a few, these are ‘greed’,
Wall Street free-market capitalism, accommodative monetary policy, plus massive
subsidies and no regulations in housing, banking and mortgages and so on.
Somehow the practices of moral hazard took place at a wide scale and regulatory
bodies could not identify these malpractices at length (Salsman, 2013). In fact,
the regulations in the form of banking accords such as Basel I and II were active
but the nature of risks could not be ascertained well. With the limitations of
Basel II regulations, the global economy witnessed a severe financial shock in the
form of GFC in 2008, and as a result, Basel III norms of global voluntary regu-
latory framework on bank capital adequacy, stress testing and market liquidity
risk were introduced in 2010 and India is set on the ongoing transition to it.
This phenomenon speaks of a sound regulatory and institutional mechanism to
safeguard the economies from such crisis. The institutional mechanism along with
regulatory reforms is of paramount importance as the implementation has been
full of intricacies, contradictions and perverse effects.1
While the international regulation of banks could not safeguard econo-
mies from the adverse effects of the financial crisis, national regulation has also
remained incapable to tackle the risks that emanated from the ill practices pre-
vailing in the financial system. In case of India, although there existed a resilient
Nataraj & Ashwani 3

banking system during the global crisis, in recent times, the banking industry
has experienced insurmountable level of non-performing assets (NPAs). In 2009,
India had among the lowest ratio of NPAs among the largest economies of the
world, which form the elite G-20 club. Eight years later, it has among the highest
ratio of such assets; India’s banking sector lags behind those of the most other
large economies in terms of capital adequacy. The stress tests of International
Monetary Fund (IMF) have also alarmed the Indian banks indicating that they
are far more vulnerable than their counterparts in other large emerging markets
(Kundu, 2018). Interestingly, India has been constantly observing the global regula-
tory mechanism, but still plagued with poor lending crisis.
Indian banking industry is taking shape in terms of rollout of innovative banking
models like payments and small finance banks along with more promotion to
private banks. While taking lessons from global regulatory bodies and keeping
in view the domestic problem of Indian banking industry, the dire need of the hour
is to maintain proper checks and balances on banking transactions, especially in
recent times as the Indian economy is undertaking innovative reforms to maintain
its growth trajectory. The rest of the article is organised as follows. The second
section presents an overview of the Indian banking sector. Banking sector reforms
in India are detailed in the third section and the institutional and regulatory reforms
for sustainable banking sector and growth are explained in the fourth section.
The current global regulatory practices are highlighted in the fifth section and the
sixth section presents the conclusion.

India’s Banking Sector: An Overview

The Indian banking system is quite diversified in terms of numbers consisting of
twenty-seven PSBs, twenty-six private sector banks and forty-six foreign banks.
India has a large presence of regional rural banks (56), urban cooperative banks
(1,574) and rural cooperative banks (93,913). However, in terms of assets compo-
sition, PSBs have dominated accounting for almost three-fourths of the banking
system assets (IIBF, 2018). Gradually, private sector banks have begun to share a
much larger pie of the total banking asset as PSBs’ share was around 90 per cent
in 1991 and came down to 70 per cent in 2017.
Even with the relatively competitive banking structure, multiple problems
have been faced by Indian banking system, especially the PSBs. The PSBs remain
the biggest contributors to the large and rising stock of NPAs, with a share of
approximately 90 per cent of the total stock. Rising NPAs have led the banks
into declining profitability ratios and even negative in 2016 for the first time in
a decade (Agarwal & Prasad, 2018). As per the compilation of data from the
RBI publications, it has been observed that the operating profit as percentage
of total assets for all scheduled commercial banks (SCBs) has come down from
2.2 per cent during triennium ending (TE) 2007 (average of 2005, 2006, and 2007)
to 2 per cent during TE 2016. For the same period, return on assets has come
down to 0.64 per cent as compared to 1.02 per cent. Return on equity has halved
from 15.3 per cent to 8.2 per cent. Also, return on investment has experienced a
marginal fall in the past decade. The falling returns cast a doubt about the viability
of PSBs in the next decade.
4 Indian Journal of Public Administration 64(3)

