Thank you, Dr. Kumar, for the kind introduction. It’s a pleasure to be here today. I want to thank Prime Minister Modi for your hospitality on my first visit to India as World Bank Group president. I welcome the opportunity to speak with all of you today about a robust financial sector, which is vital to India’s economic well-being.
India has made substantial economic progress over the past few decades. The world has made great strides in reducing extreme poverty, and India played a key role in that progress. India cut extreme poverty in half within a generation and is transforming itself into one of the world’s fast-growing economies. That’s very encouraging to us at the World Bank Group, because our mission is to encourage broad-based growth, reduce extreme poverty and boost shared prosperity.
In recent years, the Indian government has carried out important market-oriented reforms. We’ve just released our annual Doing Business report, which measures ease of doing business. For the third year in a row, India is in the top ten in terms of improvements. During that period, it has jumped from 142nd in the Doing Business rankings to 63rd. Per the new report, it’s easier than it was a year ago to file for a new business, get a construction permit and trade goods across the border.
We share your desire to see India’s economy stronger. Prime Minister Modi has set the ambitious goal of turning India into a $5-trillion economy by 2025. Reaching that goal would be good for the people of India—and for the world. It will require even more reforms on taxes, trade, infrastructure and government structures. And it will require a strong, stable financial sector and substantial progress on financial reforms: the subject of my remarks today.
BOOSTING GROWTH THROUGH FINANCIAL STRENGTH
India’s banking system is at a crossroads. We recognize important reforms already. You protected home buyers by improving the transparency of funds channeled into real estate. You introduced a system of unique identification numbers that has made it easier to make government transfers. This has especially benefited the poor. And you’ve created a unified bankruptcy and insolvency code. These are welcome developments.
Still, the financial sector faces a number of challenges. While there are signs that commercial banks are making progress in clearing non-performing loans, there’s still much work to do.
State-owned banks account for nearly 70 percent of assets in the nation’s banking sector. This heavy involvement of the public sector distorts markets, making it difficult for India to address financing gaps in key areas of development such as infrastructure, small and medium-sized businesses and housing. Non-banking financial companies, sometimes called shadow banks, have emerged as an important new source of credit for businesses and consumers. Yet their growth has also created linkages with the traditional banking sector that present new risks.
The financial sector is wrestling with these issues at a challenging moment for the global economy. Global growth is slowing amid sluggish investment and weakening trade. Like many countries, India’s economy is facing challenges, with consumption softening and investment slowing. Globally, bond yields have fallen into low or negative territory for several top bond issuers, benefiting an increasingly narrow group but leaving the productive investments needed for broad-based growth under-funded, including in India. This creates a difficult backdrop for reform. At the same time, it underscores the need for decisive action to allow faster growth.
The opportunity is tremendous. If the current challenges are addressed, India has the potential to build one of the world’s biggest domestic banking sectors. Faster private-sector credit growth would add directly to GDP, jobs and median income.
I’d like to focus on three areas of financial reform where the World Bank believes India can make meaningful progress — adding private capital in the banking system, deepening capital markets, and effectively regulating non-bank financial institutions as their role in the economy evolves. I’ll draw on experiences from other countries, while recognizing that India’s financial system will always be uniquely Indian. There’s no one-size-fits-all solution, yet some of the global examples may provide useful coordinates as you chart your course. As World Bank Group president, I’ve stressed that strong programs are urgently needed in many countries and should be tailored to the unique circumstances of each country.
INVOLVING THE PRIVATE SECTOR
In developing countries, state banks generally comprise the minority rather than the majority of market share: closer to 20 percent versus 70 percent.
The financial sector here generates a low level of credit compared with other countries. India’s credit-to-GDP level is 51 percent. That compares with 136 percent in Malaysia and 70 percent in Brazil. This trend has taken hold despite the fact that India’s gross domestic savings rate, at nearly 30 percent of GDP, is in line with peer countries. The savings are sufficient, but the system doesn’t use them effectively.
To reach the goal of building a $5-trillion economy, credit will have to grow at a much brisker pace while maintaining good credit quality and avoiding excessive risk taking.
More credit would help meet India’s needs in areas such as housing, SMEs and infrastructure. India’s annual infrastructure finance gap is expected to average 0.7 percent of GDP through 2035, more than twice the global average of 0.3 percent.
Productive credit growth would benefit the poor. Hundreds of millions of Indian citizens, and millions of businesses and entrepreneurs, operate in the informal economy, with only limited access to financial services. Many of them could use credit effectively to build a business or buy a motorbike to get to work.
The experience of other emerging markets and developing countries offers some useful lessons. In the 1980s and 1990s, a wave of developing countries moved to liberalize their financial sectors. Countries in central and eastern Europe privatized large parts of their financial systems in the early 1990s as they moved to restructure their previously centrally planned economies. In Latin America, countries including Mexico liberalized their banking sectors following the debt crisis of the 1980s.
Most, but not all, financial liberalizations were a success. One lesson we can draw: it’s important to have strong, independent regulatory authorities to oversee the transition. The global experience also suggests it’s important to carry out transitions during moments of strength, when macroeconomic conditions are balanced and the nation is on a strong economic and fiscal footing.
Within this context, we recognize India’s recent efforts to shore up the financial system. The Reserve Bank of India has worked hard to monitor asset quality. The government’s plan to consolidate public-sector banks is an opportunity to strengthen governance, supervision, efficiency and risk management.
