The RBI’s recently released “India Banking Trends and Progress Report” (RTPB) and “Financial Stability Report” (FSR) provide good quality information and analysis on the state of the system. banking in India.
There is no denying that the pandemic has left deep scars on the Indian banking system, and it is quite possible that the imperatives of the ‘new normal’ induced by the pandemic are having an impact and influencing the risk-return landscape for most businesses. economic and commercial in the years to come. Yet these two publications provide an opportunity to take a close look at the performance continuum and challenges facing banks in India.
Credit risk in the loan portfolio
Banks’ loan portfolios are the custodians of 80 percent or more of their aggregate risks, calculated by the regulatory capital required for that purpose. Losses from credit risk exposure have overwhelmed, particularly public sector banks (PSBs) from time to time, the most recent having occurred in the years following the start of the asset quality ”in 2014.
Despite this context, a perception has long been created, and in particular following the global financial crisis (2008-10), that the so-called traditional banking involving the mobilization of deposits and the granting of loans is intrinsically safe and less risky and any financial innovation such as securitization and the use of derivatives for risk taking is necessarily bad and dangerous at best, and reckless speculation at worst.
There was a slow pick-up in demand for bank credit in 2021, with the latest impression being a 7.1% year-over-year increase, most of which was led by the retail sector of their business. However, the pace of personal credit growth remains below its pre-Covid level.
In fact, the personal-led credit growth model, which has been embraced as a strategic issue by most of the big banks in India, now faces headwinds. As the FSR revealed, defaults in the consumer credit portfolio have increased, and the new credit segment, a key driver of consumer credit growth in the pre-pandemic period, is showing a drop in fixtures.
On the wholesale side, while loans to public sector entities show a decent increase, growth in loans to non-PSU non-financial entities has seen a continuous overall decline for almost two years now, with positive growth. modest for AA and above. rated companies.
As for the reasons for weak credit growth, research by the RBI, revealed in the RTPB, confirms what is already known intuitively: the slowdown in industrial activity and investment have constrained demand for credit, while that stressed bank balance sheets have limited the supply of credit.
A key question to be asked and answered in the context of the role of banks as the main intermediary between savers and borrowers in the economy, is whether credit risks of different types are properly assessed by they using the most recent tools and if the corresponding remuneration is adequate. Unfortunately, the answers to these two questions are not unambiguously affirmative.
The FSR provides us with some interesting clues to start thinking about these questions: during the period March 2019 – September 2021, the ratio between the number of rating upgrades and the rating downgrades of a selected group of non-financial companies non-PSU increased from 0.66. at 0.35, with a low of 0.06 reached in June 2020.
In general, the portfolio of these corporate borrowers tends to suffer more downgrades than revaluations, which implies a deterioration in the portfolio’s credit risk profile over time. This seems to be the experience of wholesale credit for a long time.
Are banks paid for adverse credit risk migration propensities? No. There is reason to believe that the risk-adjusted return on business credit has been woefully low for a long time. This is especially true for PSBs, whose currently stressed 12.5% wholesale credit segment is much larger than that of private banks (PVBs) and foreign banks (FBs).
What adds to the concern is that the adverse migration characteristic of credit risk is now visible in banks’ consumer credit portfolios. It is not clear at first glance if this is a consequence of the economic adversity associated with the pandemic or if there is something more lasting at work.
Compared to the onset of the pandemic in March 2020, the financial performance of PSBs, PVBs and FBs has now improved considerably. But in the case of PSBs, even a slight shift from the benchmark to 2015 or beyond would tell a very different story: They, as a group, continue to lag behind.
More importantly, the RoA (return on assets) of PSBs (see table) is not only much lower than that of PVBs and FBs, but is just over half of what has been achieved, on average, over the course of the five-year period to 2012 -13, the latest fiscal year for which disaggregated bank activity and performance data was released by the RBI.
The same is true for all other metrics. An important underlying fact about the RoE (return on equity) of PSBs is that as a group they are significantly more in debt than PVBs and FBs, which makes them structurally riskier. On the business expansion front, they have fallen far behind: their (year-on-year) growth in CASA in September 2021 was 11.6% versus 22.8% for PVBs and 17.2% for PVBs. FB.
In addition, the operating expenses of PSBs as a proportion of their total income have increased sharply, from 18% during the five-year period up to 2012-2013 to 24.4% currently, while this measure for PVBs and the FBs remained more or less unchanged. . These developments do not bode well for the ability of PSBs to compete on loan prices, all other things being equal.
Insufficient political capital
The country needs bold political initiatives to privatize most of the PSBs within a reasonable timeframe. The reasoning for doing so is simple and straightforward: A capital-constrained country like ours can hardly afford inefficient and systematic use of the financial savings and taxpayer dollars that the government uses to recapitalize PSOs.
A first step in dispelling the political fog surrounding privatization would be to debunk the myths that have been assiduously maintained over the years to justify the below-average performance of PSBs. One of these myths is that the PSBs hold ordinary people’s savings in trust and therefore their privatization would violate the social contract that underlies the current arrangement.
Fortunately, the Supreme Court, in a recent order, refused to accept the concept of guardianship. But popular perception stubbornly refuses to accept the debtor-creditor relationship that exists between a bank and its depositors. Furthermore, the message we are getting from the last minute hesitation from the government on the presentation of a bill on the privatization of two PSBs in the winter session which has just ended is that political capital required for this purpose is currently insufficient.
The author is a former central banker and consultant to the IMF. (Through the billion press)