The Legal Analyst ISSN: 2231-5594 Volume 1, 2011, pp.

92-99

THE NEXT FINANCIAL CRISIS: CONCERN FOR THE INDIAN BANKS

Nidhi Singh* and Rosy Tripathy*
Abstract: The housing bubble failed terribly and affected the banks and financial institutions world over. The G 20 leaders asked the Basel Committee to come up with new mechanism to prevent another such financial crisis in future. The recent Basel III norms aim to strengthen the present global banking system. The Indian Economy was not that grossly affected due to the crisis, however its i mpact cannot be underestimated. The author in this paper concentrates mainly on the role of the Indian Banking Industry to prevent any future crisis. The non-performing assets are on the rise and the bankers predict that the situation may be out of hand anytime. The first part o f the article begins with an introduction and discusses the U.S sub -prime crisis and its impact on India. The second part gives an overview of the Indian Banking system with respect to its performa nce in the Indian Capital Market. In the third part the author discusses the future threats that the Indian Banks might be exposed to. The fourth part moves on to analyze the NPAs o f the Indian Banking system. In the fi fth part, the author has discussed securitisation and highlights the scheme of the Act. Towards the end, the role of RBI and the Government of India in keeping the Indian Banking industry insulated and lessons that Indian Banks can draw in the after math of US sub prime crisis has been discussed. Key Words: RBI, Securitisation, Financial Crisis.

Introduction: The importance of finance in any economy can never be underestimated. Money is a medium of transaction that enables allocation of other resources in the economy. There is also a need to monitor the balance between proper quality and quantity of finance available in the economy. It is due to this imbalance that the US sub prime crisis leads to financial crisis in US and with impact on the rest of the world. The entire global economy suffered due to this, the reason being the full convertibility of the USD and large-scale participation by the Financial Institutional Investors in the US markets. The sub-prime lenders like New Century Financial Corporation (March 2007), Accredited Home Lenders Holding, WMC Mortgage of General Electric (July 2007), Countrywide Financial (Aug 2007) had to face crisis due to higher readjustments of floating rate interest rates.1 Bear Sterns (May 2007), Investments funds of BNP Paribas (Aug 2007) were equally affected.2 Investment Banks like Goldman Sacs, Merrill Lynch, Morgan Stanley also had to write off in Billions of dollar. Banks such as Northern Rock, Citibank, Macquarie, UBS were also badly impacted. 3 The economic meltdown peaked with the bankruptcy of 158 years old US Investment Bank Lehman Brothers in September 2008 that had secured creditors of $75 billion and the volume of unsecured creditors was as high as $200 billion. Moreover the acquisition of Merrill Lynch by Bank of America and Financial crisis of American International Group (AIG) has shaken the entire financial world. 4 The US Federal Reserve had to rescue financial giants like Citigroup, American International Group (AIG), etc and subsequently, to prevent a financial collapse it had to pump in $1 trillion. The European Central Bank (ECB), Bank of Canada, Bank of Japan, Reserve Bank of Australia and Bank of England similarly took steps to inject funds into the market and break the Financial Crisis. The recent financial crisis in developed economies is attributed to the credit crunch and features of a free market economy. 5
*4 th year, B.B .A. LL.B. (Hons.) and B.A. LL.B . (Hons.), KIIT Law School, Bhubanes war, INDIA.
BBC News, Sharp decline in US house sales, 24 th April 2007, available at http://news.bbc.co.uk/2/hi/business/6588789.stm Financial Crisis 2007, 19 th September 2008, available at http://www.financialcrisis2007.com/?tag=fund-redemption 3 E-execute, Headlines 2nd half of January 2008, 28th January, 2008 available at http://www.e-execute.com/postmovement/299/ 4 Jeffrey N. Gordon and Christopher M uller, Avoiding Eight -Alarm Fires in the Political Economy of Systemic Risk M anagement, February 12th 2010, available at https://editorialexpress.com/cgibin/conference/download.cgi?db_name=ALEA2010&paper_id=386 5 A. Sharma, Incomplete reform or opportunity: the role of the banking sector in the credit transmission mechanism in India, vol. 11(4) Journal of Economic Policy Reform 2008.
1 2

2011]

