Rewind: Banks in new era

Are Indian banks future-proofing themselves as the Indian economy gets impacted by global uncertainties, wars, and the impending oil crisis pushing inflation to a new high?

By B Yerram Raju

A World Bank blog titled ‘Banks with fewer branches fared worse during the 2023 banking turmoil’ in the US was published in October. A working paper ‘Bank Branch Density and Bank Runs,” in July, highlights that the three bank failures — Silicon Valley Bank, Signature Bank and First Republic Bank, with 17, 38 and 87 branches, respectively — were a manifestation of a broader problem, and that low bank branch density, in general, is related to higher deposit instability.

---

In the Indian context, urban cooperative banks, occupying 8% of India’s banking space with around 1,580 branches, are strategically moving to mergers or changing into Small Finance Banks. However, 92% of the banking is still covered by around 2 lakh branches — albeit with an increasingly less share in the rural areas. The first axe of all mergers fell on the rural bank branches.

Banks wrote off Rs 25 lakh crore during the last nine years and recovered barely 10% of it

Enter digital banking. Though it enables banks with low branch density to grow faster and attract depositors during relatively calm times, when interest rates increased and economic conditions deteriorated, those large deposit inflows took the form of “hot money” and changed their course. In this context, how best are the Indian banks future-proofing themselves? Are they complacent or in a mood to re-invent as the Indian economy gets impacted by global uncertainties, wars, and the impending oil crisis pushing inflation to a new high?

Green Finance

This is not so much to fault the Indian banking of the day but to look at the sustainability of the financial sector, and in particular, banking, in the context of Green Finance Instruments, FinTech, and Investment Strategies: Sustainable Portfolio Management in the Post-Covid Era, a Springer publication from the editors, Nader Naifar and Ahmed Elsayed (2023).

“Over the last few years, financial technology (FinTech) has been considered one of the most topical areas in the global financial services industry. The development of distributed ledger technology, big data, smart contracts, peer-to-peer lending platforms, biometrics, and new digital has motivated innovation in the financial services industry and the development of new financing and investment strategies.”

Environment, sustainability and governance considerations seem to outweigh the investment and financing decisions.

Federal Reserve Chairman Jerome Powell at the international symposium on central bank independence organised in January by the Swedish central bank Riksbank in Stockholm clearly said the Fed will not be a ‘climate policy maker’. Contrastingly, the Reserve Bank of India in its latest Report on Currency and Finance made a case for an active role for the bankers in climate change. Deputy Governor M Rajeshwar Rao said: “Climate change poses a serious threat to our long-term growth and prosperity. It has the potential to create shocks to monetary stability, growth, financial stability, safety, and soundness of regulated entities.”

Indian banks are well-tuned to the above trends. Lesser branches, more digitisation, more profits, more investment banking and wealth management services, more sales of third party products, more mergers and acquisitions, and more privatisations that would make their balance sheets great and they bulge in profits. Banks are rushing to finance the NBFCs (non-banking financial companies) that have fintechs — the pit shops for small loans. NBFCs, along with them, have charted out the path for retail lending through online shopping by customers. Have a GST registration, the client gets a loan!

But in a country like ours where basic literacy, let alone digital literacy, is still an issue, should our banking concerns be more on improving the quality of life of the poor or enhancing the rich? The mix of social banking and profit banking seems blurred now. Governor Shaktikanta Das has warned banks more than once that there is a bomb ticking in retail loans.

Systemic Risks 

The India Finance Report 2023 of the Centre for Advanced Financial Research and Learning (CAFRAL) raises concerns about systemic contagion due to the rise in lending to NBFCs and underscores the need for preventive measures to prevent such contagion risks when it says: “Although current ratios post-2017 show lower liquidity risk, they are not a good gauge for systemic risk — the risk which arises due to externalities that individual firms do not take into account in their decision-making process, and an unravelling of which can have deleterious effects on the real economy.”

Businesses in tranquil times are going to be different from times of turmoil or shocks, an observation similar to that of the World Bank blog authors. High interest rates have come to stay with the banks given that the hawkish look of the RBI has continued for over a year now. The RBI’s State of Economy report 2023 says the share of loans below 8% rate has come down drastically from 53% in March 2022 to 18% in June 2023, while that of over 10% rate has risen to 34% from 22% during this period.

Net interest margins of banks are looking southwards as they compete with each other to attract deposits parcelling out into different time periods and buckets. High-risk infrastructure lending, real estate and housing, and retail loans occupy their assets portfolio. Armchair lending or lazy banking has become a necessity with Indian banks.

Global Trends 

The Global Banking Review, 2023, of McKinsey vindicates these trends even globally where it says that banks are at a tipping point while admitting that after 2007, banks are in a great-going mood. “Below the surface, too, much has changed: balance sheets and transactions have increasingly moved out of traditional banks to nontraditional institutions and to parts of the market that are capital-light and often differently regulated — for example, to digital payment specialists and private markets, including alternative asset management firms.

