According to the prediction made by the International Monetary Fund (IMF) in May, India’s $5-trillion economy plan is likely to be set back by about two years, to 2026-27. Everyone from industry experts to government officials say a major force that can drive this pursuit forward is an upgrade in India’s banking system.
While India has made significant progress on many fronts — including Open Credit Enablement Network (OCEN), Open Network for Digital Commerce (ONDC), not to mention the Unique Identification Authority of India (UIDAI) and the goods and services tax (GST) which have made India’s financial services ecosystem one of the most advanced in the world — consolidation in the banking sector is critical to manage costs and gain scale.
State of BankingTo be fair, the banking sector’s outlook has improved, with asset quality and growth metrics possibly looking at their best over the last decade. The Reserve Bank of India (RBI), in its Financial Stability Report for June, showed India’s gross net performing assets’ ratio falling to a six-year low of 5.9% in March, highlighting the banking system’s rising ability to support economic growth.
Aniket Dani, Director-Research, CRISIL Market Intelligence & Analytics, says, “The Indian banking sector has emerged stronger from the multiple challenges it faced. With most of the legacy stress in the corporate loan book recognised, banks have stronger, cleaner balance sheets that are allowing them to shift focus back on credit growth.”
The government’s extensive recapitalisation exercise of public banks over the years has also helped these lenders become more self-sufficient. As public banks still dominate the Indian banking landscape, the good health of these banks is of utmost importance for credit and GDP growth.
“The efforts undertaken by the government are bearing results, with the banking sector returning to a decadal high credit growth and India remaining as one of the large economies which are expected to grow in the uncertain and recessionary global growth outlook,” says Aashay Choksey, Vice-President & Sector Head-Financial Sector Ratings, ICRA.
Problem Areas
But there was a weak point that was overlooked. Indian consumers have always indulged Indian banks with their wealth because of the safety and the higher savings rates these institutions offered.
Abizer Diwanji, Head of Financial Services at EY India, says, “Banks that had access to large-scale funds at low cost lent liberally and at rates that failed to represent the underlying risk. Risk assessment abilities were never built as the cheaper cost of funds offered a good buffer.”
However, a macro change, where credit growth became faster than deposit growth, has now raised some questions about the stability of the banking system.
Just out of a credit crisis, banks have become wary of lending, shrinking the pool of available credit and also risking an impact on India’s GDP growth. Also, rising interest rates — not only in India but also globally — have thrown up a new set of challenges.
For one, deposits are being replaced by investments in equity and debt markets, in search of better yields. Also, in a reversal of trends, with domestic rates at a lower level than global ones, top-rated companies in India are looking for refinancing locally, rather than borrowing overseas. While AA-rated companies soak up domestic liquidity, those rated lower than AA are finding it difficult to find funding.
Lastly, banks in India need to play catch-up with fintechs.
“Banks need to better their ability of understanding and catering to customers who do not meet conventional banking-client-acceptance benchmarks. Banks need to build strong collection capabilities to be able to replace traditional NBFC markets,” Diwanji adds.
A case for more ‘big banks’
Past Chief Economic Advisor K V Subramanian, Finance Minister Nirmala Sitharaman, and industry experts have all highlighted the need for India to have more banks that can compete on a global scale.
Despite being the fifth biggest economy in the world, India has only one bank — the State Bank of India (SBI) — on S&P’s top 100 global bank list. SBI is 53rd on the list. China has 18 banks on the list, and the United States has 12, while much smaller countries like Finland, Denmark, Belgium, Austria and Norway each have one bank.
“For India to achieve its $5-trillion economy plan, it still has far too many sub-scaled banks which are not able to provide the requisite quantum of capital required for large-scale expansions,” says Diwanji of EY.
ICRA’s Choksey agrees, adding that the government already has some solutions in the pipeline. “The amalgamation of public sector banks and the proposed divestment of government ownership in some of these large banks would consolidate the position of Indian banks and put them in the league of large global banks,” he adds.
The Road Ahead
Even though the Indian banking system is steadily improving, some key points are essential to make this performance sustainable.
Banks will need to improve risk appetite, resolution of stressed assets need to happen at a faster pace and, lastly, technology adoption should happen faster, says Choksey.
Indian private sector banks have made remarkable inroads into the domestic market. The private and some public sector banks (mainly SBI) have taken a significant digital leap and managed to pocket a bigger market share in the consumer segment.
But for India to be on a par with global banks, a few things need to happen, explains Diwanji.
First, India needs to work towards building and enabling a corporate debt market where corporate loans are traded. Even though the RBI has the regulations in place, setting up the necessary infrastructure and tax considerations need to be addressed.
Second, the structure of the National Asset Reconstruction Company needs a relook, to enable the disposal of bad loans centrally with an enabling fund to revive companies, revitalise select assets and provide employment.
Third, the RBI and the Securities and Exchange Board of India need to work together to make credit markets seamless and formulate regulations to enable neobanking, where India already has the necessary infrastructure.