THE NEXT FINANCIAL CRISIS

93

______________________________________________________________________________
The Present Indian Banking System: In the after math of financial crisis, banks, banking and bankers have become very public conscious. Banks all over the world have become aware and they are re-looking into their internal management and policies. At the international level, twenty-seven countries met in the Swiss town of Basel in September 2010 to agree to tougher bank capital and liquidity standards.6 Indias low dependence on exports helped to overcome this global economic downturn better than other countries. However, even to this, the Indian Prime Minister Mr. Manmohan Singh established a Cabinetlevel committee to evaluate the effect of the financial crisis on Indias economy and industries. This follows the November 2, 2009 when Indian and Pakistani Central banks actions to boost liquidity. India cut its short- term lending rate by 50 basis points to 7.5% and reduced its cash reserve ratio by 100 basis points to 5.5%.7 Apart from the fact that the Indian banks were least hit by the financial crisis, does not give them a reason to relax, rather learn from the lessons of the financial crisis. In the fast-changing financial world, everybody is subjected risk; therefore there is a need that we adapt to the best global practices in risk management in the Indian context. The Indian Banks resilience power during the financial crisis may be due to strength they had acquired from various structural reforms since 1991. The role of Reserve Bank of India as a banking regulator and supervisor helped the Indian banks overcome the crisis so safely. The strength of the Indian banks lies in satisfactory capital adequacy ratio and partly to their greater exposure to conventional domestic assets rather than unconventional products like sub-prime mortgages.8 FICCI recently conducted a survey on the Indian Banking Industry to assess the competitive advantage offered by the banking sector, as well as the policies and structures that are required to further the pace of growth. 9 Most of the respondents were positive with regard to the growth rate attainable by the Indian banking industry for the year 2009-10 and 2014-15, with 53.33% of the view that growth would be between 15-20% for the year 2009-10 and greater than 20% for 2014-15. 10

Figure 1: Projected Growth for the Indian Banks

As per a Press Release of CRISIL, it was stated that the quality of Indian banks assets is likely to deteriorate over the next two years. This will be driven by the slowdown in the economy, and by the aging of loans made in recent years: banking sector advances have grown roughly four-fold over the past seven years, to an estimated Rs.27.7 trillion. CRISIL projects that, by end-March 2011, the sectors gross non-performing assets (GNPAs) will increase to around 5 per cent of its advances, from 2.3 per cent at end-March 2008; in absolute terms, this will mean a tripling of NPAs to Rs.1.9 trillion. 11 Nevertheless,
The Financial Express, All about Basel III Norms, September 11, 2010, available http://www.financialexpress.com/news/all-about-basel-iii-norms/680123/0 7 Dick K. Nanto, The Global Financial Crisis: Analysis and Policy Implications, October 2, 2009, available http://www.fas.org/sgp/crs/misc/RL34742.pdf 8 Rupa Rege Nitsure, Basel III & Indian Banks, November 2010, available http://www.medcindia.org/Digest/nov/Rupa%20rege.pdf 9 FICCI Report Annual Survey, Indian Banking System: The Current State & Road Ahead, February, 2010, available http://indiainbusiness.nic.in/studies_survey/banking_systemsurvey.pdf 10 Ibid at 5 11 The sticky assets in the corporate sector will, therefore, go from 1.6% to 4.1% by 2011, while retail NPAs will go from 3.2%
6

