The global slowdown has taken its toll on Indian economy. Besides, the domestic economy too is having its own set of problems. High inflation, subdued growth, slowing investments, undesirable current account deficit levels, high fiscal deficit and battered currency have together made the growth visibility rather muted. The banking sector, being the barometer of the economy, has succumbed to these challenges. Amidst this challenging scenario, the Indian banking system is continues to deal with improvement in operational efficiency and execution of prudent risk management practices.
RBI's hawkish monetary policy stance in order to combat inflation has led to sharp increase in interest rates during FY13. The elevated costs of deposits and limited pricing power ensured margin pressures for most of the banks for major part of FY13.
Indian banking industry, valued at Rs 77 trillion (Source: IBEF), is growing at a slower pace and plagued by bad loans. In what could be termed as a challenging year, FY13 witnessed steep increase in bad loans of Indian banks and turning them skeptical to extend loans to companies. As a share of sector loan book, the bad loans have gone up from 1.3% in March 2009 to 3.4% in March 2013. Public sector banks that account for 60% of the total banking assets have been the worst hit vis-a-vis its private and foreign counterparts.
Liquidity is controlled by the Liquidity is controlled by the Reserve Bank of India (RBI).
India is a growing economy and demand for credit is high though it could be cyclical.
Barriers to entry
Licensing requirement, investment in technology and branch network, capital and regulatory requirements.
Bargaining power of suppliers
High during periods of tight liquidity. Trade unions in public sector banks can be anti reforms and orchestrate strikes. Depositors may invest elsewhere if interest rates fall.
Bargaining power of customers
For good creditworthy borrowers bargaining power is high due to the availability of large number of banks.
High- There are public sector banks, private sector and foreign banks along with non banking finance companies competing in similar business segments. Plus the RBI is all set to issue new banking licenses soon.
The Central Statistical organization (CSO) reported the lowest real GDP growth at 5% during FY13. This growth stands lowest in the decade and even weaker than the recorded during the first year of global financial crisis. Banking sector, being inextricably linked to the economy, stood in a state of limbo for major part of FY13.
During FY13, the gross bank credit grew at a slower pace recording 15.1% YoY growth as against 17.3% a year ago. The numbers also stood below RBI's projections for FY13. Sluggish demand conditions, weak monetary policy transmission, poor asset quality and debilitating macro-economic conditions led to lower credit growth during FY13.
Except retail, the slowdown in credit was witnessed across sectors such as agriculture, industry and service segments. The RBI data reveals that retail trade and credit card outstanding were the only buoyant segments during FY13. Mid-sized businesses and loans for professional services were the worst hit.
Against a backdrop of GDP growth deceleration, weak IIP data and persistent inflation during FY13, banks became more risk averse to lending credit. This deceleration also reflected banks' risk aversion in face of rising NPAs and increased leverage of corporate balance sheets. The deceleration was observed across all bank groups, being high for PSUs and private sector banks, which jointly account for above 90% of the total bank credit.
The RBI had administered a 1% repo rate cut and injected liquidity through CRR and SLR cuts as also through open market operations during FY13. However, banks have only cut their base rate by meager 0.25%-0.30% owing to the liquidity constraints and weak deposit growth.
The aggregate deposits grew marginally to 14.2% at the end of March 2013 as against 13.8% in FY12. The growth differential between deposit and credit continued to hover between 2-3% with deposit growth outpacing the credit growth. The credit-deposit ratio was recorded at 78.1% during the same period. This ensured tight liquidity conditions during the whole of the FY13.
CASA, the cheap source of funds for banks, also remained sluggish for the major part of FY13. The elevated interest rates during FY13 led to migration of money from CASA deposits to fixed deposits.
Slower loan growth and weak CASA accretion resulted in margin (NIM) pressures for the banking industry. Furthermore, lower NIMs combined with higher credit costs that were earmarked for the bad and restructured loans dampened the earnings performance of Indian banks during FY13.
The sharp industrial slowdown during FY12 and FY13 took a toll on the asset quality of the banks. Gross NPAs of 40 listed banks went up by 43.1% from levels a year ago. The restructured book also spiked up dramatically with recast assets under CDR standing around 50% more than the previous year. The repercussions were largely felt by public sector banks as they were the ones to support the productive sectors of the economy.
Private sector banks, on the other hand, were better placed than its PSU peers during FY13. Better asset quality, higher margins and strong loan growth boosted the performance of private banks during the same period.
Going forward in FY14, the Economic Advisory Council of Prime minister expects the economic growth to rise to 6.4% from the current 5% on the back of the recent structural measures and normal monsoons.
Growth is still a concern for the banking sector on account of a sustained slowdown in the economy as well as reduced demand for credit on account of the current high interest rate environment. Sectors such as iron & steel, textiles, power generation, automobiles and ancillaries, telecommunication, aviation, construction, real estate, infrastructure, steel and cement are expected to throw-up challenges in terms of asset quality pressures for the forthcoming periods.
The domestic economic slowdown will continue to play spoilsport resulting in increase in non-performing loans and restructured loans especially for PSU banks. Given the greater stress expected to confront PSU lenders going forward, the margins and earnings performance are expected to take a hit. Given the core earnings standing extremely low for PSU banks, their balance sheets will be victim of higher credit costs, higher liabilities on account of wage revisions and wider MTM losses due to rising yields.
As per regulatory requirements Indian banks need to shore up their capital base to adhere to the incumbent BASEL III norms. With PSU banks falling short of the target, a consistent annual equity infusion of Rs 160-180 bn is expected to flow from government over the next 5 years. As per the FY13 budget, the government of India had allocated Rs 127 bn for capitalization of PSU banks and plans to invest Rs 140 bn in FY14.
Going by the dynamic nature of the real economy, it is imperative that the banking system will require being flexible and competitive. Notwithstanding the expanding branch network of Indian banks, the banking penetration still stands low in comparison to the global benchmark. Hence, the pressing need for financial inclusion and the issuances of new banking licenses to the private sector will continue to take precedence even in FY14. The RBI is in the process of issuing new bank licenses to those private players that would stand consistent with the highest standards of transparency and diligence. Moreover, necessary reforms, regulations for free entry and making the licensing process more frequent also forms the agenda of the RBI for the coming periods.