Academic journal article Political Economy Journal of India

Prediction and Policy Implications of Commercial Banks in India

Academic journal article Political Economy Journal of India

Prediction and Policy Implications of Commercial Banks in India

Article excerpt

Introduction

An important component of financial planning is the forecasting of profitability. This requires not only an insight into the industry-specific variables but also involves a study of the impact of changing economic conditions, on the industry, since each industry has its unique characteristics and a unique way to react to external environment. It is generally seen that with the introduction of economic liberalization, privatization and globalization, the Indian financial market has undergone structural changes. Similarly, the role of banking sector has changed dramatically. Risk management has become an integral part of the strategic planning process of the bankers as both, the expected and unexpected events may have an adverse impact on the bank's capital and earnings. While the expected losses are generally taken care of by a suitable pricing methodology, the unexpected losses, on account of individual exposure and the whole portfolio in entirety are to be borne by the bank itself and hence are to be taken care of by the existing requisite capital. There is thus the need for a suitable capital structure and sufficient Capital Adequacy requirements.

Capital is essential and critical to the perpetual continuity of a bank. Hence, on the recommendations of the Narasimham Committee (1992), the Reserve Bank of India (RBI) introduced the internationally accepted Capital to Risk-Weighted Assets Ratio (CRAR), also called the Capital Adequacy Ratio (CAR), to be adopted in a phased manner by the Scheduled Commercial Banks operating in India. It may be pointed out that a higher amount of Non Performing Assets (NPAs) has adverse repercussions on working capital of the banks. As per Basel Committee norms, capital should be 8 percent of risk- weighted assets. Thus although the distribution base is increasing, we find profitability to be declining due to high NPAs. Accordingly, credibility of the banking system is affected and the general public loses confidence in the soundness of the system. NPAs not only affect the performance of the banks but also impact the economy as a whole.

In the Indian context, it has been observed that prior to the initiation of banking reforms in 1991; pre-emption of bank funds has been exercised through Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR). CRR plays a significant role as an instrument of credit control while SLR is mainly for the purpose of serving as a cushion to meet contingencies against potential liquidity threats to banking operations. But inspite of a CRR of 5.50 percent and a SLR of 24 percent, Government borrowings at subsidized rates implies an optimal utilization of the scarce resource, thus sending wrong signals that the comparative cost of capital is relatively less than the other countries of the world.

Inspite of the factors detrimental to the performance of all SCBs viz., priority sector lending, branch networking in rural and remote areas, overstaffing, and high percentage of NonPerforming Assets, the banking system in India seems to be unaffected by the global financial crisis of 2008 in the U.S and the European Countries. The resilience of the banking sector was marked by an improvement in the capital base, asset quality and profitability. The latter improved, both in terms of Return on Assets (RoA) and Return on Equity (RoE) resulting in a decline in gross and net NPAs. The strong economic growth in the recent past, low defaulter ratio, absence of complex financial products, regular intervention by the central bank, proactive adjustment of monetary policy and the so called conservative banking culture are some of the factors which have contributed to the safety of the Indian banks amidst the global financial turmoil. Accordingly, the Indian banks have gone in for stringent norms for credit disbursal and there is now more focus on analyzing a borrower's financial health rather than his capability.

Methodology

Keeping all the existing macro economic variables viz. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.