Sanketh Arouje is Leader – Economy Analysis Group, Dun & Bradstreet India
Over the past couple of years, the Indian banking sector has displayed a high level of resiliency in the face of high domestic inflation, rupee depreciation and fiscal uncertainty in the US and Europe. In order to stimulate the economy and support the growth of banking sector, the Reserve Bank of India (RBI) adopted severe policy measures such as increasing the key monetary policy rates such as repo and reverse repo 16 times since April 2009 to Oct 2011 and tightening provisioning requirements. Amidst this economic scenario, the key challenge for the Indian banking system continues in improving their operational efficiency and implement prudent risk management practices. Some of the key trends expected to emerge in the near future are as under:-
Economic slowdown likely to impact the demand for credit
High interest rates, subdued industrial production and domestic consumption impacted the growth of the Indian economy which slowed down from 8.4% in FY11 to 6.5% during FY12.The scheduled commercial banks’ (SCBs) overall credit grew at a slower pace during FY12 at 17% y-o-y as compared to 21.5% registered during FY11.As per the recent RBI data, the non-food bank credit increased by 15.5% in Oct 2012 over its corresponding month previous year, as compared to 18.2% witnessed in Oct 2011 over its corresponding month previous year. Similarly, credit to industry and services sector recorded a slower growth of 15.2% and 13.7% respectively as against 23.1% and 18.4% during the same period. As per RBI’s second quarter review of monetary policy for FY13, the GDP growth estimates for FY13 is revised downwards from 6.5% forecasted earlier to 5.8%.Any further slowdown in the Indian economic growth is likely to impact the demand for bank credit.
RBI may lower key policy rates, if inflationary pressures ease
Inflation continued to remain sticky and much above the RBI’s comfort zone throughout the year. In fact headline inflation as measured by WPI remained above 7.5% from Feb to Oct 2012. As a result the RBI has kept the repo rate at an elevated level, reducing it by 50 basis points only once during 2012, in April-12 to support growth.
However, in order to support the flow of funds to the productive sectors of the economy and ease the liquidity crunch in the banking system the RBI has cut the CRR by 175 basis points during the course of the year which stands at 4.25%, as on Nov 2012. Given the easing of international commodity prices, particularly of crude, decline in core inflation as demand conditions moderate, there has been some steady moderation in inflation in the recent period. As a result the RBI might decide to ease the policy rate during end Jan 13.
Asset quality will need to be closely monitored
During FY12, asset quality of banks was severely impaired, as revealed by the steep increase in non-performing assets (NPAs) of SCBs, particularly for public sector banks (PSBs) owing to their significant exposure to troubled sectors such as power, aviation, real estate and telecom. There was a significant increase noted in the NPA levels during FY12. Gross NPAs value recorded a y-o-y growth of 45.3% and net NPAs registered a y-o-y growth of 55.6% during FY12. As per RBI, this increase was due to inadequate credit appraisal process coupled with unfavorable economic situation in the domestic as well as foreign market.
Apart from increase in NPAs, the weakening asset quality trend was also apparent from the significant increase in restructured assets. Restructured standard advances of the SCBs, recorded a y-o-y growth of around 58.5% during FY12 and the ratio of restructured standard advances to gross advances also increased from about 3.5% in FY11 to 4.7% in FY12.
As per the recent data available with CDR cell as on Sep 2012, a total of 466 cases have been referred to the cell, with 327 cases amounting to Rs. 1,873.9 bn have been approved since the start of CDR mechanism. Of the total cases referred, 64 cases corresponding to Rs. 311.2 bn were under finalisation of restructuring packages as on Sep 2012 as compared to 34 cases amounting to Rs. 264.5 bn as on Sep 2011.
The slowdown in the economy increases in the risk of default and restructuring of loans can increase which could further lead to deterioration of asset quality. However, implementation of stringent policies could prevent a sharp deterioration in asset quality.
More impetus on fee based and non-interest income services
Traditionally, banks have derived limited income from fee based services such as wealth management, credit card services, treasury services, investment banking and advisory services. However, as the economy is showing signs of slowdown and the demand for credit is slowed banks are struggling to keep their margins intact. Also, with changing times, consumer needs have changed with various avenues of investment available. This is likely to increase banks focus on offering fee based services as the earnings from such services are more stable than interest bearing products and it also helps in mitigating risk via diversification of products and services.
