MORAL HAZARD is a situation in which one party gets involved in a risky event knowing that it is protected against the risk and other party will incur will incur the cost. It arises when both the parties have incomplete information about each other.
This concept can be directly linked with recapitalisation of banks(PSB). The recent step of financial institution reform taken by GOI to boost economic growth is based on infusing capital to PSB which are facing problems with NPA due to which they are unable to credit projects.
Recapitalization has created a risk of moral hazard-
* Recapitalization has been done from tax payer money- thus if it does not work ultimate loser will be the tax payer.
* Recapitalization can cause crowding out effect -
political party and bank Nexus will lead to this money be lent to corporates who are their ultimate supporter. The general public will thus again be short of lending.
*nationalised banks are allowed to tap into taxpayer money whenever they are in deep financial trouble, they have very little reason to be careful while lending and more reason to take huge risks with their balance sheets.
* Moral hazard also occurs when government protects private sector banks from the negative consequences of their actions.
Thus ultimate way is to have a competitive banking system and and reforms in bank ownership. The banks need to take Responsibility for their action government can't bail out each and every time when a bank fails.
-Here the recapitalisation is sourced from public money collected by taxation system.
-These public money is used to capitalise bank who are facing crisis of NPA caused by defaulters who did not repaid the money.
-Hence indirectly public money is channelising to Industrialists/defaulters who only think of their own profit.
-So the two party CITIZEN and GOI are in moral hazard situation - where citizen trusted GOI to save and protect such money for the
socio-economic development but GOI channelising it to defaulters(private players) who don't think of public.
-Such kind of steps would again put the PSBs in that same situation.
SUGESSION TO SOLVE THIS PROBLEM
1)Recapitalisation needs to be backed by governance reforms in banks such as ownership reform and management.
2)force banks to take responsibility for their actions.
3)Effective utilization of proposed Bad Banks to address bad loans problems in the banking sector.
CONCLUSION:Hence, instead of temporary solution of recapitalising , there is need to structural reform at administrative and managerial level in the PSBs. Such structural reform would solve the problem for long-time.