at at at at

to

94

THE LEGAL ANALYST

[Vol. I

______________________________________________________________________________
CRISIL believes that the banking sectors strong capitalisation will allow it to comfortably absorb the effect of the increased NPAs. 12 The report projected that the Indian banks are strongly capitalized to cushion the impact of higher Non-performing assets. It is due to the increase in the banks net worth over the past ten years, the capital coverage for the NPAs. This provides for the sufficient coverage for losses that might arise due to NPAs. Further as reported by Financial express, the biggest increase in NPAs will happen in most vulnerable sectors such as real estate and textiles, as 17% of the total credit growth has gone to these sectors. Almost 78% of bank lending has gone to medium-risk sectors and 5% to low-risk sectors. The most stressed sectors in the economy today are real estate, textiles, gems and jewelry, chemical and auto ancillaries. Least stressed sectors include pharmaceuticals, healthcare, power, FMCG and telecom. Little less than the least stressed would be banking.13 There has been significant increase in the NPAs as projected by CRISIL in 2009. 14 It is for this reason that banks in South India have already started to recruit retired bank officials for the recovery of NPAs for a prescribed fee. They have plans to appoint one such recovery officer for recovery of hundred accounts in each zone. The bank has decided to pay a fee of five percent of the recovered amount for unsecured advances and three percent of the recovered amount for secured advances.15 Challenges to the Current Banking System: There are many organizations, which have studied the Indian Banking scenario. The parameters to test the efficiency of the banks have been raised in the back drop of stiff competition in the market. According to a McKinsey Report on Indian Banking in 2010, four challenges must be addressed before success can be achieved. 16 Firstly, the market is witnessing discontinuous growth pattern in terms of introduction of new products and services that include opportunities in credit cards, consumer finance and wealth management on the retail side. All these activities require proficient sales and marketing and credit operations. Secondly, the weaker banks are likely to be more exposed due to the unavailability of windfall treasury gains that t hey used to get almost a decade ago in the form of declined interest rates. Thirdly, the increase in the rate of interest in India can only lead to stiff competition from the foreign banks. Lastly, the demographic shifts like changes in age profile and household income, consumers shall increasingly demand for better services and institutional set-up. Further Dr. Duvvuri Subbarao, Governor, Reserve Bank of India at BANCON 2010 in Mumbai on December 3, 2010 addressed the challenges to the Indian Banking sector at length. Some of the discussions are summarized as below:17 Preparedness to implement the Basel III norms: The Reserve Bank had issued detailed guidelines on implementation of the Basel II framework covering all the three pillars with the guidelines on Pillar II being issued as recently as on March 27, 2008 in the aftermath of the financial crisis. 18 As already mentioned above the Basel III norms calls for better quality capital, an internationally harmonized leverage ratio to constrain excessive risk taking, sound capital buffers to be used at the times of stress,
4.7%. However agri-NPAs will go from 3.2% to 6.1% and the NPAs in small sector industry (SSI) will see the maximum rise, from 3.1% to 10% by M arch 2011. Sourced from The Financial Express dated June 1, 2009, available at http://www.financialexpress.com/news/rise-in-npas-to-spoil-revival-crisil/468967/0 12 CRISIL Press Release, Bank non-performing assets to triple by 2011, but wont endanger banking sector, says CRISIL, April 23rd, 2009 available at http://www.banknetindia.com/banking/90419.htm 13 The Financial Express, Rise in NPAs to spoil revival: Crisis, June 1, 2009, available at http://www.financialexpress.com/news/rise-in-npas-to-spoil-revival-crisil/468967/0 14 The Indian Bank saw its gross NPA rise by 46 percent during the nine-month period ended December, 2010 to Rs. 752 crore (1.02 percent). The net NPA of the bank saw a three-fold rise to Rs. 417 crore in the period April-December 2010 against Rs. 89.73 crore in the period April-December 2009. Sourced from http://www.mydigitalfc.com/news/indian-bank-employ-retiredstaff-cut-npa-771 15 R. Srividhya, Indian Bank to employ retired staff to cut NPA, M arch 16 th, 2011, available at http://www.mydigitalfc.com/news/indian-bank-employ-retired-staff-cut-npa-771 16 M cKinsey & Company, Indian Banking 2010, Towards a High-Performing Sector, 2010, available at http://www.mckinsey.com/locations/india/mckinseyonindia/pdf/india_banking_2010.pdf 17 Inaugural Address by Duvvuri Subbarao, Governor, RBI, Five Frontier Issues in Indian Banking, December 3 rd, 2010, available at http://rbidocs.rbi.org.in/rdocs/Bulletin/PDFs/FBULL12112011.pdf 18 Rakesh M ohan, Global Financial Crisis and Key Risks: Impact on India and Asia, October 9 th, 2008 available at http://rbidocs.rbi.org.in/rdocs/Speeches/PDFs/87784.pdf

2011]

