It’s that time of the year when we reminisce and reflect. Most of the wishes expressed for 2022 have come true. Credit picked up, and NPAs did not, the Reserve Bank of India (RBI) normalised monetary policy, and the yield curve became uncharacteristically flat much to the bewilderment of the bond market; yet it seems to have had no impact on credit growth.
After the regulatory tightening of the fintech space, there has been a groundswell of partnerships between fintechs and banks, and the government appears to have made significant progress in privatisation of at least one PSU bank.
Although 2022 turned out to be good for banking, some new areas of concerns have emerged. My wish list for 2023 is focused on the hope that these nascent worries abate. They are:
Deposit Credit Growth Balance
While credit growth spiked up, deposit growth lagged. Currently, credit is growing ~17 percent, while the deposit growth has remained below 10 percent. Percentages growth rates can obscure the real challenge banks face; in the first five months of the current fiscal (FY23), incremental banking credit was higher than incremental deposits by about Rs 40,000 crore. In June, this author had written about the likely battle for deposits — that battle is fully upon us now. If the deposit growth remains lacklustre, it will eventually constrain banks on credit, and would hurt the profitability margins.
The proximate causes of low deposit growth relative to credit are obvious — liquidity withdrawal by the RBI, depletion of foreign exchange reserves in defence of the rupee, and rise in the level of currency in circulation (now higher as a percentage of GDP than that before the 2016 demonetisation). However, there are deeper structural factors that need policy attention — such as stagnant real wages for over a decade in many sectors, serious leveraging in households’ balance sheets, unfavourable tax treatment for bank deposits over debt mutual funds, and, lately, the sharp rise in inflation. All these are contributing to declining savings and low deposit growth. Unless some of these issues are addressed, what is a minor unease now can turn into a major problem later.
Peak Inflation
The central theme occupying banking and financial sectors across the world is the rise in inflation. All major economies have been facing sharply rising inflation as they started coming out of the COVID-19 pandemic. Most of the central banks have reacted with aggressive policy rate hikes, and liquidity withdrawals. The RBI has also increased policy rates by 225 basis points, and has brought liquidity down from a level of significant surplus to almost neutral.
It is clear that the global interest rates will remain elevated for a considerable period of time until central banks see the underlying inflationary pressures abate. It is hoped that inflation gets under control, and the rate hike cycle comes to an end soon. Elevated rates can hurt investments and bank credit, which are critical to sustain economic growth.
Contained Credit Costs
This year all banks saw significant reduction in loan loss provisioning which boosted profits. The banking sector seems to have declared victory on the NPA cycle. But we should be cautious. There are two books that could still face rising bad loans. Credit to micro, small and medium enterprises (MSMEs), especially that not covered by the government guarantee scheme (CGLS) — ~5 percent of the total credit — and unsecured consumer credit — ~11 percent to 12 percent of total credit — could face rising NPAs as these segments bear the brunt of inflation. So far, the credit quality in these books appears to have been stable, but we must continue to watch it carefully.
Return Of The Capex Cycle
While we have seen rise in the growth of banking credit, it has been mainly driven by working capital demand which in turn has been driven by rising commodity prices. Some sectors such as renewables, logistics, construction, etc. have also been driving credit demand, yet we have not seen any revival of capital expenditure in basic industries. Unless we see the return of the capex cycle, credit growth will eventually subside as global commodity prices cool off with slow economic growth or even recession.
So, it is hoped that India stands out among the large economies, and we see a return of a vigorous capital cycle in core industries on the back of economics growth and increased capacity utilisation.
Lower Operating Costs Ratios
Over the last few years Indian banks spent huge resource under that broader label of ‘digitalisation’ without any measurable impact on revenue or operating costs. Consequently, operating cost ratios of all banks, especially private banks, inched up. It is hoped that 2023 is the year when they start seeing benefits from these investments in the form of reduced (other) operating costs, and increased revenues. This year, bank margins are likely to be under pressure as deposit pricing catches up with policy rate hikes. Hence, it will be critical for banks to use the operating cost lever to maintain profitability.
Regulations On Mergers And Acquisitions
Two important transactions are facing regulatory review. Merger between a large bank and a housing finance company belonging to the same group is awaiting final regulatory approval. It is also very likely that privatisation of a PSU bank will undergo a regulatory scrutiny in the current year. It will be very important to see what concessions, if any, the regulator gives these entities while approving the transactions.
This will be important not just for the post-transaction performance of these entities, but also as a precedence for the regulatory approach to all future such transactions. In case of the PSU bank privatisation, in addition to the regulatory view, we shall also watch carefully what constraints and flexibilities, if any, the government as the current owner imposes on the new owners as its transfers management control.
Finally, let us hope that 2023 is as kind as this year has been to the banking sector.
Harsh Vardhan is a Mumbai-based management consultant, and serves as independent director to Karur Vysya Bank. Views are personal, and do not represent the stand of this publication.
