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Nine out of ten financial analysts in India today are busy counting the dismal consequences of the rising non-performing assets (NPAs) of the banking sector. The slowdown in the economy in the last few years has led to a rise in bad loans or non-performing assets deteriorating the asset quality of the banks.

That the rising NPAs are the major concern of the Indian banking industry is a reality but there is much more beyond this for the sector. Despite the rise in NPAs, India’s banking sector is set to become the fifth largest banking industry in the world by 2020 and the third largest by 2025 according to a recent KPMG-CII report. India’s banking sector has been expanding rapidly over the past years followed by the emergence of universal banking, higher economic growth and globalisation.

The banking industry is considered to be the lifeline of an economy. It plays a catalyst role in activating and sustaining economic growth. “If we look at the statistics, India being one of the top ten economies of the world and with relatively low domestic credit to GDP percentage provides great opportunity for the banking sector to grow,” the KPMG-CII report on the banking sector has observed.

Problems of bad loans

But if the banking sector has been growing steadily over the years, the incidence of piling up of bad loans has put a big challenge to its future. Indian banks’ gross NPAs or bad loans, stood at Rs. 10.25 lakh crore as on March 31, 2018. The bad loan grows by Rs.1.39 lakh crore or 16% in the fourth quarter of last fiscal from Rs. 8.86 lakh crore at the end of the third quarter. The fourth quarter addition accounts for about 11.8% of the total loans given by the banking industry. For financial year 2018, the total bad loans of these banks rose by a whopping Rs. 3.13 lakh crore.

A break-up shows that 21 public sector banks (PSBs) witnessed an increase of Rs.1.19 lakh crore or 15.4% to Rs. 8.97 lakh crore in the March 2018 quarter compared over the third quarter. The NPAs of the 18 private banks increased Rs.19,446 crore or 17.9% to  `1.28 lakh crore in the March 2018. After making provisions, the net bad loans of these banks stood at Rs. 5.18 lakh crore in the fourth quarter of the last fiscal against Rs. 4.69 lakh crore in the December 2017 quarter.

The State Bank of India (SBI), which tops the NPA chart, witnessed an increase of Rs. 24,286 crore in bad loans in the March quarter to Rs. 2.23 lakh crore. The scam-hit Punjab National Bank (PNB) reported the maximum rise of 29,100 crore  in gross NPAs to Rs. 86,620 crore in the March quarter. Except the Bank of India (BoI) and Oriental Bank of Commerce (OBC) all other PSBs’ recorded a rise in bad loans during the quarter. While Bank of India’s gross bad loans declined by Rs.1,920 crore in the March quarter, that of OBC was down by Rs.1,417 crore.

Among the private banks, the gross NPAs of ICICI Bank grew by Rs. 8,024 crore or 17.4% in the March 2018 quarter to Rs. 54,063 crore. The gross NPAs of Axis Bank went up by Rs. 9,248 crore or 37% to Rs. 34,249 crore in the March 2018 quarter from Rs. 25,001 crore in the previous quarter. The sharp rise in bad loans is feared to curb the growth prospect of the economy which after two sub-par years, following demonetisation and the implementation of the Goods and Services Tax (GST), seen recuperating to a respectable 7.5% next fiscal. The key engines supporting the upturn are largely domestic and policy-driven, though a synchronous upturn in global growth will, undoubtedly, provide some tailwind. However, this would require a huge support from the banking sector. But in view of the asset quality issues plaguing the public sector banks – with gross non-performing assets (GNPAs) touching 10.5% -- that no meaningful and sustainable economic recovery is plausible without a resolution process.

The transparent and time-bound process driven by National Company Law Tribunal (NCLT) has offered some hope to banks. After the successful sale of Bhushan Steel, the Insolvency and Bankruptcy Code seems to have come as rescue to India’s NPA-ridden commercial banks. Bhushan Steel owes close to Rs. 48,000 crore to banks and was referred to the NCLT by Punjab National Bank last year. Tata Steel’s acquisition of Bhushan Steel alone is estimated to reduce banks’ NPAs by Rs. 35,000 crore.

The Reserve Bank of India (RBI) has recently come out with yet another weapon to clean up the mess that India’s public sector banks are in. The RBI reviewed and revised the prompt corrective action (PCA) framework for banks. The central banks’ latest move, however, is feared to restrict the credit flows to industry which has already been affected by the huge loss incurred by the public sector banks (PSBs). The aggregate losses of public sector banks were estimated at over Rs. 87,357 crore in 2017-18. Scam-hit Punjab National Bank (PNB) topped the list with a loss of nearly Rs. 12,283 crore. India’s largest bank State Bank of India incurred a net loss of Rs. 6,547.45 crore in 2017-18 against a net profit of Rs. 10,484.1 crore in 2016-17. Losses by state-run banks have almost entirely wiped out the $13 billion capital infusion by the government, and the situation is unlikely to improve in the current fiscal year, said ratings agency Fitch.

