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  • : Banking: Is the worst over?

    Banking: Is the worst over?

    With the fears of subprime losses and write-offs looming large and soliciting headlines for most part of the fiscal, FY08 was not particularly the bankers' delight. The developments in the Indian banking sector in FY08, however, did not mirror that of its global counterparts. This was manifested in the government's and the RBI's efforts of reconciling the twin objectives of facilitating economic growth and containing inflation. While limited exposure to global assets itself thwarted the sub-prime risks, the meltdown in credit disbursal due to a slowdown in economic growth could not be avoided.

    While India has remained relatively insulated from the global credit crisis due to the domestic entities' limited exposure to the sub-prime and related assets in matured markets, its gradual approach to the financial sector reforms process, with the building of appropriate safeguards to ensure stability, has played a positive role in keeping India immune from such shocks. Thus, the slow and steady approach adopted by the RBI has displayed its merits.

    Surplus liquidity…
    Growth in money supply (measured in terms of broad money, M3) accelerated to 23.8% YoY until January 2008 against a 21% YoY growth during the corresponding period of FY07. This was significantly higher than the RBI's projection of 17.0% to 17.5%. The surplus liquidity was due to the accretion to the net foreign exchange assets of the banking sector (grew 34.8% YoY). As foreign investment flows kept rising, the RBI kept purchasing the foreign exchange assets (up 41.9% YoY) thus infusing additional liquidity in the system.

    RBI - Holding its guns
    As against its global counterparts, the RBI did not give in to 'market expectations' and did not compromise on fiscal prudence. The RBI's monetary policy stance was attuned to blend a prohibitive interest rate environment with consistent growth momentum and price stability. The focus was on credit quality and supporting the export and investment demand in the economy. The RBI's deliberations were aimed at maintaining macroeconomic stability in general and responding swiftly to evolving global developments in particular.

    The quarterly monetary reviews also spelt out the following three issues:

    • To be in readiness to take recourse to all possible options for maintaining stability and the growth momentum in the economy in view of the unusual heightened global uncertainties

    • Unconventional policy responses to the developments in global financial markets

    • Increased supply-side pressures evident from rising prices of primary articles; and

    • The need of the monetary policies to contend with lagged response of productive capacity and infrastructure to the ongoing expansion in investment.

    YoY % growth in credit
    At the end of Nov' 06 Nov' 07
    Agriculture 31.5 21.4
    Industry 25.6 25.3
    Personal loan 35.0 20.0
    Housing 33.4 15.1
    Credit card 43.3 43.7
    Consumer durables 11.2 (4.4)
    Priority sector 25.6 25.3
    Source: CMIE
    Caution sets in…
    Bank credit to the commercial sector has slowed down in FY08 (21% YoY) against the levels in FY07 (28% YoY) due to an overall pressure on the economy. Having said that, the incremental disbursements to infrastructure (grew 35% YoY), construction (grew 37% YoY), automobiles (grew 38% YoY), iron and steel (grew 32% YoY) and engineering activities (grew 28% YoY) were higher than credit to industry (grew 25% YoY) and agriculture (grew 21% YoY). This signaled the focus on lending to productive sectors.

    While most of the high-risk assets witnessed a significant impact in their growth rates, the worst hit were the mortgage loans. However, it is to be noted that the loans on credit cards (one of the most risky unsecured asset) showed no signs of slow down also suggesting a larger client base for the same.

    With buoyancy in deposit accretion and corresponding shortfall in credit disbursal, the banks' investments into government securities grew by 30% YoY. The monetary tightening initiatives by the RBI by way of hike in the CRR (cash reserve ratio) by 1.5%, however, heightened the margin (NIM) problems for the banking sector. This culminated in banks across the board lowering their benchmark prime lending rates (BPLR) towards the end of FY08 to garner additional loans and curb deposits thereby sustaining net interest margins (NIMs).

    Rates over the months…
    (%, per annum) Mar-06 Mar-07 Mar-08
    Bank rate 6.00 6.00 6.00
    Cash Reserve Ratio (CRR)* 5.00 6.00 7.50
    Statutory Liquidity Ratio (SLR) 25.00 25.00 25.00
    Benchmark PLR
    PSU Banks 10.25-11.25 11.50-12.25 11.50-12.50
    Private sector banks 11.00-13.50 11.75-15.50 12.25-13.50
    Weighted call money rates 7.40 7.76 7.60
    Comm.Papers by companies 6.20-7.75 7.74-10.00 7.74-10.00
    10 year GSec yield 7.20 7.73 7.60
    Deposit rate (> I year) 5.50-6.50 7.25-8.50 8.25-8.75
    Repo rate 6.50 7.50 7.75
    Reverse repo rate 5.50 6.00 6.00
    Source: Economic Survey FY08

    The economic survey has based its positive outlook on economic growth momentum and the analogous requirement for higher credit disbursals on the underlying facts that the quality of credit continues to remain healthy and that credit as a proportion of GDP is low in India by international standards. Hence, credit will continue to outpace GDP in terms of growth in the years to come.

    However, the problem lies in managing liquidity. The subprime crisis and the response of the US and other developed countries' central banks to it, by reducing interest rates and a renewed expansion of liquidity, may increase the capital flows into India and other emerging markets. On the other hand, the lesser credibility of the developed market intermediaries and increased risk aversion among their investors may defer some long-term investments in developing economies like ours.

    With the transition of the Indian economy to a higher growth trajectory, the provision of adequate and timely availability of bank credit to the productive sectors of the economy has acquired increased importance. As public sector banks still own about 71% of the assets of the banking system, they continue to play an important role in responding to the changes in the economic environment. However, it is expected that the agility of the private sector banks in Basel II compliance and consolidation in FY09 will set the precedents for the sector's future.

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