The Reserve Bank of India is watching carefully over a well-capitalised banking system, but there are challenges ahead for India’s banks, says Sunit Arora
At a time when the financial world is nervously looking at the potential fallout from a rash of bank failures in the United States and the hasty merger of Switzerland’s troubled Credit Suisse into UBS — there is a sense of confidence in India about the health of its banking sector.
There’s even some preening by financial market players who say the Reserve Bank of India’s (RBI) strong supervision means India is well-placed to ride out a banking crisis, just like it got through the great crash in 2008.
The numbers look decent. The RBI’s Financial Stability report in December 2022 has said that gross non-performing assets ratio (NPAs) of scheduled commercial banks was at 5%, a seven-year low. Banks are well capitalised and credit growth (year on year) was 17.4% on December 16, 2022.
Since 2018, three banks — LVB, PMC, and Yes Bank,— and an important financial institution, IL&FS, have needed to be bailed out. As a result, the central bank has become extremely particular (one observer put it as “paranoid, in a good sense”), about bank reporting and disclosures across the system.
Has this stringency reached such levels that it has begun impeding growth? The house is divided on this, but the RBI is clearly comfortable with stable, steady growth. Memories of the twin balance-sheet problem (overleveraged corporates and high NPAs with banks in the middle of the previous decade) have not faded.
There may be trouble ahead
There are three key systemic changes afoot in banking that will present fresh opportunities and challenges over the next few years.
First, the promise of rapid digitalisation to reach out to the unbanked and drive credit to troubled small enterprises. Will fintech quickly take the Indian economy to the next level?
Second, the shrinking role of public sector banks and the rise of private banks. This has fuelled the changing nature of lending in India — corporate lending is down, and retail loans are up. What are the implications?
Third, the need to quickly integrate risks from climate change and sustainability into banking models.
The fintech revolution
Let’s start with India’s fintech revolution. About 10.5 billion retail digital payment transactions worth ₹51 trillion (c. £503 billion) processed in January 2023 showcase the size and efficiency of India’s digital payments. The quick adoption of digital technology in parts of India has led the government to showcase its potential transformative powers.
Of course, there are challenges here. Faster processing power will improve efficiency, but the underlying infrastructure remains the same. Moreover, many experts feel fintech without adequate consumer protection and regulation is a ticking time bomb and could lead to a repeat of the travails of India’s microfinance sector.
The good news is that the RBI is aware fintech is at a critical juncture and needs handholding to avoid systemic risks. However, this is not going to be an easy journey.
The government also hopes to piggyback on technology to increase credit lending to micro, small and medium enterprises (MSMEs). Fintech and lending to MSMEs are interrelated. For example, innovations such as the Open Credit Enablement Network contribute to more formalisation of India’s shadow economy.
In April 2022, a Parliamentary committee on finance said MSMEs face a huge credit gap of ₹ 20-25 trillion (c. £197-£246 billion). The government hopes fintech and data can help bridge some of that. The government has grown its goods and service tax network (GSTN) and launched a Trade Receivables Discounting System (TReDS) platform to facilitate financing of trade receivables of small enterprises from corporates.
This formalisation has a flip side too. As MSMEs get more access to credit, this could also put them under more stress, particularly those on the margins of formalisation. Bad loans have been on the rise. The challenges of reaching out to this segment will be closely watched.
Bank lending is changing
At a broader level, there are changes in bank lending. According to an analysis by Vivek Kaul in Mint, the size of Indian banking has stagnated since 2008. Banks on the whole have not grown once the increasing size of the Indian economy is taken into account. What has happened is public sector banks have lost market share, and private banks have gained ground.
While banks are in a position to lend, they have been scarred by the bad loans saga. Around ₹10 trillion (£98 billion) of such loans have been written off in the past five years. Also, many industrial houses have lost their appetite to borrow, using increasing cash flows to reduce debt. Another factor is that private sector investments are not picking up.
So, banks are instead lending more to retail than to industry. According to RBI, absolute retail loans grew by 16.1% between 2013 and 2022. In contrast, loans to industry grew by just 4% during this period. The RBI’s report on Trend and Progress of Banking in India flags this as a risk: “Empirical evidence suggests that a build up of concentration in retail loans may become a source of systemic risk.”
Going green
Finally, there is the transition to a green economy. India’s finance ministry is working on a draft of a green taxonomy report. The RBI has just about started work on regulatory guidelines for climate change and sustainability finance. Here, it will be interesting to see how RBI balances business growth with sustainability and whether it will set the standard for the global south. It could be a key driver to push the pace of energy investments into India.
Sunit Arora is an independent journalist and editor based in New Delhi. His twitter handle is @sunitarora