The SCBs’ return on assets (RoA) remained unchanged at 0.4 per cent between
March 2017 and September 2017 while PSBs have continued to record negative
profitability ratios (RBI, 2017).
The credit growth rates of PSBs have come down to 2.2 per cent in September
2017 compared to its level of well above 10 per cent during 2013–2014, whereas
the credit growth of private sector banks remained stable (around 18%) and much
higher than the PSBs. In terms of deposits, private banks have attained considerable
growth. A lower growth in PSBs’ credit is attributed to rising NPAs mainly linked
to compulsion lending by PSBs, but there is no reason why PSBs are lagging
behind private banks in attracting deposit. Somehow these statistics highlight the
presence of asymmetry of information and moral hazard in case of public sector
banking practices, whereas the same are observed to be absent in the private
sector banks. Indian banks have been able to manage capital adequacy ratio in
past couple of years, but PSBs have maintained the capital adequacy ratio at the
cost of credit as credit growth has come down significantly; in tandem, the deposit
growth is below potential. Hence, these factors cast doubt on the functional
efficiency of banks and how long these PSBs can sustain their viability.
The PSBs’ capital adequacy ratio remained around 12 per cent during March
2013–2017, and credit growth came down from around 15 per cent to 2.2 per cent
in the same period. Deposit growth has also halved during the period. Net non-
performing ratio was 2 per cent during March 13 and reached to 8 per cent in
September 2017. However, the surprising issue is that the NPAs are growing
even with the falling credit growth. Most of the NPAs have been reported in the
industrial sector, a sector where India has experienced the ease of doing business
and major industrial reforms. The PSBs have negative growth in return on assets
as well as return on equity over past 3 years. The return on assets for PSBs
has been around 0.5 per cent during 2013–2015, but the same has reported the
negative number of around 0.1 per cent during 2016–2017. In the same period,
return on equity has fallen from 7 per cent to −2 per cent. With falling returns,
there is a doubt created about the viability of PSBs in India.
Indian banks have much exposure with industrial sector, especially with the
large industries. Notably, the increase in industrial sector was substantial during
the crisis period and even higher exposure was seen till 2014. Micro, small and
medium size industries have accessed the low level of credit. Interesting observa-
tion is that the personal loans share has come down from 27 per cent to 23 per cent
in the past decade. Out of the total industrial credit, the largest pie went to the
infrastructure sector as the ratio increased from 11.2 per cent in 2007 to 34 per cent
in 2017. However, the share of large borrowers both in total SCBs’ loans and
gross NPAs2 has declined between March 2017 and September 2017.
In the bank group-wise NPAs for priority and non-priority sectors, it is
found that the gross NPAs to advances have increased from 3.4 per cent in 2013
to 8.0 per cent in 2016. The NPA for priority sector has moved from 4.5 to 5.7
per cent; however, for non-priority sector, it has increased from 3 per cent to a
whopping 9.3 per cent. The PSBs have high NPAs comparatively but the non-
priority sector NPAs in PSBs have increased much faster than the priority sector.
Nataraj & Ashwani 5

Presently, the falling credit growth and rising NPAs reflect that banks are
considering the capital requirement a priority agenda under the international
capital requirement accord. India has to meet out the capital adequacy of banks to
a minimum total capital (MTC) of 9 per cent of total risk weighted assets (RWAs).
In the environment of rising NPAs and negative profitability, the meeting out of
credit requirements with the expanding economy amid reforms-oriented approach
remains much below its potential. As per the UN report (2018), India’s growth
rate is projected to accelerate to 7.2 per cent in 2018 and 7.4 per cent in 2019.
To maintain the high growth trajectory, India has to ensure appropriate credit
growth. The country expects the credit growth of 8–9 per cent in the financial
year 2019 albeit slower deposit growth rate of 4.45 per cent year-on-year, which
requires new capital base with public banks to the tune of `2.06 trillion. Ensuring
high credit growth seems the biggest challenge as PSBs are going to experience
the pressure on their profit accounts; however, the report gives green signal to
private banks for their stability (PTI, 2018). This phenomenon clearly states that
the RBI’s powers for regulating the private sector banks has been much effective
in controlling the market risks where private banks have exposure; the same story
gives an indication to introduce a parallel regulatory mechanism for PSBs.
The regulatory reform of interest rate deregulation is a subject matter of dis-
cussion as banks are not able to attract much deposit even with flexible interest
rates and credit growth remains subdued despite monetary easing. This is in
contrast to the hypothesis that financial liberalisation addresses the problem of
underinvestment. During the period 29 September 2017 to 5 January 2018, the
incremental credit of `1.85 trillion was significantly higher than the accretion
of deposits of `0.30 trillion. The slow accumulation of deposits can partly be
attributed to the continued increase in currency with public (CWP), reaching
almost 96 per cent of the pre-demonetisation levels (ICRA, 2018). Hence the
regulatory mechanism must explore the avenues of banking sector profitability
by safeguarding the banks from interest rate risks, liquidity risks, trained finan-
cial experts for economic evaluation of projects and so on.
Globally, banking industry has historically experienced three paradigms of
regulation—the first focused on administered interest rates, the second empha-
sised the intermediation of the asset side of the banks by way of improving the
loan supervision and the third paradigm looks towards deposit pricing of banks.
The first paradigm has been caught with mispricing of risk and, hence, misallo-
cation of capital by banks due to arbitrarily determined cost of funds. However,
regulatory issues have mainly focused on lending rates of banks, with very little,
if any, attention paid to deposit pricing.