Growth parameters of commercial banks

The Indian banking sector consists of 27 public sector banks, 22 private sector banks, 44 foreign banks, 56 regional rural banks, 1,589 urban cooperative banks and 93,550 rural cooperative banks, in addition to cooperative credit institutions. Public-sector banks control nearly 80% of the market, thereby leaving much smaller shares for its private peers. The economic liberalisation in the early 1990s that prompted huge private sector investment led to a steady increase in business of the banking sector. The credit off-take surged aided by a strong economic growth, rising disposable incomes, increasing consumerism and easier access to credit. Total credit extended by India’s scheduled commercial banks (SCB) went up to Rs. 81,162 billion by 2016-17 from Rs. 34,970 billion in 2009-10. That is, in seven years bank credit has grown 132%.

The total bank deposits too have grown steadily over the years following an increase in households’ disposable income. Total deposits of commercial banks have more than doubled (increased 2.3 times)  in the last seven years from Rs. 47,524 billion in 2009-10 to Rs. 1,11,139 billion in 2016-17.

Financial Inclusion

But not only in business, the sector has grown significantly geographically too. The Financial Inclusion Plan (FIP) of the government has provided a structured and planned approach to financial inclusion with a commitment at the highest echelons within the banks. Out of 2,259 rural bank branches opened during April 2015-March 2016 as many as 1,670 branches were opened in un-banked rural sector. Around 71 million basic savings bank accounts were added taking the total to 469 million by March 2016.

The total number of small farm sector credits (Kisan Credit Cards) and small non-farm sector credits (General Credit Cards) stood at 47 million and 11 million, respectively. With the conclusion pf the FIP’s Phase II (2013-16) on March 31, 2016 all domestic scheduled commercial banks were advised to set new Board approved FIP targets for the next three years.

Technological innovations

The banking sector world over has probably been influenced most by the innovations in information technology. The entry of digital forces like social, mobile, analytics, cloud and internet of things (IoT) are creating flow of business information in a more direct and cost efficient manner. India is in the midst of this phase of ‘Digital Darwinism’. The new technology trends such as cloud computing, artificial intelligence and biometrics etc, are bringing about dramatic changes in the payment systems. Already the Indian banking sector is making substantial investment in forming digital infrastructure to offer various solutions like mobile banking, e-wallets and virtual cards, etc. Payment systems have paved the way for new banking paradigms by bringing new financial technology driven instruments with customer’s satisfaction and risk mitigation techniques. The new technology has transformed the way banks do business today. Information technology has played a vital role in shaping India’s new-age banking activities. Banking technology today directly influenced by the spread of smart-phones and extensive availability of 3G and 4G networks. Advances in technology have also created newer customer expectations, multi-channel structure and progressive product offerings in the banking industry. 

Indian banks today have the onus of being proactive in technology making them available to customers anytime and anywhere. To note, these factors also serve as the basis for emerging trends in the banking industry. Banking technology is emerging as synonymous with the concept of everyday banking. This becomes a credible reality only when there is complete digitization of banking operations, as well as a strong ecosystem of cross-industry partners and providers.

Central banks’ concern continues

Away from the immediate concerns on growth and currency management in the light of the sharp increase in NPAs in the banking sector, the country’s central bank has pointed out some deeper concerns. On the one hand, India’s macroeconomic conditions broadly remain stable and resilient with considerable moderation in consumer price inflation. But developments in the financial sector tell a different story. The banking stability indicators as set out in the recently released Financial Stability Report of the RBI depict some serious concerns. The report highlights the elevated risks in the banking sector emanating from continuous deterioration in asset quality, low profitability and liquidity. 

The credit growth of scheduled commercial banks (SCBs) picked up during 2017-18 amidst sluggish deposit growth but the stress in the banking sector continues as gross non-performing advances (GNPA) ratio rises further, the report has said. Profitability of SCBs declined partly reflecting increased provisioning. This has added pressure on SCBs’ regulatory capital ratios. Macro-stress tests indicate that under the baseline scenario, SCBs’ GNPA ratio may rise from 11.6% in March 2018 to 12.2% by March 2019. The system level capital to risk-weighted assets ratio (CRAR) may come down from 13.5% to 12.8% during the period. Sensitivity analysis indicates that a severe shock to the GNPA ratio could bring down the CRAR of as many as 20 banks, mostly public sector banks (PSBs), below 9% worsening the asset quality further, the report has cautioned.

However, despite problems the future of banking looks positive and transformative. Despite the somewhat difficult current operating environment, banks remain the largest financial sector intermediary in India. In future, technology will make the engagement with banks more multi-dimensional even as other entities, markets and instruments for credit and financial services continue to develop and expand.

Postscript

Clearly the most serious concern for India’s banking sector today is the rising bad loans. But the question is who is responsible for this situation?  Bankers blame the regulators while the regulators blame the bankers. The fact is all of them are responsible for the mess. In the words of the former RBI governor, Raghuram Rajan, “Bankers sometimes turn around and accuse regulators of creating the bad loan problem. The truth is bankers, promoters, and circumstances create the bad loan problem.”

The recent move by RBI is feared to affect the credit flows of the banks as officials would be extra cautious to disburse loans. In fact, a recent report shows that bank officials are reluctant to work in the credit department. This will have a serious impact on the investment scenario and many new projects will be stalled forced to defer. If so, the country’s GDP  growth target will be under threat.