Financial inclusion to play a key role in the near future
As per census 2011, huge section of Indian population is still unbanked. The overall percentage of households availing banking services in India stood at around 59% as on 2011, which means still over 40% of total households, lacks access to formal banking services. This is largely driven by rural areas and/or low income group (LIG) population, due to their financial illiteracy, low level of income and savings, lack of collateral and absence of verifiable credit history.
Thus, in recent years, the RBI and GoI have increased its focus on providing formal banking/financial services to the huge unbanked population. It is encouraging banks to develop low cost products and services designed to suit the requirements of this group of population.
RBI has undertaken several policy initiatives to promote financial inclusion, such as encouraging opening of no-frills accounts, engaging intermediaries to provide financial and banking services. In the course of action, there has been increase in number of no-frill accounts from 50.3 mn in FY10 to 105.5 mn in FY12, registering a CAGR of 44.8% during this period. Similarly, the number of business correspondent (BC) agents also noted a CAGR of 70.2% during the same period.
RBI also advised banks to allocate minimum 25% of the total new branches in unbanked rural centres during a year. In the process, the number of banking outlets in villages with population above 2,000 and less than 2,000 also witnessed a CAGR of 73.5% and 55.7% during FY10 to FY12.
Further, in India there are several micro-finance institutions (MFIs) and self-help groups (SHGs) which lend credit to the LIG. This is expected to play a significant role in achieving financial inclusion by extending credit to the LIG.
Banks will expand in overseas market
In order to sustain the business growth amid highly competitive market and slowing Indian economy, banks are likely to expand in the overseas market. They will try to tap emerging opportunities by expanding into newer markets such as Africa, former Soviet region and other South East Asian countries, in which India has maintained good trade relations. They can set up captive operations or expand through inorganic means by undergoing M&A with banks in foreign countries. However, high capital cost for setting up foreign operations can act a deterrent in the way of expansion.
Mobile banking, next major technological leap
With the adoption of technology, the Indian banking sector has undergone significant transformation from local branch banking to anywhere-anytime banking. Over the past couple of years, there has been huge growth registered in the number of transactions done through mobile devices. As per RBI, there were 49 banks with a customer base of about 13 mn offering mobile banking services as at the end of Mar 2012. During FY12, around 25.6 mn mobile banking transactions valued at Rs. 18.2 bn were transacted, recording a growth of 198% y-o-y and 174% y-o-y respectively. This rapid growth is driven by availability of 3G/4G network, increasing number of smart phones and several telecom companies offering economical data usage packages.
In order to encourage cashless transactions, particularly for small value transactions, the RBI raised the cap on mobile banking without end-to-end encryption from Rs. 1,000 to Rs. 5,000. Further, the transaction limit of Rs. 50,000 per customer per day was removed, by permitting banks to fix the transaction limits based on their own risk perception.
In the near term, it is expected to emerge as one of the most preferred medium for banking transactions.
Competition set to intensify
In Aug 2011, the RBI drafted guidelines for licensing of new banks in the private sector. Thus, with the entry of new players in the market, competition among banks will increase. This is expected to benefit the consumers in the long-run as with increased competition banks will adopt fresh strategies to retain and attract customers and protect their market share. For instance, increasingly banks are tying up with insurance companies to sell insurance products. In this business model, both bank and insurance companies share the commission.
Further, with the deregulation of savings rate in Oct 2011, competition among banks has already intensified.
Passage of ‘Banking Laws (Amendment) Bill’ aimed at attracting more foreign investments
With an aim to reform and strengthen India’s banking sector, the Lok Sabha passed the ‘Banking Amendment Bill’ in Dec 2012. Once, the bill is passed by Rajya Sabha as well, it will pave way for RBI to issue new banking licenses to private sector and attract more foreign investments in the sector.
The Bill also proposes to enhance the voting rights of investors in case of both public sector and private sector banks from existing 1% to 10% of public sector banks and from 10% to 26% of private sector banks. This move will attract more foreign investment in the sector.
The Competition Commission clause in the new Bill allows the RBI to continue with its role as the banking regulator, while the Competition Commission of India (CCI) will regulate mergers and acquisitions (M&A) and will have powers to investigate and clear M&As in the banking sector.
Moreover, the bill has a clause, which will allow foreign banks to convert their Indian operations into local subsidiaries or transfer its shareholding to a holding company of the bank without paying stamp duty.