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Modi govt shows no urgency to reform financial sector even after biggest bank failure

India urgently needs legislation to tackle bad loans while allowing banks to fail without inducing system-wide panic. But no legislation is imminent.

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New Delhi: India’s messy banking system has long been a source of friction between the Prime Minister Narendra Modi’s government and the central bank. But even the collapse of the nation’s fourth-largest lender isn’t spurring any urgency to clean things up.

The 72.5 billion rupee ($980 million) rescue of Yes Bank Ltd. — the nation’s biggest-ever banking failure — has refocused attention on the Reserve Bank of India’s regulatory autonomy. While analysts have highlighted the need for the government to fast-track long-delayed legislation to tackle bad loans while allowing banks to fail without inducing system-wide panic, no legislation is imminent.

“The government will try to bring in some mechanism to resolve insolvencies and bankruptcies in financial institutions,“ said Gopal Krishna Agarwal, a spokesman for Modi’s ruling Bharatiya Janata Party, who defended the speed at which the Yes Bank crisis was resolved. Still, he said, new reforms “may not happen in the current parliamentary session.”

The central bank’s seizure of Yes Bank last week and sudden moratorium on cash withdrawals surprised depositors and investors alike. Although the RBI sought to confirm the safety of deposits by inviting the nation’s largest lender to make a confidence-building share purchase, the crisis shows the stress facing India’s financial system.

The economy is already set to decelerate to an 11-year low and the coronavirus outbreak threatens to delay a revival. There’s also rising investor discomfort over the government’s focus on its social agenda that’s caused widespread religious tensions at the expense of stoking economic growth amid a string of failures at banks and shadow lenders as stressed assets climbed to $190 billion — among the highest in the world.

Modi needs to resolve these legacy problems, including the fact that it’s not clear whether the government or the central bank holds the main responsibility for regulating the banks, according to N.R. Bhanumurthy, senior economist at New Delhi-based National Institute of Public Finance and Policy, who advises the government on economic policy.

“There needs to be a decision, once and for all, over who really supervises Indian banks — the government or the Reserve Bank of India,” said Bhanumurthy, noting that legally the RBI is still under the Ministry of Finance. “There is a need for a method in the way policy measures are taken. Banking regulation remains an issue.”

Also read: Coronavirus, Yes Bank failure, oil shock, slowdown – Indian economy has too many challenges

Blame Game

An earlier attempt to introduce a bill that would have allowed the sale of one bank to another and created a Resolution Corporation — similar to the Federal Deposit Insurance Corporation in the U.S. — to take over failing banks, was withdrawn in 2018 after facing opposition.

The tussle over reforms that started after former central bank governor Raghuram Rajan tried to get state lenders to recognize and provide for soured loans resulted in his resignation after just one term amid criticism from Modi’s allies for keeping lending rates too high and stifling growth. His successor, Urjit Patel, also clashed with the government over its demands to ease lending curbs on state-run banks and hand over more of the RBI’s capital to the state.

Patel abruptly quit before his first term had finished, shortly after raising the problem of dual regulation following a $2 billion fraud case at Punjab National Bank, one of the biggest state-run lenders.

Shaktikanta Das, one of the key officials helping to carry out Modi’s controversial cash ban in 2016, has taken a more conciliatory line since he was appointed governor in December 2018.

Rebuilding Trust

Finance Minister Nirmala Sitharaman last week said the exposure of Yes Bank to some stressed corporates occurred before the Modi government came to power. Yet even the BJP’s ideological partners agree that more needs to be done.

“The government has worked to improve the trust of people — they have done everything right in rescuing Yes Bank,” said Ashwani Mahajan, co-convenor of the Swadeshi Jagran Manch, affiliated to the ruling party’s ideological parent, the Rashtriya Swayamsevak Sangh. “But more needs to be done to improve trust. Because once trust is gone, it’s gone.” Mahajan says Modi has tried to resolve “legacy issues” but needs to strengthen state-run lenders.

Yet, while the government defends its handling of banking failures, foreign portfolio investors withdrew investments worth $1.8 billion from India in the first six days of March, BloombergQuint reported.

This is a good time to bring in a law to handle financial failure of banks to help restore investor faith, according to Suyash Rai, political economist at Carnegie India.

“They need to give a signal that they are serious about reforms — put in place legal provisions to handle insolvencies of banks and bring back the reforms lying on the back burner,” said Rai.

Also read: Everything you need to know about the Yes Bank collapse, rescue and prospects


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  1. Yes, fresh banking reforms are needed. IBC was a good start, but it is not end in itself. It amounts to treating a patient after he has been infected with COVID 19 virus. What is required is a preventive mechanism to ensure recurrence of such bank failures in future. These could include the following:
    (1) Banking is essentially a dull and boring business. There is no space for the spectacular things and superstars in banking. Such personalities quite often end up with fate of Ramesh Gelli, Rana Kapoor or their likes. If Yes Bank was growing at a breakneck speed of 35% per annum, it should be cause of suspicion and apprehension and not of celebration. Why RBI woke up so late is a moot point. RBI has to review its licensing policy. Banks should be institutionally backed and cannot be a creation of individuals.
    (2) There is a strong case for strengthening control of RBI on sanction of large loans given to big corporates. RBI should prepare list of big industrial groups whose performance or failure can impact the economy and strictly control and monitor indebtedness of these large groups. No bank should sanction loans to these groups individually and additions , if any, in their indebtedness should be informed to RBI. If necessary, RBI should go through appraisal notes of these loan proposals.
    (3) General Purpose Corporate Loans is a loan product that should be used sparingly. Terms have to project backed. Yes Bank is failed to the blatant misuse of these type loans to inflate their loan portfolio.

  2. When share holders approve for change of management and new owners take over, they inherit both good and bad legacies. The new management cannot simply take credit for good legacy, tweek it to make it better, they also should take care of bad ones and take steps to correct them instead of using as shield to cover up failures. The present government is using bad legacy as a shield to cover and use it to blame previous regime. On YES Bank, they are yet to explain hoe bad loans increased during their rule. It is fact all defaulters have contributed funds to ruling party.

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