THE NEXT FINANCIAL CRISIS

95

______________________________________________________________________________
minimum global liquidity standards and stronger standards for supervision, public disclosure and risk management. With regards to the capital, the Indian Banks need not worry about adjusting to the new capital rules both in terms of quality and quantity. The table below gives a brief of estimates of capital ratios of the banking system after taking into account the regulatory adjustments under Basel III norms. The leverage in the Indian Banking system is quite moderate and the Statutory Liquidity Ratios of our banks are also included in computing the leverage ratio, therefore it is not expected that the Indian Banks will have to face much problems in meeting the leverage ratio requirement. Considering the liquidity standards, it cannot be ignored that our financial markets have not experienced the level of stress that advanced country markets have. Therefore, a complex market scenario will have its own repercussions and the kind of judgments to be made. Further, the Governor pointed out that the Indian Banks follow a retail business model and have limited dependence on short term or overnight wholesale. They also have large amount of liquid assets to enable them to meet the new standards. The SLR should also be taken into account as these are government bonds against which the Central Bank provides liquidity. The author comes to the conclusion that in the above scenario, the Indian Banks are very well positioned to meet the Basel III norms. There are few challenges, which might come up in the implementation of the new capital norms like up gradation of risk management systems and there shall be a challenge of learning to make complex judgment calls. Most importantly, there will be the challenge of meeting the credit needs of a rapidly growing economy even while adjusting to a more demanding regulatory regime. Indian Banks Going Global: How much Feasible? The Narasimhan (II) Committee on Banking Sector Reforms had envisaged a three-tier structure for the Indian banking sector: 3 or 4 large banks having an international presence on the top, 8-10 mid-sized banks, with a network of branches throughout the country and engaged in universal banking, In the middle, and local banks and regional rural banks operating in smaller regions forming the bottom layer. However, the Indian banking system has not consolidated in the manner envisioned by the Narasimham Committee. The current structure is that India has 81 scheduled commercial banks of which 26 are public sector banks, 21 are private sector banks and 34 are foreign banks. 19 Even a quick review would reveal that there is no segmentation in the banking structure along the lines of Narasimham II. The Reserve Bank of India has continuously pointed out that such procedures should be market-driven, based on profitability considerations and through Mergers and Amalgamations (M&As). The RBIs role can only be that of a facilitator as the honest and sincere efforts has to come from the Board of the respective Banks as per their business models. Mergers can indeed lead to a synergy of better risk management, international acceptance and recognition and improvement in financials due to economies of scale and scope. However this can even fail if there is lack of synergy and coherence between the business models of two banks amalgamating. If we look at the figures released by the current global league tables on the basis of size of assets, our largest bank, the State Bank of India (SBI), together with its subsidiaries, comes in at No.74 followed by ICICI Bank at No.145 and Bank of Baroda at 188. 20 It can be very well inferred from these figures that any of our banks are even likely to be in the top ten of the global league. We cannot directly go global with the only presumption that there is a strong global presence already being felt for the Indian Banks. It should rather take a middle path and work on both-internal as well as external policies to build a sound banking structure. They need to lay the footprints globally opportunistically even if it does not get the top
Bank for International Settlements, Central Bankers Speeches, December, 2010 available at http://www.bis.org/review/r101207b.pdf 20 India Infoline News Service, Indian banks should adopt best global practices, January, 2011 available at http://www.indiainfoline.com/M arkets/News/Indian-banks-should-adopt-best-global-practices-D.-Subbarao/5010464459
19

