Mohammad Hanief
The banking system in India is significantly different from that of other Asian nations because of the country’s unique geographic, social, and economic characteristics. India has a large population and land size, a diverse culture, and extreme disparities in income, which are marked among its regions. There are high levels of illiteracy among a large percentage of its population but, at the same time, the country has a large reservoir of managerial and technologically advanced talents. Between about 30 and 35 percent of the population resides in metro and urban cities and the rest is spread in several semi-urban and rural centers.
The country’s economic policy framework combines socialistic and capitalistic features with a heavy bias towards public sector investment. India has followed the path of growth-led exports rather than the “export led growth” of other asian economies, with emphasis on self-reliance through import substitution.
Banks are highly deficient on the stock market side (a position well established by the dismal record of mutual funds and merchant banking subsidiaries floated by most of the public sector banks). Their portfolios of investments in bonds and equities (which are 100 percent risk assets) need to be screened using credit risk assessment standards and not by market prices alone. Banks also must adopt methods of converting debt into equities in NPA accounts whenever possible to either ensure turnaround in corporate performance, or else sell equities to limit future losses.
Despite competition and falling profits, there has been no significant improvement in cost structure. Also, the slowdown has not made cost consciousness a top concern. This is exactly what banks and FIs have to be worried about. Equity holders, banks, and FIs can position themselves as drivers of shareholder value. Credit risk analysis needs to be complemented by cost structure analysis and output efficiency with reference to the companies’ capital and stock of borrowed funds.
The Financial Stability Report (FSR) published by the RBI in December 2023 pertains to the first half to September 2023. It indicates that banks have become more profitable with lower asset stress, even as they have grown their asset books at a rapid pace.
The RBI Financial Stability Report (FSR) is published once every six months. It is published in the end of June to cover the second half of the previous fiscal year and again in December to cover the first half of the fiscal year. The December RBI FSR report covers the first half of FY24 for the period April 2023 to September 2023. One of the most awaited and analysed sections of the RBI FSR is the financial stability segment. Here the banks, NBFCs and other financial intermediaries are evaluated based on the progress in terms of operating margins, net interest income (NII), net interest margins (NIMs), gross NPAs, net NPAs and the outcome of the various stress tests conducted by the RBI.
Since the last FSR was published in June 2023, the Indian banking sector managed to expand its size, and capital adequacy, while also boosting its net banking spreads and reducing its NPA levels. During the December quarter, the RBI had imposed curbs on consumer lending by banks and NBFCs and that would get reflected only in the next RBI FSR. For the first half of FY24, the banks witnessed growth in deposits and in credit. The credit growth was largely led by lending to the services sector and the growth in consumer loans. Deposits a greater shift towards term deposits amidst rising yields on such FDs.
With the higher repo rates being passed on in the form of higher deposit rates, the growth in deposits veered towards higher yielding term deposits. However, that also meant that the growth in CASA (current and savings accounts) deposits remained tepid for the first half of FY24. The rate of deposit growth in the quarter to September 2023 surged to 13.4%. This was driven by 20.9% growth in deposits of private sector banks, 10.1% growth in deposits of PSU banks and 5.3% growth in deposits of foreign banks.
The overall deposit growth rate of 13.4% was sharply higher than the average of the last 3 quarters; which was closer to 10%. The surge in deposits in the latest quarter to September 2023 was also partly due to the merger of HDFC Bank and HDFC Ltd. However, even if you adjust for the merger, the overall deposit growth would only come down from 13.4% to 12.3%. That is still sharply higher than the average of the previous 3 quarters.
What about credit growth of banks? For the September 2023 quarter, the overall credit growth for all banks stood at a healthy 19.4%. Of these, private banks saw credit growth of 30.4% while PSBs saw credit growth of 13.3%. Here again, if you adjust for the HDFC Bank merger with HDFC Ltd, then the overall credit growth comes down from 19.4% to 15.3%. If you look at the overall mix of the lending portfolio, consumer loans at 33.2% is the single biggest component of the loan book of banks.
Both private banks and PSBs have seen a sharp spike in personal loans, although the latest RBI regulations on consumer lending should bring this under control. In terms of the sectoral mix of credit growth; the big contributions to growth came from personal loans, loans to services and lending to agriculture. However, growth in lending to the manufacturing sector remained relatively tepid at 6.1% for the September 2023 quarter.
To sum up the credit growth story; the lending momentum has sustained in H1-FY24. However, there has been some moderation of credit by foreign banks and PSBs. The lending growth in H1FY24 was led by lending for personal loans and to the services sector.
Even in a severe stress scenario, the CRAR would still stay above the statutory threshold. The stress test also shows that under normal conditions, the baseline CRAR would be around 14.8%. However, this could fall to 13.5% in a medium stress situation and fall further to 12.2% in an extreme stress situation. However, that is still above the threshold.
The gross NPAs would be at around 3.1% in a baseline scenario. However, in a mild stress scenario, the gross NPA ratio could go to 3.6% and even in an extreme stress scenario the gross NPA deterioration would only be to the tune of 4.4%. Even in an extreme risk situation, the impact on the overall gross NPAs is only going to be limited.
The two risk factors, as we see it is, if the cost of funds goes up further for the banks and the other risk factor is if the fast-growing consumer loans portfolio of banks starts showing stress. In that case, household finances and repayment capacity could come under stress. However, with the RBI being proactive, that looks like a very remote possibility as of now!
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