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India’s public sector banks are at the crossroads where they are supposed to remain healthy without giving up social responsibilities; they need to undertake risky experiments, yet perform well. 

India’s banking industry is a study of contrasts; on the one hand it is acting as the growth driver of the world’s fastest growing major economy, and on the other, is grappling with challenges of mounting bad loans, deteriorating asset quality and decelerating core business activities, which are threatening their future growth prospects.

The most grievous among them is the increasing burden of distressed loans. According to the Reserve Bank of India (RBI), the value of banks’ gross non-performing assets (GNPA) and restructured assets reached $150 billion in April 2016 and has been growing by almost 25% annually since 2013. The public sector banks account for more than three-fourths of the stressed asset load. Provision levels are inadequate to bring in an immediate solution to this problem.

What is probably more disturbing is that the recovery rate has been falling over the years. Data from the RBI show that in 2015-2016, the recovery rate fell to 10.3% of the net NPAs. In 2014-2015, it was at 12.4%. In 2013-2014 and 2012-2013, the recovery rates were even better at 18.4% and 22%, respectively. The public sector banks account for more than three-fourths of the stressed asset load. Not surprising since the public sector banks are more exposed to industry sectors with a higher share of non-performing loans than their private-sector counterparts. These state-owned institutions have deep networks and control 70% of banks’ asset base. From 2009 to 2016, the government made capital infusions of about $15 billion into them.

That the problem of rising NPAs is a major concern for the Indian banking industry is a reality but there is much more beyond this for the sector. For, 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.

Indeed, the headline numbers do not tell the entire story and there are many aspects to the changing face of banking in India. Even as the banks suffer from stressed assets and stagnant loan growth, they continue to support and push the country’s growth parameters.

Growth over the years

In India, there are 21 public sector banks (after the merger of SBI Group Banks), 25 private sector banks, 43 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 64,998 billion by 2014-15 from  Rs 19,312 billion in 2006-07. Demand has grown for both corporate and retail loans; particularly for the services, real estate, and consumer durables.

The public sector banks, which form the nucleus of the country’s banking system, has been the prime driver of this growth. In the last five years, between 2010-11 and 2015-16, the aggregate credit advances of the public sector banks have increased by about 65%.

Aggregate deposits of the public sector banks have grown 66.3% during the same period from Rs 27,078 billion in 2010-11 to Rs 45,019 billion in 2015-16. Deposit growth has been mainly driven by strong growth in savings amid rising
disposable income levels. Access to the banking system has also improved over the years due to persistent government efforts to promote banking-technology, and expansion in un-banked and non-metropolitan regions.

Falling C-D ratio

The growth of deposits and credit has, however, witnessed a decline in recent years. The rising NPAs and a general
decelerating investment trend the world over, has a distressing impact on banks’ operation. The growth of credit off-take has been affected seriously during the last two years causing a fall in credit-deposit ratio. The credit-deposit ratio of the public sector banks has declined by about one percentage points in the last four years from 77.85% in 2012-13 to 74.72% in 2015-16.

The situation worsened in 2016-17 and is reflected in the lower growth in credit off-take compared to that of deposits. According to RBI data, the deposit and credit growth of nationalised banks declined to 6.5% and 0.6% in the January-March 2017 quarter as compared to 11.6% and 2.9% growth in the previous quarter. Financial analysts blame demonetisation of last November as the prime reason for this deceleration. Rising NPAs together with a fall in credit off-take rate has had an impact on the overall performance of the public sector banks. This is reflected in the declining return on assets of these banks. The return on assets has fallen from 0.8% in 2012-13 to 0.2% in 2015-16.

Technological upshot

The financial sector probably has been influenced the most by the innovations in information technology. The age of digitalisation and move towards adoption of new technology have 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 is 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 of 2016. Banking technology is emerging as synonymous with the concept of everyday banking. This becomes a credible reality only when there is complete digitisation of banking operations, as well as a strong ecosystem of cross-industry partners and providers.

Technological upgradation has, however, seen banking activities to grow beyond the number of physical branches. The use of debit / credit cards and net banking has increased manifold over the past years.

In just five years, between 2010 and 2015, the total number of branches of scheduled commercial banks grew by over 47% from 85,393 to 1,25,672. The number of rural branches has grown 49% during the same period from 32,624 to 48,498. The higher growth in the number of rural branches indicates the spread of the banking network to hitherto unbanked areas, something government has been talking about for years.

The number of credit and debit cards in India is steadily rising although Indians still prefer debit cards to credit cards. According to RBI data, a total of 28.8 million credit cards and 818 million debit cards were in operation as on January 2017. Between January 2016 and January 2017, India added some 0.52 million credit cards and 56.86 million debit cards. Number of transactions on credit cards grew by 70.5% while it rose by 199% for debit cards for the year ending January 2017. In January, total number of transactions through credit cards was 118.78 million while the figure for debit cards was 328.6 million.

Financial Inclusion Plan

But not only in terms of 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.

These are good developments but to back such ambitious projects of the government the banks must do financially well and stay healthy. With corporate demand for funds shrinking, the next best growth opportunity for banks may lie in India’s vast number of small and medium enterprises (SMEs). Most of these enterprises right now look to the informal sector and non-banking financial companies for their financial needs. With the push from the informal to the formal financial sector a huge number of SMEs could enter the banking domain.

But for that the banks will need to review their traditional lending mechanisms which many of these enterprises find difficult to adhere to. Many of them cannot raise the collateral banks require. High interest rates, indebtedness and processing demands of the banks are often cited by SMEs as reasons for going to informal lenders. On the face of a declining credit off-take public sector banks will probably do well to re-look these issues to broaden their client base.