“While the growth of assets under management outside of banks’ balance sheets is not new, our analysis suggests that the traditional core of the banking sector — the balance sheet —now finds itself at a tipping point. For example, between 2015 and 2022, more than 70% of the net increase of financial funds ended up not on banking balance sheets, but held by insurance and pension funds, sovereign wealth funds and public pension funds, private capital, and other alternative investments, as well as retail and institutional investors.”

Urban cooperative banks, occupying 8% of India’s banking space with around 1,580 branches, are strategically moving to mergers or forming Small Finance Banks

The silver lining is the report of the CareEdge Debt Quality Rating Index that captures the health of credit markets. According to this report, the index improved from 92.56 in June 2022 to 93.79 in June 2023. It mentioned that such improvement is happening on a month-on-month basis from November 2021. Credit growth for the current year is slated to be around 13.5%.

Amid all this, Indian payment systems scored a century post-Covid. The UPI spends saw a whopping growth of 428% during a short period of five years, zooming from Rs 2.20 lakh crore to Rs 15.3 lakh crore, according to the RBI September 2023 data. In August 2023, the UPI transactions hit 10 billion for the first time.

But this has to be taken with a grain of salt if not a tonne of it. Banks wrote off Rs 25 lakh crore during the last nine years and recovered barely 10% of it. In an article in Moneylife (October), Debashis Basu argued: “The fact is that creditors have only been able to realise 17% of claims through the IBC process. A reply to a Right to Information query reveals that the government has written off Rs 10.41 lakh crore as bad loans since 2014. The reason for this is rampant fraud and corruption involving PSBs, leading to IBC cases. Fraud is pre-planned so that there is very little realisable value.” Toxic assets cannot be sold any longer in the markets.

Despite state-of-the-art technologies claimed by banks in their operations, bank staff sit for late hours and all the KYC forms and the evidential documents are taken in the printed forms and uploaded to the system after business hours. There are many other operations that they do after business hours. Customers are aggrieved in several cases as revealed by the numerous cases lodged with the Banking Ombudsmen as banks choose to address the complaints only on their template formats and not on the basis of actual grievance.

The Financial Stability Report of the RBI (June 2023) mentioned: “Confidence runs became intensified by mobile apps and social media. These developments presented new dimensions in the interface between macroeconomic and financial stability.” The report also drew important lessons: Resolution of contagion demands swift and forceful interventions by public authorities; distinction between systemic and non-systemic banks needs re-thinking; partial deposit insurance is a dichotomy that may not work in a banking crisis; a revisit of excessive banking regulations in the context of the speed of modern-day bank-runs; and finally, intrusive and comprehensive bank supervision alongside sound risk management by the banks to improve the banks’ resilience.

Buoyed both by private and public investment, private and government consumption demand, and rising consumer and business optimism, India’s expected consistent growth of GDP and the forecast of IMF, World Bank and rating agencies demand a robust banking as its backbone. After all, bad banking and good economy can never go together.

The Dichotomy

Notwithstanding the transitions that India is witnessing in the alchemy of growth and the fast inroads of artificial intelligence, machine learning and robots, technology risks and cyber risks are accelerating at geometrical progression.

92% of the banking is still covered by around 2 lakh branches — albeit with an increasingly less share in the rural areas

We are at a point of no return to our traditional strengths. The culture of interdependence, respect for healthy conflict in democracy and the roots of the federal structure seem to be under severe threat. Can cultural diversities and social inequalities in all the 28 States and 8 Union Territories of India with multiple languages and dialects be addressed through digital banking?

The above analysis raises the question: how is Indian banking prepared to cushion the future where the expectations that banks should also take care of climate-resilient credit interventions are high? Is their mindset of bulging balance sheets and overconfidence in their digital interventions with focus more on the shareholder value than on the customer value likely to enable any future-proof interventions?

Re-inventing the systems and changing the mindsets of policymakers require intense public consultation and high levels of tolerance to adversarial views. We have to put an end to the obscene compensations of the financial and private sector chieftains. Development and expansion are imperative but not at the cost of welfare. Wealthy make more headlines than the ameliorative measures of the poor and downtrodden. We have to keep in mind not the percentage of poor but the actual poor, still at 220-250 million, which equals to the population of at least 80 underdeveloped or developing nations of the world.

Digital Banking in Distress – Beware of UPI

• UCO Bank transferred Rs 860 crore through Immediate Payment Service (IMPS) due to a technical glitch and claims recovery of 79% with the help of customers and other banks
• Tamil Nadu Mercantile Bank just in October 2023 transferred Rs.9,000 cr due to technology glitch through UPI to a cab driver and the CEO filed papers citing personal reasons.
• Kotak Mahindra Bank through UPI SMS Messaging system sent a notification to a customer that he received Rs 753 crore. The matter is in the process of rectification.

RBI reins in unfettered lending to NBFCs, fintechs

It raises risk weights of bank lending to these two sets of institutions to 125% from 100% that would discourage banks in enhancing the indirect route to the alarming retail lending portfolio.

A Black Swan event in offing?

Japan’s lending at near-zero interest rates for the last decade prompted investors to invest in high-yielding USD assets. Japan, now reeling under deflation, may abandon its low-interest rate policy that has the potential for another Black Swan event.