India’s banking sector couldn’t be more excited now. We are witnessing the creation of the world’s fourth most valuable bank behind giants such as JP Morgan, China’s ICBC and Bank of America. The merger of HDFC and HDFC Bank is valued at $172 billion, and is expected to rise further. This is an extraordinary moment for Indian banking. Apart from this, there is good news from all Public Sector Banks (PSBs). They had a great financial year with a net profit of over 1 trillion, three times the figure nine years ago. The dividend paid to the government, their major shareholder, has been good. The Finance Minister recently released a list of impressive statistics on the health of the sector. Gross non-performing assets (NPAs) of all scheduled commercial banks have come down to a decade low of 3.9% from 11.5% five years ago. It is expected to fall further to 3.6% by next March. The net interest margin is very high at 3.3%. The case of state-owned Bank of Maharashtra (BoM) is both illustrative and influential. The BoM was under the Prompt Corrective Action (PCA) framework of the Reserve Bank of India (RBI) five years back. Its NPA was 11.8%, return on assets was negative 1%, and it reported a loss 1,372 crore in 2016-17. The same BoM has topped the league of all banks on several metrics and has topped the charts for three consecutive years. Its net NPA stood at 0.25% as of March 2023, while its provision coverage ratio (for bad loans) stood at an astonishing 98.3% and capital adequacy ratio at 18.1%. Has it been too risk averse? no way. Profit growth from business was an impressive 126% over the previous year, contributed by Its bottom line is 2,602 crores. Its loan growth was close to 30%, possibly the highest among large banks. This performance was matched by many other PSBs, so overall the last financial year ended this March has been one of the best years in the last five decades of bank nationalisation. The RBI issued a statement in February saying that our banking sector remains resilient and stable. The report was in response to media reports expressing concern about bank health, and particularly exposure to large corporates.
While we celebrate the success of the banking sector in the last year, we cannot be complacent. First, let us not forget that India’s banking has gone through cycles of boom and bust, partly caused by overzealous and reckless lending followed by belt tightening and remorse. This story has been repeated from time to time since bank deregulation began in the early 1990s. Who can forget the 1995-96 high of 18% NPAs, which came down to below 2% ten years later? Second, the plight of any bank in boom times is its vulnerability to reckless lending cyclicality, low prudence and profitability. Add to this the governance crisis, which the finance minister called “phone banking”, which is probably a thing of the past. Let us remind ourselves that between 2014 and 2019, 11 PSBs and two in the private sector were under the PCA framework. Due to poor debt ratio, insufficient provisions and working capital. And there is no point in blaming the asset quality review initiated by the RBI in 2015, which exposed the rot in these banks. Finally, remember that over the past six years, banks have written off huge 11 trillion in debt, of which barely a tenth has yet been recovered.
To put the current good performance in perspective, some serious caveats need to be mentioned. First, higher credit growth has been driven by unsecured loans and loans to the housing and retail sectors as well as MSMEs. The latter have a sovereign backstop under the Credit Line Guarantee Scheme, which means banks lend more than they normally do. There is already some concern about a deterioration in the quality of this loan portfolio. Second, rising interest rates are the enemy of the banking business. RBI has not done the work of increasing the policy rates. Inflation is still stinging, and monetary tightening is a global phenomenon. In such a scenario, the transmission of policy rates works asymmetrically, i.e. lending rates rise faster, while deposit rates for savers lag behind. Deposit growth is temporarily lagging credit growth, presenting an illusory rosy picture, which will change. Home loans will generally not increase the monthly installments as the income and take home pay of the people have not increased that much. Instead, the repayment period increases. Given the ever-increasing rates, we can extend the loan tenure up to 40 years, as long as the installments don’t increase. Ultimately, the evidence of continued credit growth lies in the investment-to-GDP ratio of the economy, which is still unsatisfactory. All this means that banks need to prepare themselves for tough times and use their current good fortune to strengthen their risk buffers. There may be a need for higher provisions, faster resolution of stressed loans and quicker NPA recognition in the coming days. India’s banks did well in handling the turmoil caused by the global financial crisis of 2008 and the collapse of IL&FS in 2018. Unlike the US, where three major bank failures happened recently, we have not seen any such disaster in India, though smaller co-operative banks went under. Banks in India should ultimately be treated like public institutions, as their leverage on public deposits is very high. The co-existence of public and private banks in India is a given, and our recent record shows that given the right framework of governance, autonomy and a vigilant banking regulator, the former can outperform the latter.
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Updated: July 05, 2023, 11:35 PM IST