Prof.

S K Monga
Deptt. of Commerce Gopichand Arya Mahila College Abohar 152116 Punjab

Global Economic Crisis - Impact on Indian Banking Sector

Introduction : The U.S. economic crisis has had its reverberations on both developed and developing world. It is not possible to insulate Indian Economy completely from what is happening in the financial systems of the world. Effectively, speaking, however, the Indian banks and financial institutions have not experienced the kinds of losses and write-downs that even venerable banks and financial institutions in the Western world have faced. By and large, India has been spared the panic that followed the collapse of banking institutions, such as Fortis in Europe, and Merrill Lynch, Lehman Brothers and Washington Mutual in the U.S. The relative freedom from the contagion spreading from the global tsunami on the Indian financial system owes much to the wise and judicious policies of our Central Bank and the Government of India. Discussions on this subject have proceeded on two lines. One is to point out that the Indian banks have taken less risks than their peers abroad. The less risk you take, the more will be safer you are. This however, begs the question, "why did the Indian banks take less risks?" The answer lies in the wise regulations and meticulous supervision by the RBI. At a time when total deregulation was the order of the day in the 90s, Dr. Manmohan Singh as the Finance Minister authorized a path-breaking study of the Indian Financial system by an experience central banker, M. Narasimham. He had the wisdom to foresee that the financial system had to be placed on a well-regulated basis. Mr. Narasimham's classic reports gave the policy framework for the Government of India and the RBI to formulate the structure of India's banks and financial institutions. Mr. Narasimham's model was based on adequate capitalization, good provisioning norms and well-structured supervision. Government of India and RBI accepted these recommendations and proceeded to implement them.

Vigorous Role played by RBI in reducing the negative effects of Global Financial or Economic Crisis. What was, indeed, important was that the model did not allow investment banking on the pattern of the American paradigm. In a sense RBI enforced its own version of the U.S. GlassSteagal Act of 1933, which insulates banks from capital market exposures. The RBI enforced strict capital adequacy requirements and if any financial institution or bank exceeded the specified limits of exposure to stock markets, it would have to provide more capital. This effectively insulated the banks and financial institutions from volatility of the bourses. Enforcement of the above instructions has paid good dividends. Erosion of the banks and financial institutions has been reduced. These exposure limits, however, deserve to be reviewed from time to time. The RBI must be congratulated for imposing Basel -II norms impartially and in a flexible manner. They have kept it in line with the Indian financial system. Observation of these limits, however difficult it may be in practice, will definitely help the Indian financial system to escape the kind of trouble, which is afflicting the financial system in other countries. There is another observation, which has to be kept in mind in judging the relative freedom of Indian Banking system from the catastrophic mess in the U.S. This is based on the important fact that the Indian banking system is basically owned by the public sector. The State owns many of the banks and financial institutions in the country. There is greater confidence of depositors in a state-owned bank than in a privately-owned bank. This is evident from the fact that in the latest version of the rescue package in the U.S., the government has come forward to infuse capital into distressed banks and financial institutions. May be, we can congratulate ourselves that India had already done what Washington is now doing in the midst of the crisis and therefore escaped much of the confidence problems. Credit is also due to the Government of India and the RBI for having avoided the temptation of total capital convertibility. Had we embarked of total capital convertibility, we would have been exposed to much grater contagion from the current mess than we have been so far. The lesson is that in economic reforms, we have to proceed with caution. Striking the right balance between boldness and caution is where wisdom lies.

