The banking sector finds itself neck deep in NPAs, frauds and a massive loss of credibility.
The last 12 months have not been good for the banking sector in India. The sector finds itself neck deep in NPAs, frauds and a massive loss of credibility. That’s the perception that one has, looking back at the last financial year. Is that an accurate assessment? Let’s dive in and see what the last fiscal was like for the sector that manages our money.
The banking sector in India consists of 27 public sector banks, 26 private sector banks, 46 foreign banks, 56 regional rural banks, 1,574 urban cooperative banks and 93,913 rural cooperative banks. That’s not counting cooperative credit institutions. Public-sector banks control over 70 per cent of banking sector assets, leaving a smaller share for their private peers.
In August last year, rating agency Moody’s announced that its outlook for the Indian banking system was stable.
One major highlight of 2017 was the merger of five associates and the Bharatiya Mahila Bank with State Bank of India (SBI), catapulting the country’s largest lender to among the top 50 banks in the world. With the merger, SBI joined the league of top 50 banks globally in terms of assets. The total customer base of the bank will reach 37 crore with a branch network of around 24,000 and nearly 59,000 ATMs across the country. The merged entity began with deposit base of more than ₹26 lakh crore and advances level of ₹18.50 lakh crore.
The big event last year for the banking sector was recapitalization.
The government announced a 2.1-trillion-rupee, or 2.11 lakh crore, recapitalization over a two year period of state-owned banks reeling under high Non Performing Assets. That’s nearly 1.3% of India’s GDP. NPAs increased two-and-a- half times to ₹7.33 lakh crore by this time last year, from ₹2.75 lakh crore in March 2015. This recapitalisation plan is expected to push credit growth in the country to 15 per cent and help the GDP grow by 7 per cent in FY19.
The debate on whether this will really be enough to meet the capital needs of public sector banks, keeping in mind the needs under Basel III norms which will kick in next year, and how much of this fund infusion is growth capital is on. But one thing seems certain: there will be plenty of strings attached to that money. The Reserve bank and the finance ministry have been jointly working on this. “Reform agenda is the highest priority which has to be implemented along with capitalisation. A whole lot of reforms will come so that genuine borrowers don’t suffer and get hassle-free, need based credit,” Financial Services Secretary Rajiv Kumar had told the media.
Recapitalization is not new for India’s PSU banks. In the three decades since 1985, the government has infused around Rs1.5 lakh crores in these PSU banks. The finance ministry usually has the biggest say in the disbursement of said capital to the banks. Generally, banks receive this capital according to size instead of efficiency and growth prospects. Now, for the first time, the truant banks will have to earn this infusion of funds. Preconditions are expected, and only upon acceptance of such conditions will banks be granted recapitalization bonds. Simply put, recapitalization and banking reforms will proceed hand in hand. Some analysts have predicted that we are very likely to some banks aggressively sell off non-core assets and shrink balance sheets.
But it’s not going swimmingly like the centre had hoped. NPAs surged by nearly a fifth from end-December levels. Two PSU banks reported modest profits. Many PSU banks, including State Bank of India claimed the worst is probably over, save for one or two quarters of pain. That probably means more bad loans being disclosed and NPA provisions shooting up as an RBI order will cause more debt defaulters to be dragged into bankruptcy.
“The government capital is only going to just plug the hole, there is definitely no growth capital,” said an analyst at Fitch Ratings’ India Ratings & Research. He said smaller state lenders with limited ability to raise capital from the market will have to curtail their lending.
The IMF had conducted stress tests on India’s fifteen largest banks—12 public sector banks and three private banks—last year. In its report, the IMF observed that the overall system seems quite resilient and 64% of the assets of the top 15 banks are with the ‘resilient’ ones. But the other banks, the remaining 36%, will find themselves in a precarious position even under baseline assumptions. All of these banks in the 36% are state-owned, the report noted, without revealing the names of the banks examined. Under an adverse stress scenario, nine out of 12 state-owned banks will breach “hurdle rates”, i.e. the rates prescribed by Reserve Bank of India for various capital adequacy ratios, according to the stress test report.
In 2009, India had among the lowest ratio of non-performing assets among the largest economies of the world, which form the G-20. Eight years later, we have among the highest ratio of such assets.
