Double Financial Repression

Indian Banking System is faced by many ideas and challenges stemming from both policy and structure. The experts have suggested that the system is affected by Double Financial Repression.

Latter, as pointed out by Economic Survey 2014-15, is a phenomenon when the banks are faced with financial repression both on the asset and liability side. Financial repression on asset side is a by-product of the SLR (Statutory Liquidity Ratio) i.e. the amount of liquid assets which banks are required to hold in form of cash, government bonds and gold. Even the provision of 40% of Priority Sector Lending has led the allocation of cash to less than fully efficient ways. Financial repression on the liability side is the result of continued inflation since 2007. This has led to negative interest rates and relative diminishing of household savings. Also, the private sector banking is plagued by structural issues covering lack of competition and ownership. It can be seen in the lack of share of private banks in the overall banking aggregates at a time when the economy is growing mainly due to the private sector banking.

Factors that led to Double Financial Repression

SLR requirements

SLR or the requirement of banks to hold certain part of assets in liquid forms is essential to efficient banking and is instrumental in meeting any unexpected demand from depositors. The rate which was hitherto 38% before 1991 reforms has been revised to 21.5% in February 2015. In recent times, SLR has come to fund government’s fiscal deficit.

Priority Sector Lending

It is a requirement of Indian banks to keep 40% target on priority sector lending. The law mandates that all domestic commercial banks both private and public, should lend 40% of their adjusted net bank credit ANBC or a credit equivalent off their balance sheets- whichever is higher to the priority sectors. In addition, banks in public sector have clearly defined subcategories in which PSL takes place-agriculture, MSME, education, housing, export credit etc. Agriculture is considered most important amongst them in which 45% PSL is made.

Inflation

India has faced high inflationary pressures especially in food and related commodities since 2007. This has had a direct effect on real interest rates and hence reduction in household savings as people have to spend more on daily food items. The inflation has eased over the years and the liability side recession has also come down considerably. High inflation and reduced return on assets of banks has further strengthened the fact that rates maintained by banks did not give a positive rate of return on deposits to households.

Lack of competition in private sector banking

At a time when the economy gained its robust character and is en-route to overtake all the major world economies, a growth which has been spurned by private sector, the private sector banks have shown a flat and lack-lustre performance. This is reflected in near-constant share of private sector banks in deposits and advances.