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Asset Quality Review – Pros and Cons

By – Vishaka Sivanainar

The RBI implemented “asset quality review” (AQR) as a component of their annual financial inspection (one-off exercise) in order to gauge the true efficiency and health of Indian banks. AQR was implemented by RBI governor Raghuram Rajan because he believed the Indian banking system required “deep surgery”. AQR diminished the profits of most public banks and several private banks.

The pros and cons of AQR can be easily understood with the help of an analogy. University XYZ publishes the results of students below the 10th percentile on the notice board. The aim of this practice is to point out the defaulters and ensure that they follow stricter academic discipline in the future. The display of marks negatively motivates the students to work harder. The weaker students begin to recognize their flaws at an earlier stage. However, since the university is new it might not be the right time to implement this policy. If this were to be made an annual exercise, it would actually bring down the goodwill of the university.

Similarly, AQR is carried out to ensure credit discipline is maintained among banks. The defaulters are highlighted and this information is made public. The negative exposure that the banks receive will affect their stock prices in the share market which is an indication of the lowering of public confidence. Higher provisioning leading to lower earnings will make the banks reluctant to lend. The process might lead to capital shortfall which would call for infusion from the government. Since India is a growing economy it is improbable to allow AQR to become an annual practice because it would be an unfair representation of the Indian banking system.

However, this tool has myriad benefits as well. Banks were given too much forbearance in comparison to other corporates, with stringent regulations their activities would be tracked meticulously. The implementation of aforementioned norms would lead to banks being more prudent. Banks will start recognizing stress early with respect to loan repayment and can adjust the terms accordingly.

Despite the noteworthy cons, we may conclude that AQR would be a boon to the banking industry and Indian economy. It would result in the improvement of governance, sustainable and profitable promotion of economic growth. It would also increase transparency, which will allow the public to better understand and trust their banks.

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