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India's Banking Sector --- A review

India’s Banking Sector -  A review

Ever since the 2008 global economic crisis, the Indian banking sector has encountered several challenges due to the weakening domestic macro-economic condition, increasing spill-over risks and subdued global growth. The Reserve Bank of India, as also the financial planners took several policy initiatives to meet the challenges, both on the supervisory and regulatory fronts. In the short term, however, the stress asset quality of banks continues to remain a major challenge. Most banks experienced rise in asset impairment, on the one hand, and dip in profitability, on the other. The only silver lining has been the comfortable capital base.

A RBI discussion paper, "Banking Structure in India—The Way Forward”, suggests far reaching changes in the banking structure so that it better serves the growing needs of the real economy.

Globally, several initiatives have been taken for ring-fencing commercial banking activities and combat systemic risks. The proposed measures range from moving businesses identified as too risky and complex into standalone entities to prohibiting banks from engaging in these activities altogether. Major global initiatives of structural reforms include Volcker Rule under the Dodd-Frank Act in the US, Vickers Reform proposals in the United Kingdom and Liikanen reform proposals in the EU. The main aim of all the proposals is to construct a firewall between the deposit taking and the core banking activities, on the one hand, and investment banking/ proprietary trading activities, on the other.

The Volcker Rule restricts deposit-taking banks from engaging in proprietary trading and complex activities. It also forbids the co-existence of such trading activities and other banking activities in different subsidiaries within the same group.

The Vickers reform proposal has recommended ring-fencing of retail banking operations of large UK banks into separate legal subsidiaries.

The Liikanen Report seeks to carve out proprietary trading and market-making activities beyond a threshold on a stand-alone basis from the deposit taking bank, but allow these activities to co-exist with other banking business within the same group as long as these are carried out in separate subsidiaries.

These reforms will help to limit capacity of bank managements for excessive risk taking, as also shield systemically important financial services from excessive or abusive investment risk shocks. 

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