how Indian banking sector works in india
A still fragile sector, dominated by public banks
The Indian banking sector has 21 public establishments, the same number of private national banks, and about forty foreign banks.
It remains mainly dominated by public entities which account for 65.8% of all assets, 70.1% of all deposits, and 65% of outstanding loans at the end of the 2017/18 financial year according to the latest consolidated figures from the RBI.
Private banks have managed to steadily increase their market share since the liberalization of the sector in 1992. They now concentrate 28.2% of all assets, 25.6% of total deposits, and 30.4% of total outstanding loans at the end of the 2017/18 financial year.
At Present, for more than a century in India, foreign banks represent only 6% of assets. Apart from the large commercial banks, the market is split between a multitude of establishments: cooperative banks (urban and rural) and more than 10,000 non-banking financial institutions, some of which can also accept deposits and cover requests for loans and insurance.
The Indian banking sector experienced a phase of rapid growth in the early 2000s, which materialized in an annual increase in outstanding loans of more than 30% until 2006 and more than 10% at the height of the financial crisis. The economic downturn in 2013-2014, such as the tightening by the Central Bank (RBI) of its macro-prudential regulation under the mandates of R. Rajan and U. Patel highlighted a gradual deterioration in the quality of outstanding credit. This situation forced most banking groups to revise their provisions upwards because public banks, in particular, found themselves very exposed to sectors in difficulty (industry and infrastructure in particular) when they had taken large positions in the absence of sufficiently adapted and developed internal procedures.
Compared to other emerging economies, the Indian banking sector is still underdeveloped. In March 2018, India had 141,909 banks or bank branches (+ 3% in one year), i.e. one establishment for every 8,000 inhabitants (compared to one for every 2,600 inhabitants in Russia and for every 2,200 inhabitants in Brazil, but one for every 12,500 inhabitants in China). A total of 19.7% were recorded in large cities (+ 4.3%), 18.3% (+ 4.2%) in other urban areas, 27.2% (+ 1.9%) in a semi-urban area,s and 34.8% (+2.4%) in rural areas.
Despite undeniable progress in recent years in terms of financial inclusion – the government program Jan Dhan opened more than 355 million bank accounts since 2014 – banking services still play only a subsidiary role in the country’s economic life, as illustrated by the high proportion of accounts with zero balance (a quarter of accounts a Dhan).
This situation partly explains the low volume of outstanding loans, which, according to the latest figures from the RBI, only amounted to 52.1% of GDP at the end of the 2017/18 financial year (compared to 52.2% a year earlier). Similarly, the banking sector is still struggling to fully play its role of supporting the private sector, as evidenced by the rate of bank loans to the private sector, which is capped at less than 10%.
On the other hand, since the start of the current decade, we have witnessed a real take-off of payment banks (Airtel, Paytm) which have recourse to a combination of non-conventional channels (mobile telephony, networks of non-banking agents scattered over the territory supermarkets) for the provision of traditional banking services in a country where more than 85% of the population subscribed to a mobile telephone subscription in 2018. The number of transactions via the mobile system has almost tripled each year on average, from 18.2 billion at the end of the 2012 financial year to more than 29,500 billion for the 2019 financial year.
A belated realization by the authorities of the need to begin a process of consolidation and consolidation…
The implementation by the RBI, in 2015, of measures aimed at better accounting for uncertain loans, with in particular the integration of a set of restructured loans reclassified as doubtful loans, resulted in a sharp increase in the rate of loans non-performing, multiplied by 3.5. The proportion of non-performing assets then went from less than 5% outstanding in 2014 to 9.3% in March 2019. Banks (particularly public ones) were thus forced to carry out increased provisioning which affected both their profitability and capitalization ratios. This also weighed on the rate of granting of new outstandings, a phenomenon which was also exacerbated by the demonetization process of November 2016.
Since 2016, the authorities have also used the new Insolvency and Bankruptcy Code (Insolvency & Bankruptcy Act –IBC-) to clear the outstanding amount. They also amended, in May 2017, the banking Regulation Act (Sections 35A and 35B) to enable the RBI to issue targeted individual instructions to certain banks on the management of delinquent loans. The Central Bank was therefore able to compel the banks to present the most important of their insolvent customers before the specialized courts.
The RBI was thus able to establish, thanks to these provisions, a list of 500 priority accounts for which it required the banks to formulate a resolution plan within six months. It also requested the launch of the procedures planned by the IBC against 12 systemic entities (including 5 metallurgists) which alone account for nearly a quarter of all non-performing outstandings. At the end of the 2017/18 financial year, it is estimated that around 40% of non-performing loans were under the IBC process.
