What is Narrow Banking?

Hey Pal,

Do you want to know what is Narrow banking? Let me assist you with the same. When differentiated lending is taken to its logical conclusion, it may be time to think about turning state-owned lenders with the lowest performance into narrow banks that don't lend at all. Narrow banks are secure banks. They practically eliminate their credit risk by refraining from lending and using their deposits to buy government bonds.

A "Narrow Bank" is a type of banking where a bank invests its money in risk-free assets with maturities that match its liability maturity profile. This prevents asset-liability mismatch issues from occurring and ensures that the quality of the assets is maintained without the emergence of subpar assets.

After understanding the narrow banking meaning, let us focus on the concept of Narrow banking in terms of India.

There is no risk of non-performing loans or repeated injections of taxpayer-funded equity capital. Supervision becomes simpler for the Reserve Bank of India (RBI) as well. Deposit insurance is not required.

Consider lenders like IDBI Bank and Indian Overseas Bank as an example. For both banks, almost one out of every four rupees is problematic loans. They are both included in the RBI's so-called quick corrective action (PCA) framework, and the central bank has imposed lending limitations in an effort to prevent a sharp decline in their capital adequacy ratios. Such lenders might simply develop into major payment banks. By gradually reducing their loan books, it can be accomplished incrementally rather than all at once.

Historically, the justification for opposing such conversions has been that narrow banks don't carry out some essential tasks, such lending to the so-called priority industries. Two decades ago, this argument could have been persuasive. For India to attain financial inclusion, there is no need for so many universal banks.

Keep in mind that even the 1991 Narasimham Committee had suggested switching to a structure that would include only 10 nationwide universal banks in addition to local banks, with four lenders serving as global banks.

When the RBI introduced separate licences, the groundwork was already done. There are therefore enough private and small financing banks to lend to the small borrower, even if the worst state-owned banks are turned into narrow banks. Newer technologies will promote financial inclusion, such as peer-to-peer lending, for which the RBI just released (unsatisfactory) regulations.

To avoid making the same mistakes twice at this scale, narrow banks should be actively studied. They'll protect a significant portion of the financial system from frequent failures that call for expensive bailouts.

Yes, the history of limited banking implementation has been, at best, patchy since governments, particularly in developing countries, prefer to own lenders to promote financial inclusion. However, in the current Indian banking environment, where crises have frequently affected state-owned banks, narrow banking may be a concept whose time has come.

I would like to conclude here about what is Narrow banking. I hope this helps:)

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