Karthik Srinivasan
The Modi government inherited a banking system that was reporting moderation in profitability amidst rising asset quality pressures. Factors such as delays in project completion as a consequence of policy paralysis, adverse rulings from Honorable Supreme Court of India regarding allocation of natural resources and licenses, apart from decline in global commodity prices adversely affected the ability of corporates to service their debt obligations in a timely manner thereby weakening the banking sector. The clear mandate to the BJP in the last general elections in May 2014 raised expectations of a revival in economic growth, boosting investor sentiment, which was also amply reflected in the sharp rise in the equity indices during FY15.
Acknowledging that getting the health of the banking sector back on track is a critical parameter for improving the growth prospects, the new government announced the “Indradhanush” plan to help turn around the public sector banks (PSBs) which form the backbone of the Indian economy.
As part of the plan, the GOI announced a planned capital infusion of Rs 700 billion over a four year period (FY2016-FY2019) and the formation of a Bank Board Bureau which would help in selecting the bank heads and also liaise with the bank boards to formulate growth and developmental strategies. In order to improve the governance structure, the post of Chairman & Managing Director was split into Non-executive Chairman and MD&CEO coupled with encouraging independent working of PSBs while framing performance indicators for PSBs.
However, the increased volatility and growth concerns in the global markets and ever-increasing inter-linkages of India with other economies, the path to recovery became more challenging. The asset quality pains for the banking sector are far from over and in fact has increased over the last few years as recovery challenges continue despite various initiatives that have been taken to revive growth.
The extension of the applicability of the SARFAESI Act to NBFC and the passage of the Insolvency and Bankruptcy Code last year are important steps taken to initiate recovery from delinquent borrowers. The recent ordinance for amendment in the Banking Regulation Act 1949 further highlights the urgency and the willingness of GOI to resolve the stressed assets woes of the banking system, though the ability of banks to take haircuts on such exposures will be critical to the resolution of the accounts given their limited profitability and capital cushions to absorb these haircuts.
Measures like “Jan Dhan Yojna” to improve the financial inclusion and the demonetisation exercise, which have benefited the citizens would surely be counted as some of the landmark decisions of the Modi Government. While these measures benefited the banking system it significantly increased their operational work load for few months. The “Jan Dhan Yojna” accelerated the financial inclusion with opening up of ~285 million bank accounts for the poor sections of the society.
The subsequent linking of these accounts with transfers related to various welfare schemes of government helped improve the efficacy of the government schemes thereby benefiting the citizens. The demonetisation measure, on the other hand, led to a sharp spike in deposit flows into the banking system and fastened the transmission of policy rates as banks cut their lending rates with the reduction in cost of funds. These measures also accelerated the pace of adoption of digital technologies as reflected in increased digital transactions across the banking system over the last two quarters. This will provide long-term benefits of lower transactions costs for the banks and lower currency in circulation or cash intensity of GDP, thereby benefiting the banks by way of larger deposit base and better profitability.
Consolidation in the Indian banking landscape has resumed with State Bank of India merging its associate banks and Bhartiya Mahila Bank with itself in March 2017. Though consolidation is a not a panacea for banking sector woes, the increasing capital requirements under Basel III and weak financial position for some PSBs could pave the path for more consolidation, subject to approvals from the government and regulator.
ICRA estimates the capital requirements for PSBs at Rs. 1.2-1.3 trillion over the next two years of which around Rs 800-900 billion would need to be in form of equity, and the balance through additional tier I capital. While the allocation by the GoI is only Rs 200 billion and raising equity from equity market seems difficult given the weak market multiples, government’s reiteration allocating higher capital, if required, is partly comforting.
The Agreement on the Monetary Policy Framework of the Government and the Reserve Bank of India (RBI) set a CPI inflation target of 4 percent +/-2 percent. With an objective of adding value and transparency to the monetary policy decisions, the government also amended the RBI Act to constitute a monetary policy committee (MPC). The decline in inflation and the government’s commitment to fiscal consolidation has supported the RBI in reducing the policy rate, which has declined by 175 bps during last two years. The speedy transmission of monetary easing has added to the vibrancy in the debt markets, which have witnessed strong growth in issuances and outstanding volumes.
A vibrant debt market coupled with regulatory push for large borrowers to tap debt markets for their capital requirements will also help in de-risking the banks from concentration risks in future.
(The writer is Senior Vice President and Group Head, ICRA)
Full coverage: Three years of Modi government
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