This is not the first time that the Reserve Bank of India (RBI) Governor Duvvuri Subbarao has suggested that banks trim loan rates while offering more to their customers; at a Bancon conference in early 2010, the government had recommended much the same thing. In the central bank?s latest review of the banking industry, Subbarao says banks need to further push up operating efficiencies by optimising costs such as wages and salaries, transaction costs and provisioning. The Governor believes this would allow them to lower lending rates but not lose out on profitability.
On the face of it, the suggestion seems perfectly valid and one would think that given the scale, bringing down costs should not be too difficult. Just for some perspective, on average, today banks are earning a net interest margin (NIM) of around 2.5-3%; this puts them somewhere in the middle of the heap with countries such as Indonesia and Brazil doing better with NIMs of above 5% and 6%, respectively.
Of course, it must be pointed out that banks in India are mandated to set aside about a fourth of their liabilities to subscribe to government paper. The fact is that branch banking in India is not cheap, especially in the semi-urban and rural areas. It costs at least R6-7 lakh to set up even a very small, spartan outlet and very often the business generated isn?t enough to make it profitable on its own because it takes time to grow the clientele and, consequently, the deposit base. Since the branch banking model?s efficacy is beyond doubt, especially because it helps banks mop up retail deposits, this cost will remain or maybe go up as banks offer better service. In fact, RBI has advised banks to set up some kind of low-cost brick-and-mortar branches between the base branch and the point where business correspondents (BC) are located. According to a report by the Boston Consulting Group (BCG), in India about 62% of the total staff is engaged in customer-facing activity. BCG believes that the higher the share the more efficient the business model. However, it?s possible then that wage bills may not come down meaningfully; currently, the average cost per employee is somewhere around R5.5 lakh and if the sector is to attract and retain talent, salaries have to be attractive, especially since nearly three-fourths of the middle-management of PSU banks will retire in the next 10 years and will need to be replaced. The cost-to-income ratio of banks today, at close to 48%, compares favourably with that in Thailand which is at
about 57% but is marginally higher than it is in South Korea and much above that in China, where the ratio is about 40%.
When it comes to profitability, Indian banks have been better off than many of their peers, but not as good as those in China and Indonesia. Of late, profitability has been under pressure because of rising delinquencies; lending to the small & medium sector enterprises can be a high-margin business but microfinance, as we have learnt, can be a high risk business too. Indeed, going by the pile-up in loan losses originating from the agriculture space, that too is not without its risks because the costs ultimately show up in the form of credit costs. RBI has made a mention of how banks need to manage their exposure to some of these sectors, pointing out that the recoveries haven?t kept pace with the slippages since 2007-08. The substantial amount of restructuring carried out during the slowdown, together with high interest rates, the central believes, could further stress the asset portfolio. It?s unlikely then that provisioning, more of which has been required over the past six months, will come down soon, given the deteriorating macroeconomic environment. So that?s one area where costs can?t really be brought down now but, clearly, over the long run, as the economy recovers, and banks grow their balance sheets, the share of provisioning should fall.
In fact, banks? balance sheets would also become more de-risked with time as they add on assets and liabilities in new geographies. Despite the possible risks, the central bank believes the larger Indian banks should scout for opportunities to expand their presence overseas, though it is clear that even after reasonable consolidation it is unlikely that any of the Indian banks will make it to the top ten globally.
Clearly, there are opportunities abroad and, with the central bank?s help, banks should penetrate countries in the Asian region as also the Middle East to cash in on the opportunities for trade financing. After all, it?s this part of the world that?s probably going to be more prosperous for the next decade or so. Of course, the opportunity to fund large Indian business houses who are growing their global footprint exists, but to be able to meaningfully fund large-ticket acquisitions, Indian banks need to have much larger balance sheets. It will be a while before they are able to build up a deposit base abroad but there is the growing Indian diaspora to tap, all across the globe, whether for loans or deposits. But that too should happen.
shobhana.subramanian@expressindia.com