The Global Financial Crisis (GFC) that unfolded in 2008 had a far-reaching impact on economies worldwide, and India was no exception. The crisis, triggered by the collapse of the subprime mortgage market in the United States, had significant implications for Indian banks, credit policies, and financial sector reforms.
Impact of the Global Financial Crisis on Indian Banks:
The GFC led to a severe global economic downturn, which also affected India’s economy. The slowdown resulted in reduced demand for goods and services, leading to lower business profitability and increased default rates on loans. This, in turn, impacted the asset quality of Indian banks, particularly in sectors heavily reliant on exports and foreign capital.
The global liquidity squeeze resulting from the crisis led to a tightening of credit availability and higher borrowing costs for Indian banks. As foreign investors withdrew their funds from emerging markets, Indian banks faced challenges in obtaining overseas funding, leading to liquidity constraints.
Non-Performing Assets (NPAs):
The economic slowdown and deteriorating asset quality due to the crisis contributed to a rise in non-performing assets (NPAs) in Indian banks. NPAs are loans on which borrowers have stopped making interest or principal repayments, leading to significant stress on banks’ balance sheets.
The Basel II framework was being implemented in India during the GFC. While the framework aimed to strengthen banks’ capital adequacy requirements, some Indian banks faced challenges in meeting the prescribed norms due to deteriorating asset quality and provisioning requirements.
External Commercial Borrowings (ECBs):
Prior to the crisis, Indian banks were increasingly relying on external commercial borrowings to fund their operations and support their credit growth. However, the GFC led to a decline in the availability of ECBs, making it difficult for banks to access foreign funds.
Credit Policies and Initiatives in Response to the Crisis:
Monetary Policy Measures:
The Reserve Bank of India (RBI) took various monetary policy measures to address the impact of the crisis. It reduced interest rates to inject liquidity into the system, encouraging borrowing and investment. Additionally, reserve requirements were lowered to free up more funds for lending.
Credit Guarantee Scheme:
In response to the liquidity crunch and to boost credit flow to critical sectors, the Indian government introduced a Credit Guarantee Scheme (CGS). Under this scheme, the government provided guarantees to banks for loans extended to small and medium-sized enterprises (SMEs), which helped enhance credit availability to this vital sector.
The government increased its focus on infrastructure development and encouraged banks to lend to infrastructure projects. The aim was to boost economic activity, create jobs, and enhance credit growth in a productive manner.
Priority Sector Lending (PSL) Norms:
The RBI increased the PSL targets, directing banks to allocate a specified percentage of their total advances to sectors such as agriculture, small businesses, and weaker sections of society. This move was aimed at promoting inclusive growth and ensuring that credit reached underserved segments.
Financial Sector Reforms Post-GFC:
Basel III Implementation: In the aftermath of the GFC, the RBI introduced the Basel III framework to strengthen the capital adequacy and risk management practices of Indian banks. This new framework required banks to hold higher levels of capital and maintain buffers against potential losses, thereby enhancing their resilience to economic shocks.
Asset Quality Review (AQR):
The RBI conducted an Asset Quality Review (AQR) to assess the true state of banks’ asset quality. The AQR exercise identified stressed assets, which led to more transparent recognition and classification of NPAs, providing a realistic picture of banks’ financial health.
Insolvency and Bankruptcy Code (IBC):
The introduction of the Insolvency and Bankruptcy Code in 2016 was a significant step toward resolving the NPA issue. The IBC provided a time-bound framework for the resolution of stressed assets, ensuring faster resolution and recovery of dues for banks.
Recapitalization of Banks:
The government initiated a comprehensive recapitalization plan to infuse capital into public sector banks and strengthen their balance sheets. This infusion of funds helped banks meet regulatory capital requirements and support credit growth.
The GFC served as a catalyst for digital transformation in the Indian banking sector. Banks accelerated their adoption of technology, leading to the rise of digital banking, mobile payments, and fintech collaborations. This transformation improved operational efficiency and enhanced customer experience.
Pradhan Mantri Jan Dhan Yojana (PMJDY):
The government launched PMJDY in 2014 to promote financial inclusion. The scheme aimed to provide access to banking services, insurance, and credit to the unbanked and underbanked population, furthering the financial inclusion agenda.