May you live in interesting times,” goes a Chinese proverb—apparently both a curse and a blessing. It fittingly describes the state of affairs in the banking space. In the past decade, the sector has weathered several storms—a slowing economy, corporate deleveraging, non-performing assets (NPAs), digital disruption, and the Covid-19 pandemic.
In such times, lenders that have been able to exploit every adversity to their advantage have emerged as winners—as the 26th edition of the BT-KPMG Best Banks Survey 2020-21 finds. ICICI Bank, the country’s second-largest private bank by market capitalisation, is the Bank of the Year for the second successive year. (See box Roll of Honour.)
The banking sector as a whole has had a better year. It posted a net profit of Rs 1.21 lakh crore in FY21 against Rs 10,999 crore in FY20. Return on assets (ROA) and return on equity (ROE)—two key parameters of profitability—also came out of the red over a three-year period. Among other parameters, the capital adequacy ratio—a measure of a bank’s lending capacity—improved from 15.3 per cent to 16.3 per cent, while gross NPAs declined from 9.1 per cent in FY19 to 7.3 per cent in FY21. “The improved parameters partly reflect regulatory relief provided to banks during Covid-19 as well as fiscal guarantees and financial support given by the government,” Reserve Bank of India (RBI) Governor Shaktikanta Das said recently. But, as Das was quick to point out, there are risks and challenges going forward that require serious introspection and action on the part of the banking system.
In the past few years, banks have been making conscious efforts to build a well-balanced loan book, with a tilt towards retail banking. “The change in advance mix is also led by macro conditions since corporate credit demand has been pretty weak whereas retail advances have grown in double digits in the past few years,” says Jaideep Arora, CEO, Sharekhan by BNP Paribas. Bankers have also turned cautious after some debacles. The focus is on a secured retail portfolio and high investment grade corporate clients. The current low interest rate regime also has its challenges. “You now need to give retail customers a bouquet of choices that will allow them to beat inflation and save something for the future,” says Madhav Kalyan, CEO, JPMorgan Chase Bank India. Banks have also realised that they need to connect with customers both digitally and through physical branches. “If you look at the numbers, credit offtake has been in retail and not so much in corporate credit,” says Kalyan.
“With increase in competition and prudence, banks could see some erosion in their net interest margins as compared to historic trends. However, we believe the pressure would be more evident in the case of mid-sized or smaller banks while the large banks would... hold on to their margins due to their strong liability franchise,” says Arora. In the retail space, banks are facing disruption from fintech players, which are innovating in payments and lending. Now, several banks have partnered fintechs to serve customers and attract new ones.
The pandemic has accelerated digital adoption and led to gains for banks. For instance, supply chains are being digitised and this offers huge potential for banking services across the network. Another gain has been employees operating from remote locations with higher productivity and efficiency. There is also much higher adoption of digital payments. “The distinction between banks is no longer who has got better digital skills, but how they personalise banking services for an individual customer,” says Shyam Srinivasan, MD & CEO, The Federal Bank. But with digitisation comes the danger of cyber frauds. A study by Deloitte India has listed large-scale remote working models, increase in customers using non-branch banking channels and the limited use of forensic analytics tools to identify potential red flags as reasons for the increase in fraud incidents over the next two years.
Regulator RBI has also been in the thick of things. Its ban on HDFC Bank’s new digital offerings was a clear message that it will not tolerate technical glitches impacting customers. In addition, the RBI is coming down heavily on banks for any compliance failure. “Post the debacle of YES Bank, the regulator is getting into business model changes wherever they are not comfortable about protecting the interests of depositors,” say sources. The RBI’s view is that banks are different from other entities as the objective of return maximisation for shareholders is done at the cost of small public depositors. “As repositories of public resources, banks need to design appropriate governance standards and implement internal controls to be worthy of the public trust,” RBI Deputy Governor M.K. Jain said recently.
The regulator has also become stricter in extending the tenures of CEOs. Last April, it had capped the tenure of MD & CEOs of private banks to 15 years. “With such a long-stipulated tenure, linking continuity and extension to performance is a good idea and rational. Further, most banks are listed and hence logical that market factors and dynamics influence the tenure of CEOs,” says Tarun Bhatia, MD and Head of South Asia in the Forensic Investigations and Intelligence practice of advisory Kroll. In fact, the CEO’s extension every three years will now have to be backed by strong financial performance with no asset quality surprises. The RBI has also introduced rules that make it mandatory for banks to rotate auditors every three years with a cooling off period of six years.
While the past decade has been challenging, there are some green shoots. Now, there’s a Bad Bank framework to deal with NPAs. The government has also set up NaBFID, led by veteran banker K.V. Kamath, to fund infra projects, which should reduce the burden on banks. Banks can focus on consumer banking as digitisation and formalisation of the economy is bringing under-banked and under-served customers into the banking net. “At the current stage, the Indian economy seems to be set for another multi-year economic up-cycle and banks are well positioned to support the same on the back of a marked improvement in asset quality and capitalisation of their balance sheets,” says Arora of Sharekhan by BNP Paribas, while JPMorgan’s Kalyan believes that “capital efficiency has now come into the banking system”. Experts suggest that the distinguishing factor in the past decade has been the quality of assets. “Some banks have distanced themselves materially on the asset side and, therefore, they have benefitted disproportionately in the past decade,” says The Federal Bank’s Srinivasan.
Clearly, banks that will be able to write good quality loans and reset their business models according to the operating environment will survive and thrive despite challenges.
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