Banking Sector Reforms in India

Indian banking industry has experienced wide scale of reforms. The first set
of reforms was to provide an enabling environment in terms of deregulation of
interest rates, relaxations in reserve requirements and widening the scope for
credit allocation. An initiative of bank nationalisation that took place in 1969 has
6 Indian Journal of Public Administration 64(3)

emphasised the government control over credit allocation of banks. Second

reforms were towards the ownership pattern of banks. Indian banking industry has
experienced the change in ownership pattern both intra-industry and intra-bank.
In fact, share of PSBs in aggregate assets has come down from 90 per cent in 1991
to around 75 per cent in 2004 and further fell to 70 per cent in the recent past.
Government shareholding in PSBs has been reduced to 51 per cent. As per the
literature, diversification of ownership has led to greater market accountability
and improved efficiency (Reddy, 2005). On the front of market structure, another
major reform has been towards consolidation keeping in view the difficulty in
distinctions of institutions providing long-term and short-term finances. In this
regard, the Development Finance Institutions (DFIs) have been reversely merged
with commercial banks subsidiaries. In the recent past, the associate banks of
State Bank of India have been merged into a large bank to meet out the industrial
requirements, and consolidation of other PSBs is under the way.
Indian reforms journey is based on a series of reports, namely, Report of
the Committee on the Financial System (Chairman: Shri M. Narasimham) in
1991; Report of the High Level Committee on Balance of Payments (Chairman:
Dr C. Rangarajan) in 1992; and the Report of the Committee on Banking Sector
Reforms (Chairman: Shri M. Narasimham) in 1998. On the front of legal reforms,
institutional capacities have been added in the form of constituting of Board for
Financial Supervision (BFS) in 1994. The board followed an integrated approach
aiming to provide regulatory policies including governance issues and super-
visory practices across financial institutions such as commercial banks, DFIs,
non-banking finance companies, urban cooperatives banks and primary dealers.
Keeping in view the diverse nature of these governed institutions, Department of
Supervision was further bifurcated in August 1997 into Department of Banking
Supervision (DBS) and Department of Non-Banking Supervision (DNBS) and
both have been working with the BFS. Later on, another board—a Board for
Regulation and Supervision of Payment and Settlement Systems (BPSS)—was
established in 2005 to deal with policies relating to the regulation and supervision
of all types of payment and settlement systems (RBI, 2005).
The regulation with respect to information access of the related parties for
prudent decisions has been strengthened by enacting the Credit Information
Companies (Regulation) Bill, 2004, followed by the regulatory and supervi-
sory powers of Reserve Bank regarding acquisition norms have been enhanced.
The regulatory framework in India has also focused on ensuring good govern-
ance through ‘fit and proper’ owners, directors and senior managers of the banks,
apart from the promotion of market discipline. The regulatory framework and
supervisory practices have almost converged with the best practices elsewhere in
the world as confirmed by alignment of Indian banks with the Basel accords.
The supervision under above given boards and other legal provisions has been
effective as Indian banking system remained resilient even during the GFC.
But since the onset of crisis, a few new sorts of market transactions have been
witnessed related to adverse selection and moral hazard not only in India but
also across the globe. This phenomenon demands another integrated approach of
setting up of an institutional framework in India to address the market discipline
in the new economic environment.
Nataraj & Ashwani 7

