Banking sector continues to wreak havoc | Experts’ views

Later, when the Reserve Bank of India (RBI) announced various restructuring plans, we were warned about the dangers of “postponing problems until later”. Analysts said that if you don’t recognise NPAs now, be prepared for higher NPAs to come later. Better, they argued, to “bite the fly” now.

They turned out to be wrong. Out-of-the-box thinking allowed the RBI to bring the banking sector back to normalcy in the post-pandemic years, despite the Ukraine shock and the shocks of banking instability in the US and Europe. By 2022-23, NPAs had come down to 3.9 per cent.

That’s fine, analysts said. However, maintaining the secular improvement in financials seen in the previous years will be difficult in 2023-24. Banks will face a liquidity crunch, with deposits failing to keep up with loan growth. Net interest margins will be squeezed and asset quality will suffer due to rapid loan growth. Returns are bound to fall.

Again, untrue, as it turns out. Yes, bank liquidity was indeed tight at the margin—the incremental credit-deposit ratio for all scheduled commercial banks was over 100 percent, as indicated by the FSR. For private banks, the incremental credit-deposit ratio was almost 120 percent. But banks apparently had no difficulty passing on the higher cost of deposits to their borrowers. The net interest margin (NIM) fell by only 1 basis point from a year earlier (3.6 percent versus 3.7 percent).

How have banks managed to maintain NIM in the face of rising deposit rates? They have done so by maintaining high growth rates in high-yielding retail products such as credit cards, personal loans, home equity loans and auto loans. The growth rate of these products in the last two years is a good 7 to 14 percentage points higher than the total credit growth rate of 15.4 per cent and 16.3 per cent in 2022-23 and 2023-24, respectively.

In what was supposed to be a tough year for banks, the return on assets for banks as a whole rose from 1.1% to 1.3%. Apart from NIM remaining high, the improvement was driven by a number of factors: higher credit growth, lower provisions, higher turnover income and higher fee income. The return on assets for public sector banks is 0.9%, which is quite close to the 1% figure that is something of an international benchmark. It looks like we are going back to the heady days of banking in the early 2000s.

Privatisation of PSBs, promised in successive budgets in the past, has been put on hold. Privatisation of IDBI Bank, which was initiated in 2018, is yet to be completed. With a return on assets of 1 per cent, PSBs can generate enough capital from internal surpluses and from the market to sustain themselves. They will not be putting much demand on the exchequer. The recovery of PSBs means that privatisation is likely to lose its momentum.

Banks have increased the share of retail and services sectors in total credit over the last two decades. The sustained growth in these sectors has not affected asset quality so far. Gross NPA in retail loans has declined from a peak of 2.1 per cent in June 2022 to 1.2 per cent in March 2024. Unsecured retail loans have long been seen as a risk-prone area in retail loans. However, the asset quality of unsecured retail loans has also shown improvement, with the gross NPA ratio at 1.5 per cent compared to 1.6 per cent a year ago.

It’s almost as if, after the infrastructure imbroglio of the early 2000s, banks can’t go wrong now. Tighter regulation and supervision, improved risk management at the bank level, and better leadership selection at PSBs through the Financial Services Institutions Bureau have all contributed to the improvement.

Can the Indian banking sector sustain itself in the state it has been in over the past few years? At first glance, there seems to be no reason to. Banking is a play on the economy. The Indian economy is expected to grow at around 6.5 per cent in the long term. FSR believes that credit growth of 16-18 per cent can occur without seriously affecting asset quality.

At the same time, competition for deposits will remain intense. As the FSR notes, net financial savings fell to 5.3% of GDP in 2022-23 from an average of 8.0% in 2013-22. The RBI’s annual report shows that the share of deposits in gross financial savings fell from a peak of 6.3% in 2016-17 to 4% in 2022-23.

The key question, then, is whether retail lending can continue to drive bank revenues and profits as it has in the recent past. The FSR sounds a note of caution. It indicates that household debt to GDP in India, at 40 per cent, is lower than in emerging markets. However, in terms of GDP per capita, it is quite high. Nevertheless, the performance over the past five years suggests that we are still far from the point where banks’ focus on retail lending could become counterproductive.

Many have commented on the remarkable resilience that the Indian economy has shown in the post-Covid years in the face of weak global growth. The stability of the banking sector is a key factor in sustaining this resilience. Our banking model has come under withering criticism from several quarters in the post-reform era. Its remarkable success in recent years should silence the critics.