Getting the banking sector back on track

THREE KEY FACTORS LED TO THE SPIKE IN BAD LOANS DURING THE LAST BOOM SHADY BANKING, POOR REGULATION, AND A GLOBAL COMMODITY PRICE SHOCK

- Pramit Bhattacharya

After a long slump, private sector investments in India may be on the cusp of a revival, according to some analysts. China’s fading star as an investment destination and improvements in India’s public infrastructure will bring in a new tide of global investments, they argue. This could raise the animal spirits of Indian industry, and catalyse a new wave of domestic investments.

The past decade has seen many such false dawns, with analysts routinely predicting an imminent recovery in investments. Favourable global conditions could be outweighed by domestic challenges even now. The poor governance of India’s State-owned financial institutions could emerge as a major bottleneck. After all, India’s last investment cycle was busted when loans to a large number of marquee projects turned sour.

Three key factors led to the spike in bad loans during the last boom — shady banking, poor regulation, and a global commodity price shock.

A 2022 research paper by economists Abhishek Kumar, Divya Srinivasan, and Rakesh Mohan suggests that the sharp fall in commodity prices after the 2008 financial crash hit the profitability of commodity-sensitive firms, which were unable to pay back their loans. Non-performing assets (NPAs) in the banking sector and profit ratios in commodity-sensitive firms moved in tandem, their research shows.