New Year may herald first round of bank privatisation, new licences for private entities

For almost a decade, the Indian banking sector has made the headlines usually for the wrong reasons. The first signs of a banking crisis surfaced with a slowdown in the economy in 2012-14. Cases of bank fraud rose, especially in public sector lenders, along with an increase in non-performing assets (NPAs), or bad loans. Asset quality reviews initiated by the Reserve Bank of India (RBI) in 2015 to identify stressed loans pushed NPA ratio levels to double-digit levels. The crisis soon spread from public sector entities to all major players in the banking system – private sector lenders, cooperatives, non-banking financial companies, housing financiers and so on.

Just as the banking crisis was easing, the Covid-19 pandemic, struck threatening to undo years of hard work. But the pandemic did not create the kind of impact analysts had initially feared. In its July 2020 Financial Stability Report (FSR), RBI estimated NPAs to rise from 8.5 percent of advances to 12.5 percent in March 2021. Yet, the FSR of June 2021 showed NPAs in March 2021 were a less-than-estimated 7.5 percent of advances. In the same report, RBI expected NPAs to rise to 9.8 percent in a baseline scenario and 11.2 percent in a severe stress scenario.

We have to wait for the December 2021 edition of FSR for the most recent NPA projections. Given post-pandemic economic recovery and growth, it would have been only fair to expect a lowering of NPA projections.

Yet, with the surfacing of the new Omicron variant of Covid-19 in November, uncertainty is again on the horizon.

What does 2022 hold in store? 

Given the background, what should one expect from the banking sector in 2022?

First, the markets will hope to hear more details on the privatization of public sector banks. In her budget speech for 2021-22, the finance minister announced that the government will privatize two public sector banks.  After the privatization of Air India, market participants will be waiting for the names of the two banks early next year and also whether the government adds more names to the list.

We could also see RBI issuing new licenses for both universal and small finance banks. In an earlier article, I had argued how the number of private banks has been stagnant over the years. In 2016, RBI allowed the grant of universal bank licenses under an on-tap basis and extended it to small finance banks in 2019. But again, there has been limited action in issuing licenses to new banks, In March, RBI formed an advisory committee to evaluate applications for bank licenses. In April, RBI received four applications for universal banks and for four small finance banks. In August, 2 more applications were received for small finance banks.

It has been eight months since the first applications were received, which is a really long time. Ideally, there should be a fixed timeline in  which the license applications are processed. Let’s hope that the advisory committee decides on the applications soon next year.

We are also seeing global regulators award licenses for purely technology-based digital banks. Will we see similar licenses in India too?

Monetary policy 

Third, banks will keenly watch for the normalization of monetary policy on both domestic and global fronts. During the pandemic, the central bank not only lowered its policy repo rate, at which it lends funds to commercial banks, to 4 percent but also increased liquidity significantly. RBI also initiated multiple policies to both safeguard the banking system and encourage lending to pandemic-afflicted sectors.

In the December monetary policy, RBI forecast inflation within the median target of 4 percent and upper band of 6 percent. So RBI can still wait to raise policy rates but it is imperative that it begins to withdraw liquidity from the markets.

The banking-related policies were time-bound and will gradually be phased out. All these reversals are likely to have an impact on the banking system.

Payments  

A fourth aspect related to banking is the payments space. Banks, apart from providing loans and collecting deposits, also play a major role in payments. Consumers often use bank-issued cheques, demand drafts and debit cards for payments. But with developments in the United Payments Interface (UPI), the instant real-time payments system,

The role of bank instruments in payments has been declining. One limitation of UPI has been that only those with smart phones can use the facility. A second is that UPI lacks a wallet feature and one needs an internet connection to make payments.

In its December policy, the RBI has undone both these limitations. The regulator announced that UPI payments will be available on feature phones and UPI will have a wallet feature to make small payments. India has so far has been the hub of innovation in Internet-enabled digital payments. The December decisions will also usher non-internet digital payments. The government and RBI are also expected to issue guidelines on cryptocurrencies, which will add another layer to the digital payments dimension.

Will banks compete or cooperate with technology players? This year, Equitas Small Finance Bank and Google Pay cooperated in deposit services but it remains to be seen whether this strategy is adopted across the banking and fintech spaces.

To sum up, 2022 will be an interesting and action-oriented year for Indian banking. We could see the first round of privatization of public sector banks and licenses given to new private banks.

Normalization of monetary policy and technology will pose both opportunities and challenges to existing banks. We also hope that we don’t see any new virus variants and normal lives and normal banking resume. There is also hope that a decade of bad news in Indian banking ends and will pave the way for far-reaching changes.