Added to this is the concerted effort of the government in terms of recapitalization. A first plan of INR 2,110 billion (nearly $30 billion) for the recapitalization of public banks was thus announced in October 2017. This amount is explained in particular by the fact that it should enable public banks to meet the regulatory requirements of the RBI as well as Basel III. This bank recapitalization would be financed by up to 73% by the Indian State (65% in the form of recapitalization b
onds and 8% in the form of a budget allocation) and 27% via fundraising on the financial markets by the banks. Nearly 61% of the initial amount of the recapitalization (around INR 1280 bn) has already been injected into public banks maturing in mid-December 2018. During the presentation of the final budget for the financial year 2019/20, the new Minister of Finance announced an additional capital injection of INR 700 billion, making a cumulative total of approximately USD 40 billion.
The merger of three public banks is also an additional step in the consolidation plan, likely to promote economies of scale and improve the structural efficiency and governance of a highly fragmented public banking sector. The new entity, which takes over the activities of the bank of Baroda, from Dena Bank (which was already under the supervision of the regulator within the framework of the PCA) and the Vijaya Bank, should become, with nearly 7% of assets, the second public bank. Other similar movements should also follow, but no deadline has yet been specified, either by the regulator or by the government.
While the major disruptions created by demonetization are tending to dissipate, the banking sector finally experienced a recovery in the credit cycle in 2018. Outstanding loans in fact recorded a 13.8% increase year-on-year annually. They would amount to INR 93,384 billion (€1,151 billion) according to the RBI, i.e. a marked acceleration in credit dynamics over the period.
The growth in outstanding loans is mainly due to the dynamics of loans to the tertiary sector and retail loans. The improvement in the financial situation of public banks should also contribute to the increase in credit growth, estimated between 11 and 13% for the current financial year.
which is nevertheless beginning to bear fruit
In this context, and according to the semi-annual Financial Stability Report published by the Central Bank, the proportion of non-performing assets in commercial banks’ outstandings reached 9.3% at the end of March 2019, a further drop after that of September. 2018 (10.8%) and March 2018 (11.5%). In addition, projections by the Issuing Institute (baseline scenario) suggest a continuation of this trend with a PNP share settling at 9% by March 2020.
The net rate of non-performing loans also fell: it fell from 5.3% in September 2018 to 3.8% in March 2019 (5.2% for public banks, 1.6% for banks Indian private banks, 0.5% for foreign banks) thanks to the increase in provisions, which averaged 60.6% of NPLs in March 2019 (up 8 points compared to September 2018).
The share of large borrowers (exposure above INR 50 billion) in NPLs fell from 83.4% in September 2018 to 82.2% in March 2019, while their share in outstanding decreased at the same time by 54.6% to 53% of the total. The share of NPLs is down in all categories of banks: it stands at 3% for foreign banks (3.6% at the end of September 2018), 3.7% for private banks with Indian capital (3 .8% at the end of September), and 12.6% for public banks (14.8% at the end of September).
The contraction of non-performing assets thus seems to reflect, overall, a continuation of the purification of toxic assets in the Indian banking sector; a positive trend that should be seen alongside the marked rebound in outstanding loans over the period (+13.1% year-on-year).
Asset quality also improved in all sectors in March 2019 compared to September 2018, with the exception of the agricultural sector, where the increase was marginal (8.4% in September 2018 at 8.5% in March 2019). This is particularly the case for the industrial sector, whose share of doubtful assets was reduced to 17.5% in March 2019 (compared to 20.9% in September 2018).
Services and distribution concentrate respectively 5.7 and 1.8% of doubtful assets (compared to 6 and 2.1% in September 2018). The share of NPLs should notably reach 28.5% (34.2% in September 2018 and 46.3% in March 2018) in the base metals sector (11.5% of total outstanding loans), 17.8% (20% in September 2018) for the infrastructure sector (36.4% of total outstanding), 16.1% (18.7% in September 2018) in the textile sector (6.5% of total outstanding), 17.6% (21.4% in September 2018) in the agri-food sector and 25% (28.3% in September 2018) in the engineering sector. It should be noted that the clearance of part of the toxic outstandings of the base metals branch seems to be the result of the first case law related to IBC.
The consolidation of outstanding loans should thus continue in the short term: the share of NPLs would thus be likely, with a neutral setting (baseline scenario: real growth of 7% in value-added, deficit target respected at 3.4% of GDP, inflation contained at 3.3%), to reach 9% within one year (March 2020) according to the resistance tests (stress tests) conducted by the RBI. It would reach 9.2% in the event of moderate shocks and 9.6% in the event of severe shocks (respectively 12%, 12.1%, and 12.2% for public banks alone).
Similarly, the capital adequacy ratio continues to improve, in particular thanks to the recapitalization of public banks (public contribution of $22.5 billion spread over the 2017/18 and 2018/19 financial years, for an overall cost slightly above 1% of GDP). At the consolidated level, the ratio remains significantly above Basel III requirements (14.3% in March 2019, compared to 13.7% in September 2018), with however significant disparities between groups and banks: 12.2% (of which 4.4% in respect of capital tier 1) for public banks, 16.3% for private banks with Indian capital (9.5% in capital tier 1), 18.5% for foreign banks (10.3% in capital tier 1).