We hope these steps will form the basis of a broader strategy to reduce the role of the public sector in the financial system. A mix of private-capital injections into state banks and full privatizations would boost the sector’s ability to support credit, would facilitate effective financial intermediation, and would reduce moral hazard and fiscal exposures.
Gradually scaling back the statutory requirement of state banks to provide liquidity, as well as the priority-sector lending policy, would also be helpful. These policies end up doing more to distort markets than to expand them. India is well positioned to take advantage of recent advances in financial technology. India has already established a good foundation for fostering Fintech, including the “regulatory sandbox” set up by the RBI, with help from the World Bank Group. Three of the top Fintech deals in Asia last year were based in India, and 80 percent of India’s people have bank accounts. India is well-positioned to share lessons learned with other countries. India can also continue to tap into its entrepreneurial spirit and allow the private sector to continue to innovate in this area, for example in the mortgage market.
DEEPENING CAPITAL MARKETS
India’s capital markets can play a pivotal role in helping the nation attain its economic ambitions. Equity market capitalization is over $2.2 trillion, up over six percent in 2018-9. However, the debt market remains at a nascent stage of development.
The debt market remains highly skewed toward government securities, while the corporate bond market is dominated by top-rated financial and public-sector issuers. Corporate-bond issuance amounts to roughly 3.94 percent of GDP, much less than in other emerging markets. Funds raised through corporate bonds increased from about $52 billion in fiscal 2012-3 to $101 billion in fiscal 2016-7. Since then, corporate-bond issuance has remained roughly flat.
Deepening India’s capital markets could complement bank financing in fostering growth, helping to create new market niches and attract interest from domestic and foreign institutional investors.
Deeper capital markets can be an important way to increase the flow of long-term finance, especially given the asset-liability mismatches in the banking sector. Around the world, long-term financing is increasingly a major focus of institutional investors such as pension funds, insurance companies, mutual funds and sovereign wealth funds.
We encourage India to revise its guidelines for domestic institutional investors, so more resources can flow to long-term finance. Another useful measure would be to adapt the funding models of your development-finance institutions so they can expand in market-based funding. As capital markets deepen, new infrastructure-finance instruments could attract more institutional investors. Globally, pension funds and other institutional investors hold about $136 trillion in assets. Many of these funds would be able to invest more in India if it had deeper capital markets and the right mix of market instruments.
STRENGTHENING NON-BANK FINANCIAL COMPANIES
The growth of non-bank financial companies (NBFCs) has played an important role in channeling credit to under-served markets through new products. IFC, the World Bank Group’s private-sector arm, has been a supporter of the NBFC sector and has helped channel credit to underserved markets. NBFCs have been a useful complement to commercial banks, helping to meet the nation’s financing needs in infrastructure, and among entrepreneurs and consumers.
The sector has recently experienced a downturn, leading to liquidity issues among some NBFCs. Many of these non-bank banks face asset-liability mismatches, borrowing short term and lending long term. They largely depend on commercial banks and market funds for financing. Thus, some banks have exposure to weakness among NBFCs. Resolving this “twin balance sheet” issue of weakness in NBFCs and related banks will be an important step in strengthening India’s financial system and reinvigorating economic growth.
The recent softness in the NBFC sector is an opportunity for the government and regulators to reconsider the role of these institutions within India’s financial system. We would welcome efforts by the RBI to strengthen its regulatory and oversight framework to capture all licensed financial institutions, including all systemically important NBFCs.
Properly regulated, NBFCs will play an important role in fostering innovations in Fintech. This is why it’s even more important that policymakers ensure NBFCs are properly regulated and adequately capitalized as their role in the financial system continues to evolve.
The RBI has done a commendable job overseeing the growth of NBFCs. Going forward, we would recommend that the authorities view the sector constructively as broad, eclectic coalition of various types of institutions with different business models and risk profiles. You should consider applying the same risk-based approach to supervising NBFCs as you apply to banks, applying more stringent regulations and greater scrutiny to institutions, depending on the risks they present to the financial system.
TOWARD A STRONGER INDIA, TOGETHER
In closing, I want to reiterate the importance of a strong financial system to realizing India’s goal of becoming a $5 trillion economy. Allowing more private sector participation in the financial system, making it easier for funds to flow into capital markets, and properly regulating systemically important NBFCs are all ways for the financial sector to evolve in a direction that can position India for fast, broad-based growth. A modernized financial system is essential to delivering it.
In recent decades, India has made impressive progress in building a financial sector that fits its unique development needs. Yet in a world where payments can be sent with a click of a button from the most basic cell phone, it’s crucial that countries have financial sectors that ensure stability while offering deep, well-regulated markets and being agile enough to respond to rapid innovation in the industry.
At the World Bank Group, we’re proud of our longstanding partnership with India. Our first project in India, which financed agricultural machinery, took place in 1948, a year after the nation achieved independence. Over the years, our support evolved from a focus on infrastructure and agriculture to economic liberalization and poverty reduction. In recent years, we’ve supported the emergence of the housing-finance and microfinance markets. Our financial-sector experts are available to consult with the government as it moves forward with reforms in the banking and financial system. As I said earlier, it’s important to design a program that meets the unique profile of the Indian economy.
Prime Minister, on your recent visit to the United States, you left some inspiring words for the many members of the Indian diaspora living in the U.S. and elsewhere. You said, “We are challenging ourselves, and we are changing ourselves.” As you take on this next challenge, as you lead financial change, the World Bank Group looks forward to remaining a close partner.