With India’s growth, its banking sector needs to grow at least 2.5 times the GDP growth in order to ensure that our growth momentum continues. Thus, if our economy is to grow at even 7% p.a., our banking sector needs to grow at minimum 17.5% p.a. However, whether the banking industry can live up to such expectations, is debatable. The banking sector is undergoing a number of changes in terms of asset quality, technology and regulations. The sector’s success in adapting to these changes will determine whether our banks will remain the main source of financing India’s economic activities or will undergo a gradual change in their roles and functions.
Problem of stressed assets
The Indian banking sector has been in the news ever since former Governor of Reserve Bank of India (RBI), Dr. Raghuram Rajan, introduced the Asset Quality Review in 2015. The review brought to the fore a significant amount of stress in the banking system, especially in the public sector banks (PSBs). The asset quality has been on a declining trajectory over the last few quarters and the gross non-performing advances (GNPAs) ratio of Scheduled Commercial Banks (SCBs) stood at 9.1% as on September 2016, pushing the overall stressed advances ratio to 12.3%, as per the Financial Stability Report (FSR) released by RBI in February 2017. In addition, banks are capital starved. It has been estimated that Indian banks need a total of Rs.3.7 trillion to be infused as capital between fiscal 2017 and 2019 to meet the Basel-III norms, of which government infusion should be Rs.1.4 trillion. As a result, banks have very little appetite for taking fresh exposures in new projects. And this can have serious repercussions for India’s GDP growth.
Five sectors namely mining, iron & steel, textiles, infrastructure and aviation account for more than half of the total stressed advances. Initiatives by the RBI to resolve this issue like the 5/25 scheme, the Corporate Debt restructuring (CDR) under Joint Lending Forum (JLF), the Strategic Debt Restructuring (SDR) and the Scheme for Sustainable Structuring of Stressed Assets (S4A) have not quite yielded the desired results. The issue of NPA evaluation has been the bone of contention where all initiatives have so far come to a naught. In the process, precious time has been lost and the problem has only aggravated as interest cost has kept escalating.
One of the major factors that discouraged banks from taking the dive in the various loan restructuring initiatives so far has been the fear of retrospective probe from various vigilance authorities. A few recent incidents have added to that sense of fear.
With the recent implementation of the Insolvency & Bankruptcy Code (IBC), the chances of turning around stressed assets have improved substantially. The creditors and lenders can go through the process set out by the Code. There will be dedicated Insolvency Professionals (IPs) who will overview the entire restructuring process. If required, there can even be a change in the management for turning around the stuck projects. Under IBC, the restructuring plans are to be endorsed by the National Company Law Tribunal (NCLT) thus providing it immunity from any future investigation. However, IBC may take some time to get fully operational.
To break this deadlock and to bring about a sense of urgency into the process of resolution of bad loans, a Banking Regulation (Amendment) Ordinance 2017 has been introduced which has recently got the President of India’s assent. This ordinance now authorizes RBI to direct banks to resolve specific cases of bad loans by initiating a resolution process under the new insolvency law, something generally avoided earlier. RBI has issued a new set of rules to make the functioning of JLFs more efficient, pragmatic and time-bound. Since building consensus on Corrective Action Plan (CAP) among lenders in a JLF takes up too much time, RBI has lowered the threshold needed for implementation of a CAP.
RBI has also been empowered to specify one or more authorities or committees to advise banks on resolution of stressed assets. The oversight committees are to help banks with the decision making and monitoring of the progress on the resolution processes initiated. This will lead to creation of more sector-specific oversight panels which will shield individual bankers from subsequent investigations in future.
However, while the ordinance is welcomed at this stage, what is needed for a long-term sustainable growth of the banking sector is systemic reform. The reasons behind bad loans vary from case to case. Thus, customized solutions are needed. As a starting point, we need to review the composition of the PSB Boards. Those boards routinely have representatives from RBI, Ministry of Finance, chartered accountants, and professionals with legal experience among others. What seems to be missing is the presence of people with adequate industry experience. The industry perspective is very important in taking a view of the bigger picture while evaluating project proposals and then taking credit decisions. If we can think of oversight committees comprising sectoral experts during the resolution process, why not involve the sectoral experts at the decision making stage? Even after that, if a loan goes bad, the restructuring exercise should ideally be taken by an empowered committee formed by the Board. The committee can comprise of the independent directors. Such a committee will be better equipped in coming up with a plan. In cases where a loan has gone bad for a lending through a consortium, the committee can comprise of the independent directors of the lending banks so that there is consensus on the restructuring plan. More importantly, the decisions of the committee are made on commercial lines and those should not be subject to later investigation.