Growth of Indian Banking: At a time when the financial system across the globe is engulfed in a deep crisis, the Indian banking system continues to show resilience. The underlying fundamentals of the Indian economy would continue to underpin the robust performance of the banking sector which remains profitable and well capitalized. There are good reasons for such optimism. First, unlike in the west where credit supply has collapsed, credit grew at 25% in 2007-2008 and by 24% in the year to date. Banks may be expected to slow down credit growth in 2009-10 given the uncertainties in the environment. But growth of around 20% is still an impressive figure. Secondly, spreads in the Indian banking system remain high in comparison with other banking systems, although they declined for the second year in succession. The net interest margin, an indirect measure of spread, was 2.4% in 2007-2008. This is lower than the spread of around 2.8% we had until 2005-06. But volume growth today is higher than in most of the post-reform period. Higher volume growth should offset the decline in spread. Besides, bans have learnt to boost revenues through non-interest income. Thirdly, non-performing assets (NPAs) are at an all-time. The ratio of net NPAs to et advances is down to 1% down from 9% a decade ago. Fourthly, return on assets in the Indian banking system was 1% in 2007-08. This figure is a widely accepted benchmark for performance in banking. We must expect a rise in NPAs and higher provisions in 2008-09 and 2009-10. But banks stand to gain on their bond portfolios as interest rates fall. So any decline in return on assets should be small. Does this all sound too good to be true- the Indian banking system as an islet of tranquility in a sea of turbulence? One alarmist scenario is a big collapse in property prices - remember, the rise in property prices here has been steeper than in the US or Europe. No fears. Housing loans are only around 10% of overall banking assets. Even if 20% of housing loans go bad, a figure we have seen in the subprime crisis, the maximum impact would be a rise in NPA/asset ratio to 3%. With an average capital adequacy ratio of 13% banks are well placed to withstand an increase in NPAs of this order. But even this is unlikely because banks finance around 70% of the white component of housing loans. If we assume a black component of just 30% of the value of the property banks are protected against a decline in property prices of 50% from their present levels. There is always the danger of one or two weak players having serious problems. But we do have the capacity to contain systemic risk arising from such a situation. The broader lesson of

the Indian banking system emerging relatively unscathed in the present crisis should not be ignored. Out unique approach to the issues of bank ownership and regulation, our reliance on home-growth solutions, has served us well. The need for caution is to be made on several fronts. However, there are two areas that do not receive the attention they merit. One is the need to improve the quality and performance of public sector bank boards. The RBI has laid down 'fit and proper' criteria for elected directors. It must extend these to all directors. It must also advise PSBs to increase the sitting fee from the disgraceful figure of Rs. 5,000/- this pretence of austerity is not helping anybody. Another is the sharp rise in off-balance-sheet (OBS) assets in the banking system in recent years. For banks as a whole, OBS assets are 333% of balance sheets assets. The biggest exposures are among foreign banks (2,803%) and new private banks (302%). OBS items have proved the undoing of banks in the recent crisis. The RBI needs to keep its eyes and ears peeled. Extent of the Crisis on Indian Financial Sector : The Indian banking sector, backbone of the financial system had no impact of sub-prime markets of US economy. Indian banks global exposure is small with international assets of 6% of total assets. Investment exposure of banks to financial institutions is also less. So the attainment of losses has been comparatively low. The position of Indian banks became better after the attainment of capital adequacy norm in accordance with Basle recommendations. The Indian banks are basically suffering due to slow GDP growth, depressed capital market and high interest rate. Profitability of banks are being affected due to increased cost of borrowing. Exceptionally, there have been certain Indian banks which suffered because of credit spreads on term liquidity due to sub-prime crisis. It is mainly the equity market in India which has severely been affected by the crisis. In the Stock Market, there has been fall in value of stocks and real estate as a result of credit, assets and investment bubbles. Facts have revealed that, "The capital market witnessed a 60% decline in the index and a wiping off of about US $ 1.3 trillion in market capitalization since Jan. 2008 when the sensex had peaked at about 21000. It is primarily due to the withdrawal of US $ 12 billion from the market by foreign portfolio investors between September & December 2008." (Reference : Report on Impact on India & Policy Response) Foreign investors withdrew their credit in order to improve the balance sheet of the parent companies. So commercial credit have been tightened. In India, major amount of investment is done

