The banking sector is seen as a replica of the economy; and currently the sector is facing the brunt of slowingeconomy thanks to stringent policy action by the RBI to tackle the rising inflation and falling currency.

Currently, interest rates in the country have peaked out due to continuous tightening by the RBI to rein in inflation and the falling rupee. This higher interest rates environment is taking a toll on banks’ credit growth, asset quality and in turn on margins.

Banks’ asset quality deterioration can be evidently seen with gross NPAs of 40 listed banks increasing by 36.9% to Rs 2.22 lakh crore in Q2FY14 from Rs 1.62 lakh crore in Q2FY13. Rising NPAs are also eroding banks’ capital, especially in the case of PSU banks who are suffering from poor asset quality and capital shortage. The total amount of capital infused in PSU banks by the government was Rs 62,234 crore between FY05 and FY14.

To aid the banking sector, the RBI has taken several steps like swap window for banks FCNR (B) and overseas borrowing; it introduced term repo and frequent intervention through OMO, freeing up of new branch licensing and stronger NPA recovery norms.

Also, to improve the health of the banking sector, the RBI has issued instructions which stipulate that every bank should have a board-approved loan recovery policy.

Banking sector in India has a huge potential and it is fairly under penetrated. We feel that the issuance of banking licences by the RBI will be a game changer because this will not only intensify the competition in the sector but also help achieve the objective of financial inclusion. Also, to support its financial inclusion agenda, the RBI has come out with revised norms for foreign banking regulation.

However, to support the banking sector we feel that major contribution should come from the government to put economy on track and boost investment sentiment in the country. The government should focus on building infrastructure and clear backlog on various projects’ approval.

This will not only boost investment environment but also help in churning some cash flow for these companies. In turn, the banking sector can see some relief as it has major investments there. We expect that by boosting investment sentiment and by removing policy paralysis, the economy can be put on track; and so the banking sector will improve.

New government should support banks to take action against willful defaulters by reviewing these cases frequently and intervene wherever required. Also, there should not be pressure on banks from the government to lend without having all parameters checked. Banks should have their independent mechanism for risk analysis to assess the viability of the project without considering underlying government security.

Most PSU banks have asset quality problems due to poor credit appraisal skills and inadequate risk management tools in place.

Efficient management and better operating efficiency will not only help them to compete with new generation private banks but also increase their profitability.

There should be a centralised database where cases under CDR or under restructuring or those who are NPAs, can be shared by banks. This will helps banks’ credit appraisal quality and ability.

(Disclaimer: The author is Research Analyst Institutional Broking, Bonanza Portfolio Limited. Views and recommendations expressed in this section are his own and do not represent those of