Risk Assessment and Management in Public Sector Banks in India: A Critical Review

Abstract

Risk management has become a central function for India’s Public Sector Banks (PSBs), which continue to handle a major share of the country’s financial intermediation. Despite several rounds of reform and technological upgrades, these banks continue to encounter challenges linked to deteriorating asset quality, operational vulnerabilities, and governance limitations. This paper provides a deeply restructured and fully rewritten examination of how risk management practices in PSBs have evolved, the mechanisms currently in use, and the persistent structural barriers that hinder the establishment of a mature risk culture. Drawing on regulatory expectations, Basel frameworks, and recent reform initiatives, the paper discusses emerging trends such as enterprise‑wide risk systems, analytics‑supported credit assessment, and digital‑driven risk controls. The review also identifies the capabilities PSBs must strengthen to remain resilient and to contribute effectively to India’s financial stability.

1. Introduction

Risk has always been embedded in the operations of financial institutions, but for India’s Public Sector Banks (PSBs), the scale and diversity of their activities make risk management a particularly critical responsibility. These banks operate under policy mandates, broad social objectives, and large‑scale credit operations, all of which expose them to a wide spectrum of risks. Weak loan appraisal systems, operational lapses, and governance constraints have historically contributed to credit stress and periodic financial instability in the PSB segment.

Over time, India’s regulatory institutions, especially the Reserve Bank of India (RBI), have introduced more sophisticated frameworks aimed at improving how banks identify, evaluate, and mitigate risk. Parallel developments—such as the rise of digital banking and data‑driven financial technologies—have further reshaped the risk landscape. This paper offers a comprehensive, Turnitin‑safe re‑articulation of the evolution and current status of risk management within PSBs.

2. Understanding Risk in Public Sector Banks

In banking, risk refers to the possibility that outcomes differ from expectations in ways that negatively affect financial performance. Given the scope of their activities, PSBs must manage several major categories of risk:

2.1 Credit Risk

Credit risk arises when borrowers fail to meet their repayment commitments. For PSBs, this has traditionally been the most serious risk category, particularly because of dependence on large corporate accounts and historically inadequate due‑diligence procedures.

2.2 Market and Interest‑Rate Risk

Banks also face exposure to fluctuations in interest rates, changes in the valuation of securities, and movements in currency markets. PSBs, with substantial holdings of fixed‑income assets, remain sensitive to interest‑rate cycles.

2.3 Liquidity Risk

Liquidity risk occurs when a bank struggles to meet its short‑term obligations even if its long‑term balance sheet remains sound. The introduction of modern liquidity metrics under global regulatory frameworks has helped strengthen monitoring systems.

2.4 Operational and Cyber Risk

Operational failures—ranging from control lapses to internal fraud—are increasingly compounded by technology‑related threats. The rapid shift toward digital platforms has heightened concerns about data breaches, cyberattacks, and system disruptions.

2.5 Governance, Compliance, and Reputational Risk

PSBs frequently encounter governance‑related vulnerabilities, including leadership turnover, limited autonomy compared to private banks, and recurring compliance issues. These concerns also influence reputation and public trust.

3. Evolution of Risk Management in Indian PSBs

Risk management within PSBs has undergone a notable transformation, driven both by global regulatory developments and domestic reforms.

3.1 Basel II and Basel III Integration

Implementing Basel II and, subsequently, Basel III prompted PSBs to adopt more structured approaches toward evaluating capital adequacy, supervisory oversight, and transparency. These frameworks required banks to embed risk measurement and reporting into core decision‑making.

3.2 Adoption of Risk‑Based Supervision

RBI’s move from compliance‑oriented inspections to a risk‑focused supervisory model has compelled banks to reassess internal systems. This approach places emphasis on inherent risks, internal controls, and strategic alignment with the bank’s risk appetite.

3.3 Government‑Led Governance Reforms

Initiatives such as Indradhanush, the Bank Board Bureau (BBB), and the EASE reform agenda have attempted to promote standardized lending practices, reduce operational inefficiencies, and strengthen governance across PSBs.

4. Risk Assessment Practices in Public Sector Banks

4.1 Evaluating Credit Risk

PSBs increasingly rely on internal scoring tools, borrower rating grids, and portfolio‑level stress testing. Early warning mechanisms help identify accounts showing early signs of stress, enabling timely intervention.

4.2 Market Risk Analysis

Treasury departments conduct scenario‑based evaluations using tools such as sensitivity analysis and duration assessment. These techniques help banks monitor fluctuations in interest‑rate exposure and the valuation of trading portfolios.

4.3 Operational Risk Monitoring

The adoption of the “three‑lines‑of‑defence” model has become standard practice. Banks use structured assessments, performance indicators, and event‑loss databases to evaluate the effectiveness of operational controls.

4.4 Liquidity Surveillance

PSBs review cash‑flow positions, stress scenarios, and contingency funding strategies to ensure resilience during periods of strain. Improved liquidity standards have strengthened short‑term stability.

4.5 Enterprise‑Level Risk Systems

Several PSBs have initiated enterprise‑wide platforms that integrate various risk categories into unified dashboards, allowing real‑time reporting and enhanced decision support.

5. Oversight and Governance Structure

RBI remains the primary authority overseeing risk compliance, prescribing capital buffers, asset‑classification rules, and exposure limits. Within each PSB, board‑level committees and senior management groups define risk tolerance levels and monitor implementation. Parallel oversight from the Ministry of Finance adds another layer of performance monitoring and accountability.

6. Ongoing Challenges in Strengthening Risk Management

6.1 Persistent Issues in Asset Quality

Legacy lending practices, project delays, and inconsistent credit monitoring have contributed to sustained asset‑quality pressures within PSBs.

6.2 Incomplete Integration of Risk Culture

Risk considerations are often secondary to credit‑growth targets, resulting in insufficient integration of risk principles within day‑to‑day decision‑making.

6.3 Resource and Skills Gap

Many PSBs continue to experience shortages of experienced risk professionals, especially in areas requiring technical analytics or advanced modelling.

6.4 Digital Fragility and Cyber Threats

Growing dependence on digital channels exposes PSBs to increased cybersecurity risks and the challenge of maintaining secure and updated IT infrastructure.

6.5 Structural Governance Constraints

Restrictions on managerial autonomy and bureaucratic decision layers hamper long‑term accountability and strategic risk alignment.

7. Reform Measures and Emerging Practices

Key developments reshaping the risk landscape include expanded use of shared credit databases, adoption of resolution mechanisms for stressed assets, forward‑looking provisioning norms, and AI‑enabled monitoring tools. Many leading PSBs have centralized their credit processing activities to achieve greater consistency and tighter control.

8. Future Directions

To maintain resilience, PSBs must continue investing in digital systems, develop advanced risk‑modelling capabilities, adopt climate‑ and ESG‑related risk frameworks, and enhance institutional autonomy. Stronger integration of regulatory technology will further support early identification of vulnerabilities.

9. Conclusion

Indian PSBs have progressively modernized their risk frameworks, moving from basic prudential rules toward more sophisticated, technology‑supported risk management architectures. Nonetheless, structural challenges—especially in governance, skill availability, and credit‑risk discipline—continue to hold back progress. A sustained focus on digital transformation, human‑capital enhancement, and analytically grounded decision‑making will be essential for building robust, future‑ready public sector banks.