The RBI however indicated that five public banks could have a capital adequacy ratio below the minimum regulatory threshold of 9% at the end of the 2020 financial year if no further recapitalization is planned by the government and until nine public banks in the event of a severe shock.
The net performance of the banking sector remains in negative territory for the second consecutive half-year (-0.1% for assets and -1.5% for equity). The surplus generated by Indian private banks and foreign banks, whose rates of return on assets were respectively 1.2 and 1.6% for rates of return on equity of respectively 10.8% and 9 .1% does not compensate for the performances of the yield rates of public banks (rate of return of respectively – 0.9% for assets, against -0.7% in September, and – 13% for equity, against – 10.2% six months earlier). The net interest margin for the sector as a whole remained stable at 2.8%.
The pursuit of reforms faces several obstacles, including political arbitration
First, the issue of supervision of the banking sector crystallizes the tensions between the Ministry of Finance and the Central Bank. The RBI is indeed increasingly critical of the lack of progress made in the governance of public banks (which was to be the counterpart of their recapitalization). A few weeks after the revelation of a large-scale fraud at the Punjab National Bank, Governor Patel thus publicly regretted not having the same prerogatives vis-à-vis them as vis-à-vis the private sector (ability to replace the Board, to order the resignation of a director, to force a merger, withdraw a license, etc.). This intervention was then strongly condemned by the Ministry of Finance.
The strengthening of the rules for provisioning non-performing loans, then the tightening of the rules relating to their restructuring, both of which aimed to contain the increase in the share of non-performing loans in outstandings, have thus earned the Bank the accusation of having unnecessarily curbed the growth of outstanding loans. The decision taken in February 2017 to require banks to initiate, within six months, resolution proceedings against their insolvent debtors under the new Bankruptcy Code has also come up against resolute opposition from the government, concerned about the risk that it would jeopardize the execution of several outstanding strategic projects in the energy sector.
The framework for fragile banks (preventive component of the financial supervision framework or BCP), under which 12 credit institutions, including 11 public banks, have had measures imposed that could go as far as freezing outstandings, is finally considered too severe.
Out of a total of 21 state-owned banks, 11 (whose outstanding amounts would represent 20% of total assets) were considered very fragile and were subject to corrective action by the regulator. After being the main beneficiaries of the recapitalization plan launched by the government in 2017 (about two-thirds of the total capital injections in 2018), three of them (Bank of India, Bank of Mahārāshtra and Oriental Bank of Commerce) were thus able to improve their ratios and exit the BCP. Banks that are still under the supervision of the regulator are subject to numerous credit policy and governance constraints.
In addition, the Indian government has identified priority sectors for investment (SMEs, agriculture, education, housing, etc.) and seeks to use the financial sector to develop the economy, especially in rural areas and among low-income groups. income and disadvantage. The authorities have thus set lending targets for domestic commercial banks and foreign banks equivalent to 40% of their total outstanding loans. However, these priority sectors are also the main source of non-performing loans.
This partly explains the difference in the rate of non-performing loans between the public sector (first relay of public authorities) and the private sector. The latter, instead of lending directly, tends to buy back loans and securitized portfolios from other non-banking financial companies (NBFCs) or by subscribing to specialized government agency bonds which present a lower risk of default.
Ultimately, if the regulator wishes to continue to reduce the exposure of financial players (banking and non-banking) to bad debts, this will necessarily involve a reduction in the lines of credit granted to rural populations and SMEs, with potentially extremely political reactions. negative. In addition, the many exemptions to the repayment of agricultural loans at the level of the Federated States, combined with the weak legal framework governing the resolution of bad debts at the national level, should continue to weigh on the discipline of loan repayment by borrowers, in particular in the agriculture and SME/VSE sectors.
In addition, the degree of interconnection and exposure between players in the financial sector (banking and non-banking) has accelerated recently and increases the risk of contagion linked to the default of one of the players. The sector of non-banking financial institutions, which had taken over from traditional players in the financing of real estate and infrastructure projects, has thus been hit, for several months, by a crisis of confidence and liquidity following payment defaults, in September 2018, from the conglomerateIL&FS.
Both the Ministry of Finance and the Central Bank are trying to prevent, at the sector level, the contagion phenomena that could result from the rationing of credit intended for non-bank intermediaries (and therefore of its ability to refinance itself). But this episode highlights the growing interconnection between players in the financial sector (banking and non-banking), which will have to be the subject of particular vigilance in view of the underlying risks of contagion.
Finally, political arbitration also appears necessary with regard to the share of foreign direct investment (FDI) in the capital of commercial banks. The government is reluctant to authorize the removal of the ceiling on the share of FDI in the capital of private credit institutions, currently limited to 49% and up to 74% with the approval of the government. It would be increased from 20% to 49% for public commercial banks.