96

THE LEGAL ANALYST

[Vol. I

______________________________________________________________________________
of the league table. Should we mandate Foreign Banks to come in only as subsidiaries? In 2005, the Reserve Bank of India allowed foreign banks the option of coming either as a branch or as a subsidiary, but not both at the same time.21 Even so, all foreign banks have so far opted to come in only in the branch mode. There are currently 34 foreign banks operating in India with a total of 315 branches and they account for about 7.2 per cent of the total assets of scheduled commercial banks. 22 A possible downside risk of foreign banks is that it will dominate the domestic banking system. This could have systemic implications during normal times, which would amplify in times of crisis. Further mandatory subsidization may not be that wise call as it is not the correct manner of protecting the domestic interests. The reason being that foreign banks facing a crisis at home could very well abandon their subsidiaries. Need to Rewrite the Laws governing the Banking Sector: There is a wide array of laws governing the Banking sector, which have helped in maintaining a robust banking system in India. The nationalized banks are governed by the Banking Companies (Acquis ition and Transfer of Undertaking) Acts of 1970 and 1980. Their respective statutes govern the State Bank of India and its subsidiaries. Private sector banks come under the purview of the Companies Act, 1956 and the Banking Regulation Act, 1949. Foreign banks, which have registered their documents with the registrar under Section 592 of the Companies Act, are also banking companies under the Banking Regulation Act. Certain provisions of the Banking Regulation Act have been made applicable to public sector banks. Similarly, some provisions of the RBI Act too are applicable to nationalized banks, SBI and its subsidiaries, private sector banks and foreign banks. The Banking Regulation Act, 1949 was passed to consolidate and amend the law relating to banking companies. The instant law has stood the test of time even during crisis. Few provisions like minimum paid up capital and reserves, restrictions on payment of dividend, transfer of a percentage of profits to reserves, maintenance of SLR, restrictions on connected lending, maintaining a percentage of domestic liabilities as assets in India have all helped the Reserve Bank in preventing crises and maintaining financial stability. Still, the need to amend the laws with changing times cannot be ignored. The above statutes were crafted reflecting the needs of that time. Therefore considering the fast changing dynamic financial world, laws need to be amended at a similar pace to cope with any future threats. Firstly, there is a need to create a same level playing field for all the Banks as their respective statutes govern all the Banks. 23 Secondly, a consolidated legislation governing all the Banks can lead to better transparency, comprehensive and clarity. Thirdly, there are primarily two sets of laws governing the Banking sector namely Banking Regulation Act and other ancillary laws applicable to this sector. Further the newly enacted Competition Amendment Act, 2007 has certain provisions under Section 5 and 6 regulating combinations. These provisions are inconsistent with the provisions under the Banking Regulation Act governing amalgamations. Such inconsistencies need to be re-looked into to review the Banking Laws. In the aftermath of the financial crisis there is a need of convergence of Indian Accounting Standards with International Financial Reporting Standards (IFRS), which shall empower the Reserve Bank of India for consolidated supervision. There has been ongoing debate with regard to this since 2007. 24 The new regulations to be crafted must reflect lessons from the crisis must have a futuristic perspective and must have the capability to maintain financial stability in a complex globalized financial system. The Finance Minister in order to strengthen transparency and public accountability proposed to set up a Financial Sector Reforms Commission addressing that most of our legislations governing the financial sector are
Sustainability of Foreign Banks in India- A Statistical Analysis, December, 2005 available http://www.scribd.com/doc/13141905/Foreign-Banks-in-India-2005 22 The Indian Express, Subsidiary route ideal for foreign banks: RBI governor, December 4 th, 2010 available http://www.indianexpress.com/news/subsidiary-route-ideal-for-foreign-banks-rb/720242/ 23 Taxmann, RBI Governor Calls for Review of Banking Laws, available http://www.taxmann.com/fileopener.aspx?stype=4&newsid=2357 24 The Business Standard, India should adopt IFRS without changes: Ernst & Young, September 3rd, 2009 available http://www.business-standard.com/india/news/india-should-adopt-ifrs-without-changes-ernstyoung/72573/on
21

at at at at

2011]

THE NEXT FINANCIAL CRISIS

97

______________________________________________________________________________
very old. Therefore the job of this Commission should be to revamp the financial sector laws and bring them in consonance with the requirements of the sector.25 It is not completely true if we say that we were not affected at all due to the global crisis as it showed its impact on the overall growth of the economy affecting the poor people at large. The graph below shows the trend in Capital flows into the economy and has been considerably stable but indeed there has been reduction in few components. 26