With the growing NPAs, the reforms of supervision have been strengthened.
In this regard, a comprehensive and forward-looking Supervisory Programme
for Assessment of Risk and Capital (SPARC) has been launched in 2013. RBI
has put in place the asset quality review of banks announced by the Reserve
Bank in 2015. In order to address the growing NPAs, two ordinances—Banking
Regulation (Amendment) Ordinance, 2017, and Insolvency and Bankruptcy Code
(Amendment) Ordinance, 2017, have been enacted by the Government of India
(Nayak, 2018). The ordinance has empowered the banks to expedite the bank-
ruptcy proceedings for large defaulters after completing the 6-month time-bound
mechanism of resolution (Bandyopadhyay, 2018).
Very recently, the Insolvency and Bankruptcy Code (Amendment) Ordinance
(2017) Bill has been passed by Rajya Sabha.2 Government of India has empowered
the RBI under the Banking Regulation (Amendment) Act, 2017, to issue direc-
tions to the banks for resolution of stressed assets, In this regard, RBI could lend
about 40 per cent of banking sector’s overall exposure to the high valued stressed
assets. In April 2017, the RBI tightened the rules under its ‘prompt corrective
action framework’ which aims to rein in lenders whose operational and financial
metrics look weak (Dugal, 2018). The RBI in June 2017 identified twelve loan
accounts with 25 per cent share of gross bad loans in the system for immediate
bankruptcy proceedings. In continuation, RBI announced a time-bound insol-
vency mechanism for another list of twenty-eight large stressed accounts having
exposure to the tune of `1.4 trillion. However, the same has not been realised as
per the plan and these cases are under lens of the National Company Law Tribunal
(NCLT) for bankruptcy proceedings.3
However, RBI has issued a revised framework for prompt recognition
and resolution of stressed assets in the beginning of 2018. The rationality
behind this move is that the schemes launched by RBI in the pre-Insolvency
and Bankruptcy Code (IBC) context especially the forbearance is that one
could not achieve much on the front of resolution. The new framework aims
to strengthen the credit culture in the economy by ensuring early resolution of
stressed assets in a transparent and time-bound manner. The revised framework
is broader in context as it focuses not only on structural reforms in the credit
system, rather it pronounces the dictation of resolution plan for stressed assets.
It provides absolute flexibility to the lenders and puts in place a credible res-
olution plan, as under the pre-IBC schemes, and puts a bar of 180 days from
the date of default for resolution plan to the accounts with aggregate exposure
of greater than `20 billion, failing which these would be referred under the
IBC. The new revised framework incentivises the lenders through efficient
turnaround plan to get a quicker upgrade in case of restructuring, and borrowers
to not overborrow, rather to manage the business cycles stemming the default.
The possible implications of new regulatory environment may be to reduce the
crony capitalism happening due to promoter-bank nexus and thereby addressing
the NPA/credit misallocation problem mainly created by ever-green suited
stakeholders—borrowers as well as lenders.
8 Indian Journal of Public Administration 64(3)

