Defects of Indian Banking System (With Suggestions)

In this article we will discuss about the defects of Indian banking system with suggestions to improve it.

Defects of Indian Banking System:

Despite the tremendous progress made by Indian commercial banks during the last two decades, they are still faced with a number of problems which are as under:

1. Low Profitability:

Banks in India have low profitability. Irregularities and corruption in lending operations, misappropriation, frauds, rising operating costs, etc. have led to decline in their profitability. During 1992-93 and 1993-94, scheduled commercial banks incurred a net loss of Rs. 4,150 crores and Rs. 3,625 crores respectively. But in 2002-03 they earned a net profit of Rs. 17,077 crores.

2. Growing Non-Performing Assets:

The non-performing assets of Indian commercial banks have been growing rapidly.

Non-performing assets consist of:

(i) Debts recalled,

(ii) Suit-filed accounts i.e. where legal action or recovery proceedings have been initiated,

(iii) Decreed debts i.e. where suits have been filed and decrees obtained; and

(iv) Debts classified as bad and doubtful.

In the case of public sector banks ending March 2003 non-performing assets accounted for 9.36 per cent of their gross advances.

3. Low Capital Base:

The capital base of Indian banks in India was very low and not uniform. In the case of 28 public sector banks, the capital base was the same as at the time of their nationalisation. For Private sector banks, the required capital was linked to their geographical location while foreign banks operating in India were required to have foreign funds equivalent to 3.5 per cent of the deposits deployed in Indian business as at the end of each year. As a measure of capital adequacy, there was no weighted risk-asset ratio system for banks in India till March, 1993. There were 2 commercial banks with a ratio of less than 9% in 2002 – 03.

4. Window-Dressing of Balance Sheets:

Despite compulsory audit of banks, many banks indulge in window- dressing of their balance sheets. They artificially, increase their deposits in the last week of the fiscal year.

5. Favouritism in Advancing Loans:

Some banks favour certain companies in advancing loans. This is not only in the case of public sector banks. Often such loans turn into bad debts, thereby weakening the financial position of the concerned banks.

6. Bad Quality of Loan Portfolios:

The quality of loan portfolios of a number of banks is very bad. Often, they advance loans under extraneous (or political) pressures. They extend letters of credit and guarantee limits as a routine affair without adopting commercial procedure in granting loans.

7. Indulge in Share Speculation:

Many banks indulge in share speculation, thereby misutilising public deposits. A number of public sector banks and their subsidiaries in the form of mutual funds have been found to be involved in share speculation. The recent securities scam involving Harshad Mehta and other brokers revealed the role of a number of public and private sector banks in the entire episode.

8. Irregularities in Maintaining Accounts:

Many banks resort to large scale irregularities in operating their accounts. Often, bad accounts of one bank have been taken over by the other bank without proper scrutiny.

9. Banks as Sick Units:

As a corollary to the above, many banks operate as sick units. Consequently, they are amalgamated, dissolved or liquidated. During 1985-91, ten banks were amalgamated. As on 30 June, 1991, three banks were dissolved. New Bank of India became so sick that it was merged with Punjab National Bank in 1993. Even during 1999-2000, three nationalised banks were sick.

10. Social Banking Inadequate:

Despite the fact that a number of schemes have been in operation to help the weaker sections of Indian society, banks mainly cater to the needs of the corporate sector. For instance, bank credit to medium and large scale industry was 33.7 per cent in 1999-2000 to agriculture 9.5 per cent, to small scale industries 8.7 per cent and to trade 5.7 per cent.

11. Dual Control:

The Indian banking system suffers from dual control of the Government and Reserve Bank. It is over-regulated and over-administered. The credit decisions in individual cases and matters pertaining to internal management have been subjected to excessive administrative and political pressures and interferences. The investing and lending programmes are directed from above. So are the appointments of chief executives and directors.

Suggestions to Improve Working: Narasimham Committee Report:

From time to time, a number of committees have suggested measures to improve the working of the’ Indian banking system. However, we give a summary of the recommendations of the Narasimham Committee of 1991.

1. Structure of the banking sector should be revamped so as to have 3 or 4 large banks which could become international in character.

2. Eight to ten national banks with a network of branches throughout the country should be engaged in universal banking.

3. Local bank operations should be confined to a specific region.

4. Rural banks, including RRBs, should operate only in rural areas and their business should be predominantly to engage in financing of agriculture and allied activities, but based on profitability considerations.

5. One or more rural banking subsidiaries by each public sector bank should be set up to take over all its rural branches.

6. RRBs should be allowed to engage in all types of banking business.

7. Abolition of branch licensing and opening or closing of branches should be left to the individual banks.

8. Foreign banks should be permitted to open offices in India as branches or as subsidiaries.

9. Foreign banks should be subject to the same requirements as applicable to Indian banks.

10. Foreign operations of Indian banks should be rationalised.

11. Computerisation of bank operations needs to be stepped up.

12. No need to set up a banking commission.

13. Individual banks should be permitted to recruit officers.

14. Inspection by supervisory staff should be based on the internal audit and internal inspection reports.

15. Duality of control over the banking system between the RBI and the Banking Division of the Ministry of Finance should end, and the RBI should be the primary agency for regulation of the banking system.

16. To perform supervisory function over the banks and other financial institutions, there should be a separate authority to operate as a quasi-autonomous body under the aegis of the Reserve Bank.

17. Appointment of chief executives of the banks and directors should be depoliticised.

18. SLR requirements of banks should be brought down to 25 per cent over a period of five years.

19. CRR should be progressively reduced.

20. Directed credit programmes should be phased out.

21. The priority sector should be redefined.

22. There should be deregulation of interest rate so as to reflect emerging market trends.

23. The commercial banks should achieve a minimum 4 per cent capital adequacy ratio in relation to risk weighted assets by March, 1993.

24. Banks should adopt uniform accounting practices

25. They should impart transparency to balance sheets and make full disclosure in them.

26. Government should set up Special Tribunals to speed up the process of recovery of loans.

27. An Assets Reconstruction Fund (ARF) should be established to take over from basks and financial institutions a portion of their bad and doubtful debts at a discount

The recommendations of the Narasimham Committee would have far reaching implications on the working of the banking system. They have not yet been implemented except in the case of reduction of SLR.