The picture is still a bit grim. State-run banks posted a combined loss of 853.7 billion rupees or $12.65 billion in the fiscal year ended this March, according to Reuters. For the last quarter alone, total losses stood at 626.81 billion rupees, or $9.30 billion, negating modest profits at Indian Bank and Vijaya Bank. Gross non-performing loans at the 21 banks rose about 15 percent from three months earlier to 8.96 lakh crore rupees or a staggering $133 billion at the end of March. Bad loans as a percentage of total loans also rose at most banks, with IDBI Bank clocking the highest bad-loan ratio of 27.95 percent, followed by Indian Overseas Bank’s 25.28 percent.
In its push to bring down burgeoning NPAs, the government issued two ordinances -- Banking Regulation (Amendment) Ordinance, 2017 and Insolvency and Bankruptcy Code (Amendment) Ordinance, 2017.
The Banking Regulation (Amendment) Ordinance, 2017 became the Banking Regulation (Amendment) Act in August. This bill permits the Reserve Bank to direct any bank to initiate insolvency proceedings and give directions for resolution of stressed assets. An internal RBI committee homed in on 12 large stressed cases worth over ₹5,000 crore that accounted for 25% of total gross non-performing assets, or GNPAs, worth ₹1.75 lakh crore, for proceedings under the insolvency and bankruptcy code. The RBVI then advised banks to set aside 50% provisioning against secured exposure and 100% against unsecured exposure in all cases referred for bankruptcy. The government then put in place an ordinance that bars willful bank loan defaulters as well as those with NPA accounts from bidding in auctions being done to recover loans. This skewers the plans of any defaulting promoters seeking to reclaim their firms that are under insolvency proceedings.
The war on loan defaults began in 2015 when banks were asked to classify some of their ‘standard assets’ as NPA, which led to the recognition of bad loans amounting to about 11% of total advance until December 2017. Once the government introduced the IBC, the reserve bank was vested with legislative powers to initiate proceedings to recover bad loans. That’s when the central bank released the list of 12 companies we mentioned earlier, what it called the dirty dozen. The list included biggies like Bhushan Steel and Essar Steel for immediate resolution and gave 488 others six months’ time to resolve their debt. Insolvency proceedings were initiated in most cases in following months. About 28 more companies were identified for the IBC resolution in December 2017.
Even insolvency proceedings against some of the biggest loans defaulters got underway, the government found that the parent company of Essar Steel Ltd were trying to bid for the company’s stressed assets because IBC “allowed promoters” to bid for their company. Days later, in a Cabinet meeting, the government passed an Ordinance barring not only willful defaulters but defaulter promoters and related persons too. Like we said, skewered plans.
Of particular concern in the new rules was Section 29 A. Some experts claimed it would mean higher haircuts for banks as too many people or companies would be deemed ineligible under the clause. Others praised it as a wise move that was required to curb the hazard of promoters defaulting and yet wresting back control of such companies. So far, according to Financial Express, evidence suggests that Section 29 A has worked - it has made up to 2,100 companies, including Lakshmi Mittal’s ArcelorMittal, clear their dues.
An overhaul of the existing RBI debt-restructuring schemes into a single streamlined and timely framework in accordance with the IBC was the next step. The central bank warned banking institutions against concealing the actual status of any account, and for purposes of transparency, has demanded monthly disclosures from April 1 on the status of defaults to the RBI credit registry — CRILC.
This set the cat among the pigeons. More NPA numbers tumbled out, leaving us with a clearer picture of bad loans in the banking system. A Crisil report last month claimed that India’s total NPA may surge up to Rs 11.5 lakh crore or 14% of the of bank advances due to RBI’s new framework. However, corporate credit quality has improved in last four years.
It is important to remember that “Banks books are getting cleaned up and NPAs are also being recognised in a transparent manner,” in the words of Financial services secretary Rajiv Kumar. He added that, “even if there is a (higher) provisioning requirement or even if there is a loss for one or two quarters, it is okay….”
Speaking of cleaning up, what really set 2017 apart for the banking sector was that bankers took loan defaulters to court. Weighed down by Rs10 lakh crore in stressed assets, they have been chasing rogue borrowers. In 2017 though, they were on a mission, even if they were pushed into action by an aggressive banking regulator. This came about largely to the discovery of the LoP fraud in Punjab Natiinal Bank to the tune of 2 billions dollars or 13400 crores.