Institutional and Regulatory Reforms for

Sustainable Banking Sector Growth
Indian banking sector is presently paralysed by frauds as value of frauds has
increased by almost three quarters from `97.5 billion to `167.7 billion in the past
5 years. According to the RBI’s Financial Stability Report of December 2017,
they currently stand at 10.2 per cent of all assets, while stressed assets, which are
believed to be NPAs in effect, stand at 12.8 per cent (Roy, Subramanian, &
Ravi, 2018). As per the speech of RBI Governor, the excessive lending by banks
to the enterprises during loan growth cycles without truly identifying the asset
quality coupled with artificial accounts settlements of full repayment on past
dues, protracted control for promoters over failed assets, has created an acute
banking crisis and the same has been out of purview of the RBI’s jurisdictional
reach.
Today, Indian banking industry demands a three-step process, namely, strength-
ening the provisions related to NPAs, sound capital base of banks to strengthen
their ability to expand credit and to launch efficiency-oriented reforms in
the banking system (Ahluwalia, 2017). Reducing the government equity below
51 per cent and attracting some strategic investors seem most promising banking
reform as it would pave the way for more commercial orientation for PSBs as well
as lessen the burden on exchequer in the form of recapitalisation while at the same
time smoothly financing the credit requirements. The policy actions suggested
by the Nayak Committee, if not implemented at length, may at least partially be
done in the form of administrative monitoring from Ministry of Finance; bank’s
autonomy under the competent board can be exercised.
The Nayak Committee constituted by the RBI Governor on 20 January 2014,
to review the Governance of Boards of Banks in India, has suggested diluting the
stake of the government in PSBs below 50 per cent for freeing the banks from
various government constraints (RBI, 2014). The committee also recommended
a Bank Investment Company (BIC) to act as the holding company for various
PSBs. Since BIC was a time-consuming process, and in the meanwhile the setting
up of a Bank Boards Bureau (BBB) was advised and has been created in 2016.
In order to have appropriate capital into the banks, specified investors by RBI
can hold up to 20 per cent in banks without regulatory approval. However, on all
these provisions, there is not significant achievement and the same can be carried
out systematically.4
Two new full service banks, IDFC Bank and Bandhan Bank, started operations
during the second half of the 2015. Also, twenty-one new niche bank licences
were issued in 2015 catering two services—half of the banks made into payments
banks to provide remittance services, and half of the banks indulged into catering
the niche market of micro-financing, especially targeting the informal banking
system. These two steps create the pathway for a regulatory body aimed at
creating an efficient banking system by way of diversifying the banking opera-
tions and thereby contributing to the efficiency aspect (Saha, 2015).
Bank credit, which grew at 2.5–3 times the real GDP growth, has slipped to
1–1.5 times in the past 4 years. Notwithstanding this, the centre has been doling
out subsidy for such loans. In fact, the subsidy payout under the interest subvention
Nataraj & Ashwani 9

scheme has gone up over nine times since 2009–2010. This year, the allocation
has been set at `150 billion (Business Line, 2018). Such incentivised schemes can
be enlarged while extending the scope to other sectors of the economy, but there
must be fair monitoring of these transactions.
The major regulation for banking sector can be towards understanding
the credit culture at originations, default and assets quality recognition and
resolution stages. The government has provided the IBC, the related ordinances
and the bank recapitalisation package (Patel, 2018). The new paradigm of regula-
tion at global level focuses on the sources of financing with appropriate pricing.
New international capital accord gives due importance to equity financing for
the banks; however, the attraction of equity shareholders rests on the capacity
of banks to ensure reasonable returns. In case of India, the situation is severe as
banks have high NPAs along with rising fraudulent cases. The banking system,
especially PSBs, is facing the key challenges of liquidity risk, undercapitalisation,
no attraction to the equity capital and so on. Thanks to the demonetisation drive
that enhanced the bank deposits, poor credit delivery casts a doubt about financial
stability. As per the present nature of bank capital mainly insured deposit, and
their functions of critical payments and settlements, banks are quite vulnerable
amid the hypotheses of ‘too big to fail’ or ‘too many to fail’. This phenomenon
requires the effective enforcement of investigative discipline, market discipline
and regulatory discipline. Regulation focus can be to attach severe penalty amid
fraud cases, sound checks and balances of credit delivery from both sides—
management of banks as well as borrowers, the institutional capacity to address
the undercapitalisation of banks through its timely calculation and facilitating
equity financing. Institutional capacities can be strengthened to understand the
holistic credit requirements at central level and accordingly associating the respec-
tive bank as per their capitalisation. For larger investment projects, sound capitali-
sation banks must be attached and small capitalisation banks with respect to time
can be linked to micro-financing.
In the wake of falling bank credit and shift of corporate sector to new sources
of financing, banks would again face the pressure on their profitability and in
this context the competitive pricing of finances of banks is an important agenda
before regulation. Higher-rated borrowers are shifting to either bonds market or
to mutual funds for their credit requirement. In the year 2011, the share of bank
loans and non-banks in the commercial sector credit was in the ratio of 56:44;
however, the same has reversed to 38:62 in 2017 (Nair, Moghe, & Bitra, 2018).
In this context, the lower credit standard may render the banks into adverse selec-
tion problem and thereby further disintermediation and also competitive pricing
can put the banks into credit rationing. Both the cases are very acute to the banking
industry. In this regard, the provisions related to RBI’s powers in terms of removal
of directors and management, to force a merger, to revoke the license, to trigger
liquidation in case of PSBs can be aligned with RBI’s powers for these parameters
in case of private sector banks (Patel, 2018).
Indian banking sector requires regulations on the front of dual controlling
mechanism, namely, ownership and governance level control as well as operational
control that the Union finance ministry exercises. A programme like the Pradhan
Mantri Jan Dhan Yojana (PMJDY) is operationally guided by the ministry and
10 Indian Journal of Public Administration 64(3)

