Privatising state-owned banks will not restore confidence in letters of credit (L/Cs) issued by India's banks according to a professor at the National Institute of Public Finance and Policy.

Ila Patnaik was commenting on the serious bad loans recently reported by state-owned banks, many of which are the result of the banks' own officials conniving with jewellery and precious metal dealers to fraudulently obtain L/Cs from overseas banks.

Strengthen supervision

State-owned banks have racked up billions more in bad loans and performed much worse than their private-sector counterparts.

But according to Patnaik, unless the government first strengthens its ability to supervise all banks, public and private, selling some of them off will be what she describes as a "slim guarantee against another crisis".

Checks and balances

At a minimum, the Reserve Bank of India's (RBI's) supervisory capacity needs strengthening and supervisors need to have processes in place to evaluate bank corporate governance and clearly set out expectations for boards she says.

But that alone would be inadequate Patnaik argues, and greater checks and balances need to be built into the system.

Early warnings needed

The government is planning to create a resolution corporation similar to the US Federal Deposit Insurance Corporation, which would partner with the RBI in handling failing banks.

But under current plans, the corporation would only become involved in the latter stages of a bank failure. Patnaik says it should at any time be able to help RBI evaluate all banks, including those considered at low or moderate risk so that problems are identified early and can be solved.

The National Institute of Public Finance and Policy is an autonomous research institute under the ministry of finance.

This article represents the views of the author and not necessarily those of the ICC or Coastline Solutions.