Indian banks are currently walking a tightrope, balancing the need for credit expansion with the imperative of managing risk and ensuring operational efficiency. Recent news highlights the multi-pronged challenges confronting the banking sector, from mispricing credit risk to the need for greater transparency in internal operations like employee transfers.

Risk Mispricing Woes

The fundamental business of banking hinges on the ‘return journey’ of money lent out. As a recent analysis points out, banks, like airlines, reward round trips – in this case, loan repayments – but the calculation of this ‘reward’, or the interest rate, is proving increasingly complex and sometimes, dangerously flawed. The piece rightly notes past instances where banks have ‘grossly miscalculated credit risk premium’, often with detrimental consequences. This miscalculation isn’t merely an oversight; at times, it appears to be a wilful blindness to risk, leading to significant losses and write-offs when borrowers default. The article underscores the critical role of the regulatory ecosystem, including the Reserve Bank of India (RBI) and the legal framework like the Insolvency and Bankruptcy Code (IBC), in ensuring banks’ accountability and providing redressal mechanisms.

Regulatory Tightening

Recognising the need for banks to ‘learn good behaviour’, the RBI is pushing for stricter norms to ensure banks accurately price credit risk. This is not just about compliance; it is about the very sustainability of the banking sector. However, as the article suggests, banks are seemingly resistant, often ‘running to the government with concerns’ rather than embracing the necessary discipline. The piece also highlights the concerning trend in the microfinance sector, where lenders are repeating past mistakes by over-leveraging borrowers. The proposed limit on the number of loans per borrower by MFIN, the self-regulatory organisation, is a welcome step, but as Nomura analysts note, this may lead to ‘higher stress in the near term’ before bringing about long-term discipline.

Transparency in Transfers

Adding to the operational landscape, the Finance Ministry has issued guidelines aimed at improving transparency in transfer policies for public sector banks (PSBs). This move towards automating transfer processes and prioritising employee preferences, especially for women and officers within linguistic regions, is laudable. The directive to tag ‘Difficult Zones’ and offer transfer preferences for service in these areas also addresses a key concern for bank employees. The aim is clear: to foster fairness, boost employee satisfaction, and enhance operational efficiency. Implementing these revised policies by FY 2025-26 is crucial for PSBs to demonstrate their commitment to employee welfare and streamlined operations.

Impact on Banking

These developments collectively signal a period of significant adjustment for Indian banks. The pressure on net interest margins and profits, coupled with deposit flow challenges and increasing lending stress, necessitates a more cautious and disciplined approach. While regulatory tightening and transparency measures may present short-term challenges, they are essential for building a more robust and sustainable banking sector in the long run. The focus must shift from chasing high yields to prioritising safer borrowers and accurately pricing risk. For banks, the message is clear: shrewd risk assessment and transparent operations are not merely compliance exercises, but fundamental to their survival and success.

Will these measures truly instill the necessary discipline in banks? The coming quarters will be crucial in observing how effectively these regulations and guidelines are implemented and whether they can indeed steer the banking sector towards a more stable and responsible trajectory.

Image Courtesy: X (Bank of India)