bypasses the board-directed strategy (Sriram, 2018). It requires a holistic devel-

opment agenda and integration of both the regulators to decide the clear pathway
of the banking system. Both the regulators must align their regulation and
policies. Some of the academicians have suggested developing institutional facili-
ties regarding the setting up of secondary market for NPAs in order to have more
transparency in price of assets.
The banking system is entering into new era as adoption of financial technolo-
gies as the fintech providers for money transfer and payment services rose from
18 per cent in 2015 to 50 per cent in 2017. About three-fifths of the global banks
are expecting to become digitally mature or digital leaders by 2020. Banks are
going to spend intensively in technology-driven system to strengthen their com-
petitive positioning (Ernst & Young, 2018). With growing digital technology in
the banking industry, new regulations must ground the monitoring and supervi-
sion by way of enacting respective provisions to safeguard the banks from issues
of cybercrimes. The use of artificial intelligence for the supervision of financial
transactions could prevent financial fraud.

Current Global Regulatory Practices: Lessons for India

In the past decade, global banking system has been posed with certain challenges
including protracted lower interest rates, rising non-performing loans (NPLs),
temporary bubbles in residential and commercial real estate markets, shift in
political powers, euro area’s fiscal imbalances and accordingly rising sovereign
debt and so on.5
The regulatory environment is gaining its way in the presence of promising
growth opportunities in emerging economies.6 Also, the global regulatory envi-
ronment is giving a new direction to the banking system on the front of capital
management. Recently, European Central Bank (ECB) has put forth these key
challenges on priority on the regulation front and has also delved upon cybercrime
and IT disruptions, cases of misconduct, non-bank competition, the potential failure
of a central counterparty and a rigid business environment.
The ECB has carried out a systematic approach to deal with the above chal-
lenges by focusing on four components. The utmost important area is the identifi-
cation of key profitability drivers of the banking system. In fact, the improvement
in bank balance sheet based on their core strengths would serve the prime objec-
tive of maintaining the balance sheets. It is added that several factors such as eco-
nomic growth, nominal interest rates, competition, financial innovation, financial
market and taxation/regulation regime play an important role for banking sector
valuation (Murali, 2009). Addressing the profitability issue must be a key agenda
for regulation as it will pave the way for banks to meet the capital requirements
in the future.
The macroeconomic policy environment has much bearing with lower profit-
ability of banks. In this regard, the most important area for regulation should
be the consistency in the economic policies and banking regulation. The sover-
eign crisis witnessed the phenomenon of irresponsive fiscal policy, making the
banking system vulnerable. Also, the consistent low interest rates in the USA and
Nataraj & Ashwani 11

