Credit creation for economic activities is the prime function of any bank. Apart from raising resources through deposits, borrowing, recycling of funds constitutes major part of its activity. Lending is encouraged because it helps the economy to expand. However the process carries a risk, called the credit risk which may arise due to the failure of the borrower. Non- recovery of loans, either principals or interests forms a major hurdle in the process of credit cycle, and affects the bank’s performance. Non-performing assets (NPAs) have emerged as an alarming threat to the banking industry and it is sending distressing signal on the sustainability of the banks. As per Economic Survey 2015-16 the Gross NPA of Scheduled Commercial Bank as a proportion of Gross Loans were 5.5 % by Sep 2015. The Net NPA rose from 2.5 % to 2.8 % from March to Sep 2015. As per Economic Survey 2016-17 Net NPA is 9.6 Lakh Crores at the end of Dec 2016. Similarly there is an urgent need to bridge the gap between the government and central bank that has arisen due to the difference in opinion on various issues such as dividend distribution, policy rate determination, appointment process etc. Causes, Effects and Analyses 1. During the boom period, i.e. mid 2000, the world economy was doing with a growth rate of 9 to 10 %. Majority corporate assumed that the growth was a result of the economic reforms of India of the 1990s. Companies started investing in various projects such as infrastructure, highways real-estates etc. 2. Investment further increased due to the relaxed lending norms especially for corporate houses when their financial status and credit rating was hardly analyzed during the lending process. So the boom period credit disbursal was associated with very less stringent credit appraisal. 3. Another factor is accelerated credit growth, resulting from competitive credit disbursal encouraged by the sharp decline in the statutory liquidity ratio (SLR) from 30.5% of total assets at end March 2005 to 22.6% at end March 2008. To survive in the competition banks started selling unsecured loans. Corporate and banks both followed the same model despite of a fear of formation of bubble having a thought that there is unlikely that majority can be wrong. 4. Even if they were convinced about the risk, they still believed in a particular idea because majority follows it and there is a sense of assurity. In economic terms this is called Herd behavior or Bandwagon Effect. It is a tendency of people to align their beliefs and behaviors with those of a group is also called a Herd mentality. However it was never realized that we had to pay a lump sum amount in a long run. Soon due to the global crisis, international demand as well as the local demand fell down in various sectors including aviation and Information Technology. The misfortune is compounded by the fact that there is an open nexus between the politicians and the business community. Crony Capitalism and Favouritism are major issues and many business loans get passed due to close relationship between the business officials and the bank officials. Various studies say that in the past two decades, giant lenders especially the public sector banks were very busy to appease the government who acted as their promoter. After two rounds of nationalization in 1969 and 1980 the state run banks extended their arms and exploited their balance sheets for populist goals. Very little attention was paid to the quality of the assets. Sometimes, with the new government or boards of member of the bank, banks gets new policies for operations which makes the task difficult to tackle with the NPAs. The majority of the share of NPA is in public sector banks. Decisions were taken without thoughtfulness or rationality. Banks granted loans without following the procedure and it continued for long. So Habitual Decision making is another major cause for banking crisis. Effects: • Increased NPA level is likely to have an adverse impact on the bank business as well as its profits; shareholders value of money may get eroded. • It is further responsible for lowering the confidence and credibility of the banking system resulting trust deficit. • People withdraw money and this event may have cascading effect on all importance ratio of the banks viz Profitability, Dividend Payout, Net Interest Margin, Return on Assets, provision coverage ratio, Credit contraction etc. Banks to avoid stress on their balance sheet, over invest their net demand and time liabilities in G-Security which are less risky. So the high level of stressed asset encourages Public Sector Banks to overinvest in risk free G-sec to maintain risk weighted Capital Adequacy Ratio and to comply with “Basel-3” Norms. So since banks also gets less return by investing in government securities they are not expected to give more interest to the customer deposits. This results in diversion of investment towards non-productive assets such as Gold, land and other assets, as the consumer thinks it’s not the right time to park money in the bank. Further it aggravates the problem as there is a sharp decline in the deposits of the banks due to this event and the entire cycle of borrowing and lending process gets affected. There is Negative spillover due to the decrease in deposits. Bank’s main source is deposits. When the deposits in the Bank declines, Banks are not expected to decrease the borrowing cost (i.e. rate of interests) even if RBI decreases the repo rate. Companies postpone their investments and so the growth rate will decline and it will lead to inflation and unemployment, if not stopped. As bank’s reliable source is term deposit. So any slow-down in time deposit will hamper the credit lending capacity. On one side this event puts additional stress on the current account and on the other hand it also affects the savings of the households. If it continues for a long, it increases the current account deficit of the country and as a result of which Rupee gets depreciated. However on the positive side this event is the rise in foreign investment as the sovereign rating would look good. Similarly there is another area which can be very controversial i.e. RBI’s role to control the inflation and debt management. The Reserve Bank of India Act 1934 has empowered the central bank to manage the public debt incurred internally by way of selling various types of instruments. The Government’s worry is that as a manager of debt, RBI will have to sell the Govt bonds cheap to reduce interest burden on the Govt. Where as a monetary controller it should tighten the rates to contain inflation. This creates conflict in interests. The RBI which operates according to Reserve Bank of India Act of 1934 has an obligation to allocate surplus funds to the centre. The RBI mainly earns its profits from the interest it gets from the sale and purchase of government securities, the interest earned from lending to banks and an interest earned on open market operations etc. Special dividends to the government don’t really help the government with its budgetary constraints because much of the surplus that RBI make comes from interest it get on government assets or from the capital gains that RBI makes market participants. When RBI pay this back to the government as dividends. It means that it is putting back into the system the money RBI made from it there is no additional money printing or reserve creation involved. This will not resolve the problem of inflation. Majority of the decisions taken by the banks are influenced by the government. The appointment process of governor of central bank is more political and less on merit with no clear indication of the tenure. A longer tenure is necessary as India is moving to a new rules based monetary framework and so stability is decision making is necessary. Recommendations: 1. First of all, morality should be separated from Non Performing assets. It should be understood that every defaulter is not a willful defaulter, loans can become bad loans due to the bad luck of businessman, regulatory clearances etc. So, entrepreneurial wealth is not sinful and if the entrepreneur is not a will full defaulter, yet tarnishing his image would led to loss of reputation, insecurity in the market and economy will not get right kind of investors in the future. 2. Restructuring of loans logically and scientifically is necessary. RBI should direct the banks, not to wait till a loan gets into NPA category; rather track them much before to know if there is any default in payment of interest or loans. 3. Joint lenders forums should be formed and more power to deal with willful defaulters. 4. RBI should go for the policy of publicity, like publishing weekly statements of assets and liabilities etc. This can bring more transparency and moral pressure erring banks no to violate norms. 5. So banks start abiding by the credit control measures. If that does not work then Central bank can take action under the Banking Regulation Act 1949 which gives power to RBI. 6. Public Debt management agency should be given statutory rights. Bond market should be deepened and regulations should be passed in this respect. References: -Economic Survey 2014-15 Government of India. -Economic Survey 2015-16 Government of India -Economic Survey 2016-17 Volume 1, Government of India. -Financial Stability report, Reserve Bank of India, Issue No 13, June 2016 -Article “regulation of government bonds to stay with RBI”.