The underlying theme of the Reserve Bank of India's report on ‘Trend and Progress of Banking' for 2010-11 is that domestic banks, which have acquitted themselves quite creditably in the recent past, will have to equip themselves to face an uncertain future. Increasingly, the banks and their regulator will be evaluated against global benchmarks. So far, banks in India have grown, showing remarkable resilience. Sporting adequate reserves of capital and liquidity, they have been able to improve both their profitability and asset quality. Given the high growth potential of the economy and favourable demographics, banks have immense opportunities to expand their business with traditional as well as innovative products. However, they face a number of challenges. Important among them are two: to maintain capital adequacy and to put in place risk management systems that would meet global standards. For some of the larger banks, the process of moving towards the Basel III regulatory regime has already begun. While the banking system as an entity may not have any great difficulty in adjusting to the new capital rules, there might be slippages at the level of individual banks, and they would have to augment their capital urgently. Studies by the RBI show a high level of inter-linkages among banks and this introduces an element of vulnerability. Checking the contagion will become particularly onerous for the RBI if the less regulated entities such as non-bank financial companies and mutual funds are also taken into reckoning.
Management of asset quality has always been a challenging task. It's more so now, because the apparent improvement in the levels of non-performing assets hides some disquieting trends. For instance, loan recoveries have not kept pace with slippages since 2007-08. The rising interest rates and the substantial restructuring done during the crisis period can undermine the asset quality of banks. There is an urgent need for all banks to address the NPA-related concerns and tighten their credit risk management systems. Over the past 15 years, Indian banks have raised the productive level remarkably and, in the process, moved closer to global benchmarks. Yet, they should do a lot more by way of attracting people's savings and channelling them into investment. In effect, this means banks will have to cut their ‘net interest margin', which in any case is high compared to some emerging economies. In the long term, the bank sector should work towards financial inclusion, where its products are accessible to everyone and its services run efficiently. In the medium term, banks have ample opportunities to grow, the challenges notwithstanding.