The Economic Survey 2014-15 has proposed a 4-D prescription to the Indian banking sector, which is hobbled by policy constraints, which create double financial repression, and, by structural factors, impede competition.
The four Ds include: De-regulation (addressing the statutory liquidity ratio (SLR) and priority sector lending (PSL)), differentiation (within the public sector banks in relation to recapitalisation, shrinking balance sheets, and ownership), diversification (of source of funding within and outside banking), and disinterring (by improving exit mechanisms).
Elaborating on the challenges, the Survey pointed out that the banking system was afflicted by “double financial repression” which reduced returns to savers and banks, and misallocated capital to investors.
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On the liabilities side, high inflation lowered real rates of return on deposits and a sharp reduction in households’ financial savings. On the assets side, statutory liquidity ratio (SLR) and priority sector lending (PSL) requirements had depressed returns to bank assets.
Private sector On the structural side, problems related to competition and ownership. First, Private sector banks did not partake in the biggest private-sector-fuelled growth episode during 2005-2012. This was reflected in the near-constant share of private sector banks in deposits and advances. Second, there was substantial variation in the performance of the public sector banks. Hence, they should not be perceived as a homogenous block while formulating policy. There needs to be greater selectivity in relation to recapitalisation, exit and the level of government ownership.