Global growth did not recover as expected across most major developed and rapid-growth economies in 2013-14. During the year gone by, the central bankers across the globe took decisive steps to restore confidence in markets and broader economy. In Europe, the banking situation improved in part due to the long-term refinancing operations of the European Central Bank (ECB), which helped ensure there was plenty of liquidity in the system. In the US, the picture was more upbeat but still mixed. And although businesses and consumers started to borrow again, credit growth remained tepid. The global economic environment broadly strengthened, and is expected to improve further, with much of the growth impetus emanating from advanced economies. There was acute financial volatility in emerging market economies, and increases in the cost of capital which dampened investments and weighed on growth.
The banking sector, being the barometer of the economy, is reflective of the macro-economic variables. While the Indian economy is yet to catch strength, the Indian banking system continues to deal with improvement in asset quality, execution of prudent risk management practices and capital adequacy.
The Reserve Bank of India (RBI) maintained a status quo in interest rate since January 2014. However, despite the retail inflation softening in recent periods, it'll be a little while before the Central Bank would opt for rate cut.
Indian banking industry, with total asset size of Rs 81 trillion (USD 1.34 trillion), is expanding continuously but on a cautious note. The fact that the industry is plagued by bad loans, the lenders have chosen to go slow in terms of credit offtake. Fiscal 2014 saw a combination of various external and internal events that kept markets turbulent, interest rates high and investor confidence low, resulting in shrinking investment and GDP growth.
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.
India's underlying economic growth trends remained weak during FY14. High and persistent inflation remained a key macroeconomic challenge facing India throughout the FY14.
During the year, the operating environment for the banking system continued to be challenging with persistent high inflation, muted growth, slowdown in credit off-take, concerns over higher non-performing assets and a high incidence of restructured assets.
Against the backdrop of a slowdown in the domestic economy and tepid global recovery, the growth of Indian banking sector too remained under pressure in FY14. That said, the deposit and credit growth was marginally better than that in FY13. The growth in deposits of scheduled commercial banks (SCBs) at 14.6% in FY14 was marginally better than the growth at 14.2% in the previous financial year. However, this growth came on the back of the liberal policy adopted by the RBI towards non-resident Indian deposits. The credit growth at 14.3% in FY14 too was marginally better than that at 14.1% in FY13. As a part of monetary transmission, base rate of major banks inched up from 9.70%-10.25% in April 2013 to 10.0% -10.25% in March 2014, while deposit rates were readjusted from 7.5%-9.00% to 8.0%-9.25% in the same period.
In FY14, private sector lenders experienced significant growth in credit cards and personal loan businesses.
Owing to elevated inflation levels, the banks were compelled to offer attractive interest rates on their term deposits so as to protect their liability franchise. The higher deposit rates coupled with lower credit offtake impacted the net interest income and thereby the earnings profile of commercial banks. Additionally, the macroeconomic challenges and poor repayment capacity of borrower's deteriorated the banks' asset quality further in FY14. Consequently, the restructured assets moved north during the year. However, despite the challenging environment, few banks with prudent risk management systems and the ones with robust cash recovery delivered a sound performance during FY14.
The aggregated profit after tax (PAT) of PSBs declined by 27% YoY during FY14. The gross NPAs of banks (PSBs + private) increased over the last one year from 3.3% to 3.9% as on March 2014. Restructured advances of the PSBs remain at elevated levels of 6.2% as on March 31, 2014. Private sector banks were able to hold on good asset quality as reflected in their gross NPAs of 1.8% as on March 2014.
Banks started reporting capital adequacy as per Basel III norms since June 2013. The Tier 1 capital of PSBs stood at around 8.6% as on March 31, 2014 as against the required Tier 1 capital of 6.5%, while that of private sector banks was well above the norms around 12.8%. Return on net worth for PSBs dropped to single digit in FY14.
While the medium term prospects point towards an improving growth scenario, given the improved macroeconomic fundamentals it is highly likely that there will only be a modest economic recovery in FY15.
That said, the Indian economy is now on the threshold of a major transformation, with expectations of policy initiatives by the change in guard at the Centre. Positive business sentiments, improved consumer confidence and more controlled inflation should help boost the economic growth. With a new and stable Government in place now, a clear revival in the investment climate is sure to come. Higher spending on infrastructure, speedy implementation of projects and continuation of reforms will provide further impetus to growth. A moderate recovery is likely to be seen in FY15 and the real GDP is expected to grow by 5.3%-5.5%. While the CPI inflation is expected to remain an important challenge for India, it should witness a downward trajectory during the major part of FY15
The worst seems to be over for the Indian banking industry, as there will be increased clarity on macroeconomic and political fronts during FY15. On the positive side, liquidity remains steady, inflation is expected to move downwards for the major part of FY15 and the RBI is in full control to manage any volatility. Macroeconomic improvements and potential for post-election reforms should see a gradual reduction in stressed loans on lower slippages and higher recoveries. Recovery in macroeconomic environment and expected revival in economic growth will help to mitigate risks and resolve problems of asset quality.
Not just that, the banking industry may see more participants and greater healthy competition. Two new banks have already received licences from the RBI i.e. IDFC and Bandhan Group, which apart from providing impetus to financial inclusion, is expected to intensify competition in the banking sector in the medium term. In addition, by postponing the implementation of Basel III capital norm by one year, RBI has given some breathing space to banks struggling with stressed margins and lower profitability on account of increase in NPAs. The RBI's new norms will further encourage banks to identify potential bad loans and take corrective actions.
The overall credit growth may revive marginally at 14-15% in FY15; private sector banks may continue to outpace PSBs in credit growth. Overall (PSBs + private banks) gross NPAs could remain at 4-4.2% by FY15 as against 3.9% in FY14.
Banks need to raise capital of Rs. 1.8-2 trillion over the next two years (FY15-FY16); of which 45-50% may be issued in the form of additional Tier 1, 35-40 % through Tier II and balance through common equity. However, if there are no seekers for additional Tier 1 capital instruments, Indian banks may need to mop up Rs. 1-1.3 trillion common equity capital over the next two years as mentioned by a rating agency report.