Moneycontrol Pro Panorama | Banking fragility and the heavy hand of the State

Indian rules for banking are already significantly conservative now. Since bankers seem to be doing a lousy job in risk management, regulators and the state have been parenting them. (Representative image)

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Banking 101 is basically borrowing money from a person by way of a deposit and lending that money to someone else in need of funds. The depositor trusts the bank to return the money when he or she wants and the bank trusts the borrower to repay the funds so that the depositor can be paid back. Anything that happens in between is the risk that the banker takes. At the heart of it, banking is the business of getting this risk right. If we look at the latest bunch of accidents in the US banking industry, misjudging this risk has been the key cause. Whether you lend to governments or individuals or corporations, the banker should know the underlying risk.

Lulled by central bank money printing (that ironically was to heal from a financial crisis) bankers at Silicon Valley Bank began to chase yields and put money into bonds. We know how that ended.

Bankers in India are no less to blame. The bad loan cycle that decimated public sector lenders came to be owing to over indulgence in infrastructure lending which bankers termed as ‘nation-building’. Unbridled lending to infra led to toxic assets surging to 15 percent for the banking industry, hollowing out capital for many lenders. In nation-building, banking became incidental.

Since the pandemic, bankers are now flexing tech muscles. Data mining, artificial intelligence, machine learning and super apps now dominate banking discourse. Risk is becoming a by-word yet again. Technology is centre stage and banking is again incidental. Martin Wolf aptly begins his piece in the Financial Times by saying that banking is designed to fail. Wolf has proposed measures to fix US banks by tightening rules.

Indian rules for banking are already significantly conservative now. Since bankers seem to be doing a lousy job in risk management, regulators and the state have been parenting them. Indian bankers got the insolvency and bankruptcy code to recover their money back from borrowers. The asset side has been slowly fixed here.

But what about the liabilities side, the depositor? After all, depositors have the power to decimate a bank through a run. That is what happened to SVB. Indian banks fare well here, having a large portion of sticky retail deposits. But bankers are finding it hard to get depositors over the past one year. Videos and pictures of bankers hawking their deposits through campaigns and even road processions in social media have grabbed attention. It has nothing to do with trust like it does in the US but more to do with pricing.

Indian savers have been losing out on returns as deposit rates have been slow to rise. In fact, at one point, deposit rates were lower than inflation. That, along with juicy returns offered by mutual funds and the stock market, has made it difficult for banks to get a steady flow of deposits. Enter the state here again.

What is the best way to make a product lucrative? Tweak its tax liability or even better increase tax liability on rival products. This is what seems to be at play now in India. The Finance Bill is said to have proposed removal of long term capital gains tax on debt funds. In other words, debt fund proceeds will be taxed as short term capital gains at all times. This removes a crucial tax benefit that debt funds have over bank fixed deposits, the benefit of indexation.

Debt funds have been marketed as a better alternative for deposits, given higher returns and tax benefit. With a higher tax rate eating into their returns, funds will have less of an argument in trumping deposits. This comes as a relief to bankers out on streets to get deposits. If the amendment to the Finance Bill is pushed through, it will mean that once again India’s government has come to the rescue of banks, this time to fix the liabilities side.

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Aparna Iyer
Moneycontrol Pro