Figure 2: Trends in Capital Flows

Non-Performing Assets with the Indian Banks: NPAs are indicative of the performance of banks. An increase in NPA indicates large loan defaults and as a result affects the net profitability of the banks. Rising NPAs can also be a threat to the banking sector. Past trends show that the growth in NPA has been more than in the growth in credit. Post nationalization, the banks were expected to increase the credit availability to the rural sector, which it achieved successfully. Since the early 1990s the focus has shifted towards improving quality of assets and better risk management. The Narismha Committee further helped in tightening of the prudential norms and hence led to the change of classification of an NPA. When a borrower, who is under a liability to pay to secured creditors, makes any default in repayment of secured debt or any installment thereof, the account of borrower is classified as non performing assets (NPA). NPAs cannot be used for any productive purposes because they reflect the application of scarce capital and credit funds. Continued growth in NPA threatens the repayment capacity of the banks and erodes the confidence reposed by them in the banks. The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 under Section 2 (o) defines a non-performing asset as an asset or account of a borrower, which has been classified by a bank or financial institution as sub-standard, doubtful or loss asset, (a) In case such bank or financial institution is administered or regulated by any authority or body established, constituted or appointed by any law for the time being in force, in accordance with the directions or guidelines relating to assets classifications issued by such authority or body; (b) In any other case, in accordance with the directions or guidelines relating to assets classifications issued by the Reserve Bank; The above definition makes it evident that any asset of a borrower has been knowingly been incorporated by the legislature and the term cannot be restricted to mean only an account of a borrower

Budget 2010-2011, Speech of Pranab M ukherjee, February 26 th, 2010, available at http://indiabudget.nic.in/ub201011/bs/speecha.htm 26 Supra note 19
25

98

THE LEGAL ANALYST

[Vol. I

______________________________________________________________________________
under all situation. 27 Rising NPAs are indeed a challenge to the banking sector. The problem India faces is not lack of strict prudential norms rather 1. The legal impediments and time consuming nature of asset disposal process. 2. Postponement of the problem in order to report higher earnings 3. Manipulation by the debtors using political influence. 28 Today laws passed for the creation of Asset management companies, foreign equity participation in securitisation and asset backed securitisation favor the banks in the recovery of assets. As we already know that NPAs do not generate income as such for the banks rather have an adverse impact on them. It also disturbs the capital adequacy ratio and economic value addition of the banks. Very recently the Supreme Court set aside a Gujarat High Court order that prohibited banks from transferring debts, including non-performing assets, to one another. It was held that the transfer of debts between banks is legal and the Banking Services Regulation Act allows this activity. 29 Securitisation in India: The SARFESI Act, 2002 was passed with an aim to provide a structured platform to the Banking sector for better management of non performing assets, allow banks to take possession of securities and sell them. This Act ensures financial discipline and control in respect of the rights and obligations of the players. Debt or asset securitisation is one of the latest techniques in the financial market. Under asset securitisation, a financial institution pools and packages individual loans and receivables, creates securities against them, gets them rated and sells them to investors in a market.30 The Honble Supreme Court of India, in the case of Mardia Chemicals Ltd. and Others v. Union of India and Others31 upheld the validity of the Act except that of sub-section (2) of section 17 which was declared ultra vires Article 14 of the Constitution. In view of the above judgment of the Honble Supreme Court and also to discourage the borrowers to postpone the repayment of their dues and also enable the secure creditors to speedily recover their debts, if required by enforcement of security or other measures specified in sub-section 4 of section 13 of the said Act, it had become necessary to amend the provisions of the said Act. Since the Parliament was not in session and it was necessary to take immediate action to amend the said Act for the above reasons, the Enforcement of Security Interest and Recovery of Debts Laws (Amendment) Ordinance 2004, was promulgated on the 11th November, 2004. The said Ordinance amends the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, the Recovery of Debts Due to Banks and Financial Institutions Act, 1993 and the Companies Act, 1956. 32 The instant Act was not the first measure taken by the Indian government; there have been several ad-hoc measures to cure the sickness among the financial institutions. The Act has made provisions for registration and regulation of securitisation compan ies or reconstruction companies by the RBI, facilitate securitisation of financial assets of banks, empower SCs/ARCs to raise funds by issuing security receipts to qualified institutional buyers (QIBs), empowering banks and FIs to take possession of securities given for financial assistance and sell or lease the same to take over management in the event of default. The Act provides for alternative methods for recovery of NPAs, namely Securitisation and Asset Reconstruction. 33 The Reserve Bank of India issued guidelines and directions relating to registration, measures of ARCs,
Narendra Sharma, Non Performing Asset, M arch 4 th, 2011 available at http://www.lawyersclubindia.com/articles/NonPerforming-Asset-NPA--3546.asp 28 Prashanth K Reddy, A comparative study of Non Performing Assets in India in the Global context - similarities and dissimilarities, remedial measures, October 2002, available at http://unpan1.un.org/intradoc/groups/public/documents/apcity/unpan013132.pdf 29 The Economic Times, SC sets aside High Court order on transfer of debts between banks, September 30 th, 2010 available at http://articles.economictimes.indiatimes.com/2010-09-30/news/27576354_1_gujarat-high-court-sc-sets-npas 30 M .L. Tannan, Banking Law and Practice in India. 23 rd edition, (Nagpur: LexisNexis Butterworths Wadhwa2010), , at 20152016 31 Mardia Chemicals Ltd. v. Union of India, (2004) 120 Comp. Cas. 373 (SC): 2004 2 BC 397 (SC): 2004 2 SLT 991 relied in Nahar Industrial Enterprises Ltd. v. Hong Kong & Shanghai Banking Corporation, (2009) 3 BC 539 (SC) 32 Ibid at 2019 33 SARFESI Act, 2002: An Assessment, available at http://www.dnb.co.in/Arcil2008/SARFAESI.asp
27