Japan have affected the banking sector’s functioning. So the regulation must be
grounded on the intensive studies capturing the linkage between macro-policies
and banking performances.
The ECB has also concentrated on credit risk by making a quick dialogue with
banks to understand the nature of NPLs strategies, and improving the timeliness of
NPL provisioning and write-offs. The same gives much scope for India to have a
constant vigil about every strategic action for improving the bank balance sheets.
Another merit-based area of supervision in the ECB is towards understanding the
banks’ exposures in specific asset classes. The ECB has considered the supervi-
sory approach combining off-site and on-site elements mainly where banks have
higher exposure. The same puts forth the scope for India to see the inter-temporal
asset classes of banks along with the national priorities and possible outcomes of
respective strategy and also, to identify the major push factors and delving upon
them based on today’s economic circumstances. Obviously, the banks’ collateral
management and valuation practices are most important agenda to be pursued.
In fact, ECB has considered the importance of supervision of complex financial
instruments like Level 2 and Level 3 assets and also carried out the Targeted
Review of Internal Models (TRIM) project aiming to assess the performance of
banks in the TRIM inception year (2017) through on-site inspections at banks
continuing for credit, market and counterparty credit risk and gradually improv-
ing its effectiveness. These practices can form an important component for regu-
lation of Indian banks. As per the practice of ECB, major inputs must be sought
from banks while devising the supervisory guidance related to management of
capital and adequacy of liquidity. In fact, illiquid banks may result into below
potential investment but at the same time capital management will help in
maintaining the credit risk.
At global level, the practices of internal capital adequacy assessment process
(ICAAP) and the internal liquidity adequacy assessment process (ILAAP) are
taking shape. In addition, work aiming at improving the transparency around the
risk-by-risk composition of the Pillar II requirements will also be performed.
Besides, the reporting system what ECB is planning to implement is IFRS 9
though today it is in nascent stage, but India can consider its major components
for improvement in reporting system. True reporting will strengthen the institu-
tional capabilities of bankruptcy code to timely quantify the possible risks and
take the necessary actions. Further regulatory changes in relation to which banks’
preparedness will be monitored including the net stable funding ratio (NSFR), the
leverage ratio and the minimum requirements for own funds and eligible liabilities
(MREL).
In sum, India can learn from the ECB supervisory initiatives, albeit EU has
some different economic circumstances like the break-up of the Union (BREXIT)
and accordingly resource diversion, but India can take necessary actions for
capital management, liquidity management and possible credit management.
Stress testing can be made an integral part of the supervision and its scope in terms
of institutions and financial products needs to be strengthened. Nonetheless, the
risks emanating from IT and cybercrime stand equally important amid growing
digitisation of economic transactions (ECB, 2018).
12 Indian Journal of Public Administration 64(3)

Conclusion
The role of regulation in shaping the welfare of economies and society can hardly
be overlooked. The objective of every country is to have a regulatory policy that
is not only effective but is in public interest. However, regulation happens to be
weak in many poor and developing economies across the world. India is no excep-
tion. Although by and large, regulation has been a relative success in India in
some sectors, there is a need to revisit regulatory issues and make them more
effective and the Indian banking sector is one such sector which needs special
attention. The banking sector in India is regulated by the RBI Act, 1934, and the
BR Act, 1949. RBI which is the central bank of the country issues various guide-
lines, notifications and policies from time to time to regulate the banking sector.
In addition, the Foreign Exchange Management Act, 1999 (FEMA), regulates
cross-border exchange transactions by Indian entities, including banks. From the
above discussion, it is evident that the Indian banking industry is taking shape in
terms of rollout of innovative banking models like payments and small finance
banks along with more promotion to private banks. While taking lessons from
global regulatory bodies and keeping in view the domestic problem of Indian
banking industry, the dire need of the hour is to maintain proper checks and
balances on banking transactions, especially in recent times as the Indian economy
is undertaking innovative reforms to maintain its growth trajectory. However, a
few key regulatory issues and challenges continue to impede the growth of the
Indian banking sector. As discussed above, the Basel III implementation, lack
of regulation for specialised banking, ineffective provisions for understanding
the credit culture, limiting the credit growth amid rising NPAs, etc. are the key
challenges on the regulation front facing the banking industry. From the ECB
supervisory initiatives, India can take necessary actions for capital management,
liquidity management and possible credit management. Stress testing can be made
an integral part of the supervision and its scope in terms of institutions and finan-
cial products needs to be strengthened. As explained in the article, the government
has taken several measures to deal with these challenges and also adapting regula-
tory measures from global best practices which are expected to help the banking
sector in India become more robust, efficient and effective in not only preventing
all fraudulent transactions but also in enhancing the quality of its assets which is
the need of the hour.

Declaration of Conflicting Interests

The authors declared no potential conflicts of interest with respect to the research,
authorship and/or publication of this article.

Funding
The authors received no financial support for the research, authorship and/or publication of
this article.
Nataraj & Ashwani 13

Notes
1. Léon Courville (2018).
2. See https://www.ibef.org/industry/banking-india.aspx
3. See  https://www.livemint.com/Opinion/tfi3VBN1wdVMbnWz1WKu7L/2018-Year-
of-resolution–recovery-for-public-sector-banks.html
4. See  https://www.livemint.com/Industry/55l4XnriGrAYQr87EP58PJ/Why-Indias-
banking-sector-is-among-the-most-vulnerable-amon.html
5. See  https://www.bankingsupervision.europa.eu/ecb/pub/pdf/ssm.supervisory_
priorities_2018.en.pdf
6. In the emerging market context, exports are growing at their fastest clip in six years on
the back of a pick-up in global growth (RBI, 2017).

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