Quo vadis public sector banks?

More than the bad loans and the losses, what should worry us is the state of lending

At ₹10-lakh crore, India’s bank NPAs crossed a dubious milestone this March, with the losses of public sector banks zooming by over 600 per cent. In a sense, it was a self-fulfilling prophecy coming true from the RBI’s new provisioning rules. More than the bad loans and the losses, what should worry us is the state of lending.

Double whammy

The latest results of the 10 largest banks (accounting for over two-thirds of the system) for the year ended March 2018 seem to confirm that lending is no longer viable. Income from lending grew only 10 per cent, a result of past NPAs and low incremental lending. Even non-operating income, a saviour in the past, has declined for most banks, since a large chunk of this income comes from lending-related fees and commissions.

For an economy whose financial sector is banking-dependent, this should be a huge cause for worry. What is more, the double whammy also rendered operating profits insufficient to absorb the increased provisioning; thus, far from creating cash reserves for future losses, provisioning has increased the current losses of the banks.

The latest Financial Stability Report of the RBI acknowledges the impact, and warns of worse to come, but offers little by way of analysis. Its prognosis rests largely on the economic stress argument, which is not entirely convincing. Consider this: only four developed nations have larger NPA ratios than India (Portugal, Italy, Greece and Ireland), and they have all experienced economic distress, whereas India’s economic growth is reported to be among the fastest.

Further, the current economic fundamentals (the baseline scenario in the report) can hardly be termed stressed, yet the RBI expects NPAs to climb to 12.2 per cent by March 2019. Clearly, there must be other factors at play.

A costly switch

For one, the innumerable scams and frauds associated with NPAs point to wilful default and bad governance as a top reason. Two, credit data show that banks’ foray into project finance played a major role — loans to industry form 37 per cent of outstanding, and over 50 per cent of this is to three sectors (infrastructure, electricity and basic metals); almost 60 per cent of all credit is in the form of term loans — a huge turnabout from an earlier era when banks financed only working capital. The NPA data mirror this — 23 per cent of loans to industry were NPAs, while about 46 per cent of loans to the basic metals sector were stressed as of March 2018. It is evident that the transition from working capital financing to project finance has proved costly for banks.

In trying to fill the gap left by the specialised development financing institutions such as IDBI, ICICI and IFCI, public sector banks burnt their fingers, mainly for two reasons. One, their liability profiles did not permit them to lend long-term; and two, they lacked the risk-assessment and appraisal skills which the other institutions had honed over decades. Many analysts have attributed the large industry exposure as the result of an unbridled asset chase by banks, but it was more likely the inevitable outcome of a role they were forced to play. In hindsight, the cause is immaterial, because the key lesson seems to be that bank funding is not best-suited for industrial project financing. It is no coincidence then that the private and foreign banks (with a few exceptions) that had little or no exposure to these sectors were healthy and profitable.

Catch 22

Public sector banks seem trapped in an existential crisis — 11 of them have lending restrictions imposed under prompt corrective action (PCA), with more likely to follow. If they cannot lend, their funds will find their way into government securities, running up risks of a different kind.

Private banks have focussed on retail consumer finance to remain profitable, but that cannot be a sustainable option for 21 PSU banks. While we are now rightfully worried about the magnitude of bad loans, there are larger questions looming. What should be the business strategy for PSU banks? If nothing were to change, can we be sure they will not accumulate bad loans again? How would the industry and infrastructure sectors meet their credit requirements? Finally, will the banks be able to stack up to the disruptions from technology and innovation that are sweeping the world?

Core banking functions are already unbundled, and ‘platformification’ of banking is getting regulatory backing in many countries. These trends are likely to make traditional banks extinct. These may be some distance away for us, but with a 1.3-million workforce and a 1.4-lakh-strong brick-and-mortar network, they could well be the right scenarios for our banks to be stress-tested against.

The writer is an independent consultant.

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