through stock market. Different forms of investments in Indian companies are Promissory Notes, GDR's, ADR's and direct investments. Failure of Lehman Brothers and other Biggis were enough to increase the intensity of slowdown. RBI & the government put all their efforts to prevent the reduction of foreign investments. Ban on Promissory Notes was announced as a measure but it further affected the market. The Primary Markets also became the victim of the crisis. Companies were not ready to have new issues. The development of capital Market was necessary to make the Indian Banks attain further capital adequacy norms accessing the equity market. While the Indian banking sector has significantly grown in size in the recent years, its soundness has largely been maintained even during financial crises. The impact of sub-prime crisis on banks was almost negligible due to limited exposure to toxic assets owing to the counter-cyclical prudential norms prescribed by the Reserve Bank. The Economics crisis & Financial Soundness of Indian Banking. The impact of financial market developments on banks is reflected by the trends in their various soundness indicators, namely, Return on Asset (RoA), Capital to Risk Weighted Assets Ratio (CRAR) and Non-Performing Assets (NPAs). Some of these major soundness indicators of the banking system showed significant resilience even during the times of the crisis. The Returns on Advances and Investments moved in opposite directions during phases of rising and falling interest rates. As a result, banks could earn a stable RoA in a volatile market environment by making appropriate adjustments to their portfolios, while ensuring sound assets quality and high levels of CRAR. The stable performance and sound health of the Indian banking system, however, does not preclude important initiatives that need to be taken in order to further increase operational efficiency of banks. There is also a need to strengthen the countercyclical prudential regulatory framework and step up capital adequacy to meet unforeseen risks emanating from developments in the financial markets. The banks are doing so well in this time of recession. The reasons that big banks are able to beat the recession and rake in the profits are 1. Underwriting increases provide investment banks with more income As businesses go to investment banks. Banks that do the underwriting collect fees, and if they actually make the loans, they also collect the interest.

2. Trading revenue is also up as investors try to play the market, getting In when prices are low and trading to take profits on the rallies. Many of the big banks (like Goldman) do over the counter traders, so they get commissions as well. 3. Less competition is the result of failed banks and takeovers. This Means a bigger piece of the pie for those banks that are left. 4. Retail banking has been providing a boost. People still need a place to keep their money. With a lower Fed funds rate, they can pay less in interest to their savings customers, while still charging between 5% and 10% interest(more for credit cards) on loans they make. That difference is resulting in profitability.. Performance of Indian Banks in Present Scenario: In spite of the sinking ships and crashing boats in the stormy ocean of international business particularly the banking sector some countries have managed to hold on and sail through the troubled waters. Indian and Chinese banking houses are a fine example. Though Indian share markets have plunged to more than half of their value in one year the banking sector has managed to post profits in the third quarter of 2008. The State Bank of India declared a quarterly profit rise of 40% over the last quarter. State of Bank of India is India's first non Oil based sector to feature in fortune 500 prestigious lists of companies. It has upheld the trust of Indian investors and FDIs with this good news. Conclusion :When the financial crisis erupted in a comprehensive manner on Wall Street, there was some premature triumphalism among Indian policymakers and media persons. It was argued that India would be relatively immune to this crisis, because of the "strong fundamentals" of the economy and the supposedly well-regulated Banking System. This argument was emphasized by the Finance Minister and others even when other developing countries in Asia clearly experienced significant negative impact, through transmission of stock effects have been most marked among those developing countries where the foreign ownership of banks is already well advanced, and when US-style financial sectors with the merging of banking and investment functions have been created. If India is not in the same position, it is not to the credit of our policymakers, who had in fact wanted to go along the same route. Indeed, for some time now there have been complaints that these "necessary" reforms which would "modernize" the financial sector have been held up because of opposition from the left parties. But even though we are slightly better protected from financial meltdown, largely

because of the still large role of the Nationalized Banks and other controls on domestic finance, there is certainly little room for gratification.

References: 1. World Bank Global monitoring Report 2009: A Development Emergency, Washington DC 2. Word Bank (2008) - "Global Development Finance 2008" 3. Rakesh Mohan-"Coping with liquidity management in India. A practioners view" 4. "Development of financial markets in India" RBI Bulletin - 2008 5. "Supplement to RBI Bulletin, September - 2011" 6. "Ghosal SN (2009) "Global Financial Crisis - cause and Impact" Icfai Reader, Mar 2009. 7. IMF (2008)"Global Finacial stability Report." October 2008. 8. Singh Dhananjay (2009) " Global Financial Crisis - positive for India," Icfai Reader, Jan 2009. 9. Word Bank (2009)" Global Development Finance 2009,"June. 10. Global Financial Crisis - Jayanti Ghosh 11. www rbi.org 12. www.wordbank.org. 13. www.imf.org. 14. www.recession.org. 15. IMF, "World Economic outlook"' April & October - 2009 16. www.wikipedia.org.