In what many believe is the biggest fraud in India's banking history, Punjab National Bank, the country's second-biggest state-run lender, announced in February that it had been defrauded of about Rs. 12,954 crore by celebrity jeweler Nirav Modi, and his uncle Mehul Choksi - owner of Gitanjali Gems. The two jewelers allegedly raised credit from overseas banks based on fraudulent guarantees issued in collusion with rogue PNB staff. Choksi and Modi fled the country a month before PNB filed its first complaint against them. The scam has now ballooned to a massive 13400 crores and set the ball rolling for the government’s crackdown on bad loans and NPAs. We’ve rarely seen the acronym NPA dominate news headlines this much.
The other big development was in payment services and payments banks. Rather, the rough weather in that sector. Back in 2015, the Reserve Bank gave in-principle approval for 11 entities to set up a new lender entity, ‘payments banks’. The objective - to establish entities that could facilitate digital payments with minimal friction and attract more people into the banking system.
Cut to 2018 and these entities are treading water. In fact, three of them — Cholamandalam Distribution Services, Sun Pharmaceutical and Tech Mahindra — surrendered their licences without even starting operations. Among the rest, Reliance’s Jio payments bank was launched last month. India Post has had a soft launch its payments bank but is yet to announce full operations.
As we speak, only three companies have completed more than six months of operation in this new space — Fino Payments Bank, Airtel Payments Bank and Paytm. Fino started with the broadest base - 410 branches across 14 states, 25,000 banking points across the country - and it sees a little over 15 million monthly transactions. It has increased its base by 12 branches since launch.
The second player, Airtel Payments Bank, took advantage of the Airtel’s large telecom base, converting Airtel wallet users to banking customers. It launched with the highest interest rate on deposits, 7.25 per cent annually. This was brought down to 5.25 per cent in February this year. Airtel Payemnts ran into some trouble recently. The chief executive quit last year, after some controversy around usage of the Aadhaar e-KYC for converting customers to banking without their consent. Airtel was fined Rs 50 million by the RBI for breaking the KYC rules.
Hiccups aside, some industry executives are optimistic. Even though these entities cannot lend or give credit and may only hold deposits up to Rs 100,000 a customer, they have found workarounds. Fino has entered into agreements with entities that can provide these services. “It is too early to say where the industry is headed,’ said Shailesh Pandey, head of strategy and marketing at Fino Payments Bank. He added that Airtel was the first to launch but is still going through the UIDAI (Aadhaar) issue. “Except Fino and Paytm, I don’t think anyone has done any serious work yet,” he said.
He claimed his company made money like any other bank. They can’t do credit but can do it on someone else’s behalf. “We have a tie-up with ICICI Bank, where we disburse gold loans and the book is about Rs 800-900 million every month,” Pandey said.
But analysts aren’t convinced about the potential of payments banks. “Unless you have a large eco-system supporting it, the business is very difficult to sustain. Barring a few, most of the rest may not stand the test of time,” said Jindal Haria of India Ratings and Research. The balance sheets seem to bear that out. While Airtel doubled its loss from Rs 2.5 billion in 2016 to Rs 5 billion in 2017, Fino posted a loss of Rs 820 million for the year ended March 2017.
Payments banks have another major issue: competition. Too much of it. They’re all trying to pull the same customers. Every regular bank is providing digital payments and services, which payments banks were supposed to. There’s UPI, Aadhaar payments and everything else for each bank, which diffuses the differentiation of payments banks. One executive at a mobile payments banks reportedly told the Business Standard that payments banks were a great idea when floated but with digital payments, it runs the danger of becoming redundant.
One more reason for their struggle is regulation. A web of regulations, to be precise. Amol Kulkarni, fellow at CUTS International, a development agency said, “The biggest constraint is that they cannot lend, which is the whole and soul of banking as we understand it. This is why they have trouble making money. Additionally, they have the challenge of doing double KYCs, as the automatic KYCs by telecom companies have been deemed invalid. This is a large friction area, which reduces the competitive advantage of using digital technologies to gather a large number of customers quickly.”
The future does not look very promising for more than a few players in payments banks. Now that WhatsApp is entering the space, it is expected to be a two-way slugfest between Paytm and WhatsApp.Those were the big news in the banking sector in India over the last 12 months. All in all, it has been a challenging yet revelatory year for the banking sector. The perception one gets is that a lot of work has gone into a much needed clean up. As one expert noted, unless the government undertakes structural reforms seriously in order to overhaul the way in which state-owned banks are managed, the sector will continue to be the weak link in India’s financial system, dragging down growth and investments over the long term.