The public sector banks (PSBs) are more focussed on limiting losses from the previous bad debts rather than seeking new lending opportunities, and thus cannot give low demand as an excuse for their credit slowdown, according to the mid-term Economic Survey.
The Economic Survey Volume II 2016-17, tabled in Parliament, said: "The problem is that public sector banks are in damage limitation mode rather than seeking out new clients and opportunities. So, how can they regain their true function of providing credit to support economic growth? What actions will be necessary to ensure that problems will not recur?"
"Inadequate demand cannot be the full explanation for the credit slowdown because the growth in lending by private sector banks is robust and much greater than for the PSBs," it said.
The Survey, authored by Chief Economic Advisor Arvind Subramanian, noted that burdened by stressed assets and atmosphere of uncertainty that existed for some considerable time, banks, especially those in the public sector, have focussed on their Non-performing asset (NPA) problem than on new lending.
Highlighting India's Twin Balance Sheet (TBS) challenge, the earlier Economic Surveys have emphasised that tackling this challenge will require four R's - Recognition, Resolution (which targets corporate balance sheets), Recapitalisation (which targets bank balance sheets) and Reform.
The government and the RBI have taken important actions to address the Twin Balance Sheet challenge. It is to be hoped that they will work expeditiously. But even as they play out, thinking about a strategy - of complementing resolution with reform and recapitalisation - to create a banking sector that can help revive credit, investment and growth must be an ongoing priority.
"Even as the new measures aimed at resolution unfold, it is worth thinking about the other 'R's in the context of a strategic approach to the banking sector," the Survey said.
The most important element, surely, is the fourth R - Reform. Three elements will be key to any reform package. First, rescues can be selective. The prompt corrective action (PCA) framework can be invoked to ensure the worst performing banks are winnowed out of future lending and shrunk in size over time. Rescues could then be extended solely to the group of viable and near-viable banks.
Second, the role of private sector discipline could be expanded, including by allowing, in some cases, majority private sector ownership. Third, these measures should be coupled with specific actions, for example recapitalising banks and strengthening their lending procedures and risk management frameworks, the Survey said.
Over the past few years, the government and Reserve Bank of India (RBI) have moved decisively on recognition and most recently on resolution. In May this year, the government had passed an ordinance to promote resolution.
The RBI followed up decisively by identifying 12 loan accounts to be taken up under Bankruptcy Law.
Meanwhile, to facilitate reform, the RBI has placed six weak banks under the Prompt Corrective Action (PCA) framework, forcing these banks to start reducing the scale of their banking operations, amongst other measures.
"It is to be hoped that these actions will decisively address the TBS challenge. Some doubts have been expressed by observers on the scope for delay in, and stymieing of, the resolution process because of the relatively untested procedures and the inherent difficulty in writing off debts to the private sector," the document said.
Early and prominent successes will help quell these doubts and policy-makers are closely monitoring progress, it added.