Why Indian Banks Are Relatively Safe

If the Finance Minister is to be believed then everything in the Indian banking sector is hunky dory. The banks have enough cash and the RBI is doing a wonderful job. At least, that’s the impression one would have got if he or she were present at a press conference addressed by P.Chidambaram earlier today. Cynics have already pegged this estimation as a deliberate lie that misguides people about our banking system making out the case for Indian banks to be as bad as faced by banks in the US.

Both arguments are valid but on this count it’d the Finance Minister’s statements that have turned out to be more accurate. Indian banks aren’t as comfortable as he says they are but they definitely have an ample supply of liquidity to power the Indian economic engine.

In the hectic financial activity during the past three days every market’s index has been hit. In most of these markets shares of the banking sector were and continue to be pummeled. Even Indian banking sector stocks were pummeled but the difference is that our banking sector has bounced back. The BSE’s Bankex index did take a beating but not as much as one would have expected.

Reasons for this are varied. Indian bank stocks did not in any way deserve the treatment they have received during the past three days. The drop in value of stocks in this sector is definitely NOT an indication of its performance. It is the misfortune of being caught up in the crossfire of a global market downturn which we have seen since the Bankruptcy of Lehman Brothers and the AIG bailout.

The same reason was also given by the Finance Minister. Indian Markets have been losing money because people have been selling off their shares in order to recuperate from losses across other markets. A large scale wave of this panic selling has led to the Sensex and Nifty being drubbed. However, while certain sectors continue to get hit due to constant selling pressures, the banking sector continues to bounce back, albeit gradually indicating a slowdown ,not a total crash of the system as a whole.

It indicates that once people have recovered their marginal profits, they decide to re-invest it into the Indian banking sector. It will however take a lot of time for the sector to start dominating again.

A reason why Indian banks are healthy is because of the tight framework and policies executed by the RBI.Unlike American banks our banks are not a direct victim of the sub-prime problem because Indian banks fundamentally do not follow the mortgage system of the US. Getting a loan in India requires going through a very stringent process. A large number of banks are also public sector banks which are forced to comply with RBI policies.

There is also a significantly comfortable store of Foreign Exchange and Gold in the RBI’s kitty which is used only in dire need. The problem for banks however remains dealing with double digit inflation. Today’s figure indicates a higher figure than last week. The key remains in balancing the liquidity needs of the growing economy without contributing to inflation.