Also the definition of NPAs is probably worth reviewing. It does not make logical sense to have the same yardstick for NPA classification as for a car loan, a home loan and or an infrastructure loan. The asset classes are vastly different. For example, the number of factors that affect an infrastructure loan is much more than the other two asset classes. Thus, the risks associated with each asset class are different from the others and by that logic the definition of NPAs should also vary asset-wise.
Indian banks’ emphasis and focus on security rather than the projected cash flows while doing credit assessments and loan appraisals is quite intriguing. Going forward, cash flows should get adequate weightage in lending decisions.
Instead of getting into micromanagement, RBI’s long-term focus should be to facilitate banks. RBI should strengthen the individual bank boards and allow the banks to come up with their own resolution plans. Decision making process has to be faster. Individual boards can consult the newly constituted Banks Board Bureau (BBB) for framing the revival strategy. RBI should ideally allow increasing the general provision norms in times of stress. For long term sustainable growth, especially in PSBs, there is a need to embrace higher levels of professionalism and adopt more scientific techniques of decision making.
The asset quality issue will get addressed in due course. However, it will be the pace of technological advancement that will test the banking industry more. During the last 2-3 years, use of technology has become integral to banking operations and technology is used for data analysis, for understanding the
credit needs of customers, customer interaction, etc. and even helps banks to offer more focused products to customers. Thus, banking and technology are now inseparable. This emerging technological landscape in the financial world will be a formidable challenge and at the same time, a huge opportunity. Players who will be able to successfully ride the technology curve will emerge winners, while those who will fail to do so will lose out. Some of the banks who have taken the lead in embracing technology are now being equated with ‘technology players with banking licences’.
Technology can be truly disruptive. New age tech-enabled products like digital cash or mobile wallet which provide services by completely bypassing the banking channel have tasted success. In addition, 2015 has also witnessed the birth of two new types of banks – Payment Banks and Small Finance Banks – whose aim is to essentially increase financial inclusion. They further enabled with technology can formulate low cost models and can give incumbent players stiff competition. However, one area where the incumbents definitely have an edge over the new entrants is the fact that they are sitting on a gold mine of data. The value proposition to the customers can be driven by that data. This is where the existing banks can use data-driven technology to disrupt the disruptors.
It is the consumer who will be the ultimate beneficiary of the technological revolution. However, it must be kept in mind that 70% of the customers may be below the age of 35, but 70% of the money resides with customers who are above the age of 40 and a large chunk of them want things to be delivered personally rather than digitally. Thus, banks need to cater to both segments.
Another phenomenon which is still at a nascent stage in India but has the potential to emerge as a competition as well as a disruption to traditional banking is crowdfunding. This concept has taken off in developed economies like USA and Europe and during the last couple of years it has gained considerable traction in Asia as well. Presently, the crowdfunding of projects is done online on social network platforms and these mostly bypass traditional banking intermediaries. Crowdfunding is an attractive route especially for MSMEs and start-ups whom banks are reluctant to fund. Given that one of the core concepts of crowdfunding is the focus on transparency, globally banks are adapting their business models in order to follow suit and provide more transparent products. Before it emerges as a competitor, Indian banks can consider setting up digital platforms to bring together potential borrowers and lenders to promote and finance entrepreneurs. This would be one way of
benefiting from the “collective intelligence” of the crowd. However, RBI would need to put in place necessary regulations for that to happen.
Being a technology-driven service industry, the future of India’s banking industry will ultimately depend on the people working in this industry and their skill-sets and on how well they are able to blend the advantage of technology with the ingenuity of the human mind. The transition must happen from the top to the bottom. There is a need for a new thought leadership not only at the bank management level but at the regulator level too. Technology is continuously evolving and the contours of the banking sector are also changing. There is need to upgrade the skill-sets. While technology can at best be an enabler, it is ultimately the human intellect that would need to take the final call on matters like risk management or investment.