2011]

THE NEXT FINANCIAL CRISIS

99

______________________________________________________________________________
functions of the company, prudential norms, acquisition of financial assets and related matters under the powers conferred by the SARFAESI Act, 2002 under The Securitisation Companies and Reconstruction Companies (Reserve Bank) Guidelines and Directions, 2003. 34 Concluding Observation: The best solution to the problem of NPAs seems only proper credit assessment and risk management mechanism. The prudential norms definitely help in minimizing the risk of NPAs. Further, there is a need for increasing the proficiency of the internal management of the banks to do a proper assessment of credit worthiness. In the aftermath of the financial crisis, with its origin in the sub-prime mortgage crisis in the U.S. has led to a more conservative attitude amongst the banks in their lending business. As already discussed above, the Reserve Bank of India acted promptly during the crisis to help the Indian banks maintain their liquidity. As per the FICCI Report35 92% of the participants firmly concur with recent stress test results that Indian banks have the ability to absorb twice the amount of their current NPA levels. Credit information bureaus are very important for the measurement of asset quality. Further the challenges to the Indian Banks in terms of implementation of Basel III should not be of much problem as the liquidity and capital adequacy ratio for the Indian banks is sound enough to adjust to the new capital market norms. Consolidation has its both positive and negative implications. The challenges in the process of consolidation may be dilution of management control, credit quality concerns, regulatory issues, cultural issues and Human Resources Development issues. The need to revamp the laws governing the financial sector as emphasized in the last years budget session need to speed up so that we are well equipped to prevent any financial crisis if likely to hit India. Even the bank management must fundamentally strengthen institutional skill levels especially in sales and marketing, service operations, risk management and the overall organization performance ethics. India has mostly been spared of the global meltdown for various reasons as discussed in the previous sections. The growth of the economy is basically domestically controlled. The current prudential norms prevent the banks from excessive risk taking. However, this does not give a reason to the Indian regulators to relax as there are many other challenges to the Indian Banking system, non-performing asset being one of them. There is no mathematical formula to solve the problem of financial crisis; still the need to restructure the strategies of the banks is an imperative. India is a growing economy, which is now on its way to integration with the world economy. This means that the export route is going to open up which shall lead to flow of more income into the economy. This shall be a major concern for the Indian banks if they are not equipped with adequate laws, policies and regulations. The more opening of the economy shall subject it to more risks; therefore even India can be a victim of such crisis in future. With the current laws in place, it is just not enough to fight the crisis situation. Thus, it is a concern for the Indian Banks to re-look into the entire financial system to match the international standards. There is a need for a well-articulated policy especially with regard to Bankruptcy Laws as banks are the first set of institutions affected during financial crisis.

The Reserve Bank of India, Income Recognition, asset classification and provisioning norms for advances, Circular No: DBOD.BP.BC. 132 / 21.04.048/ 2000-2001, June 14th, 2001 available at http://rbi.org.in/scripts/NotificationUser.aspx?Id=412&M ode=0 35 Supra note 11
34