Road ahead for banking

While 2017 was largely a forgettable year for banking — credit growth was anaemic growing by only 9 per cent, gross NPAs rose to over ₹8 lakh crore by September and banks’ as a whole barely managed to remained profitable — it was still in the news on several counts. The ₹2.1-trillion bank recapitalisation plan of the Government initially sent bank stocks surging, but with little clarity on the sourcing, this will still be a work-in-progress.

The Insolvency and Bankruptcy Board got working but with modest progress (2,750 cases ‘disposed’ of and realisation of about ₹40 crore till November end) to show.

Finally, towards the fag end, there was the FRDI Bill, touted as a resolution solution for banks, but controversial for a different set of reasons.

Even the new class of licensed banks that were to be operational — payments banks and small finance banks — struggled to find their feet. Only four of the eight left in the race for payments banks began operations but struggled to raise deposits, managing only ₹236 crore.

The small finance banks were greeted with the demonetisation shock that pushed up their NPAs, besides having to cope with the new set of regulations as SFBs. Many of them probably feel that the bank model was not a good idea. As for bank consolidation, the SBI merger may have created a colossus in terms of size but there were little visible signs of any realised synergies.

The outlook for banking therefore is likely to be a continuum with so many unfinished tasks. First, additional capital for the banks will see activity on many fronts, with ₹58,000 crore to be raised by banks from markets and the ₹1.3 trillion recap bonds which will involve financial engineering on a huge scale. The plan seems to be to convert the huge deposits with banks post-demonetisation, into recap bonds which will find a way back into banks as capital.

But there are two larger issues here — the recap will leave Government holding a higher stake in PSU banks, at a time when debate is about reducing the stake.

Second, while this may address the capital erosion from the anticipated haircuts on bad debts, will they be sufficient to kick start a credit boom? Unlikely, when we consider that 90 of the 93 scheduled banks in the country have had CRAR in excess of 10 per cent since 2015, but lending declined continuously.

Clearly, increase in lending is quite different from increase in lending capacity.

Consolidation of banks is another exercise that is bound to see action. This has been on the cards for some time with the objective being to create a three-tier structure that will have three to four global-sized banks and around 12 state-owned lenders (from 21 currently). But without clear-cut objectives, consolidation may achieve little besides merging balance sheets.

There seems to be a lurking belief that mergers would somehow address additional capital requirements of weaker banks by their piggy-backing on stronger banks. But SBI’s merger is a case in point where, post-merger, its NPA ratio jumped from 7 per cent to 9 per cent and net profits turned to losses for the March quarter. Besides, leaving it to banks to find suitors seems a strange approach. It is unlikely that any such progress would happen in a hurry but forced mergers cannot be ruled out. A surprise entrant during the year was a new resolution tool for bank sickness, in the form of the FRDI Bill. But what attracted controversy was the bail-in provision that gives powers to the regulator to extinguish or convert the deposit liabilities.

While the fears of bank insolvencies may be exaggerated, it is somewhat ironic that bail-out using tax-payers money is viewed as more acceptable than bail-in using deposits. It is probably the specificity of the provision than any specific threat that seems to be the issue. Else, deposits would not have grown even as banks’ health deteriorated, underscoring the trust in Government’s implicit guarantee.

Finally, the investment climate and the behaviour of interest rates will be crucial. With no perceptible signs of improvement in private investment and with all large investment proposals in core infrastructure sectors, it is difficult to visualise banks getting into project lending in a big way. The focus will be on recoveries, investment and treasury activities.

As for interest rates, with RBI’s continued neutral monetary stance, they are more likely to go up than fall, given the steady rise in inflation. If that happens, banks could take a hit from lower investment gains and higher borrowing costs, but the larger threat to bottom lines still will be from any lurking bad debts or haircuts that may be forced on them.

The writer is an independent consultant.