Ever since the evolution of India’s banking system, Reserve Bank of India has been stressing on building a comprehensive, decisive and credible framework to resolve bad loans and stressed assets. Banking sector distress, which essentially points out to the inability and difficulty of banks to pay off their financial obligations, has been a contributing factor in establishing the Insolvency and Bankruptcy Code (IBC, 2016).
This brings to light the inevitable the role of market discipline; a channel through which depositors and investors penalise banks for excessive risk-taking by withdrawing their funds or by charging a higher interest rate on the supply of funds. In such a situation, market prices and returns reflect the level of individual bank risk. Since market investors, unlike secured depositors, demand a risk premium, they would incorporate this information while pricing the bank and forming their expectations on its likely performance in the future.
Financial literature suggests a negative correlation between the stressed assets ratio and market adjusted stock returns alluding to the conclusion that Indian markets have weak predictive power with respect to banking distress. With the onset of rising Banking services, issues such as recapitalisation, improvement in banks’ corporate governance, implementation of Ind-AS and containment of cyber security risks have assumed great prominence. This lecture addresses the evidence of market discipline
in India and examines the relationship between bank distress, supervisory and financial market variables to ascertain the degree of market efficiency in predicting market distress.
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