Across the globe, 2009 was one of the most challenging years for banks, their regulators and governments. The economic crisis that belched in the US has had global reverberations. The collapse of numerous banks in the UK, Belgium, Russia, Spain, etc adversely affected their economies. In the US itself, more than 60 banks went belly up (several were tagged too big to fail).
The globalised nature of the Indian economy and its increasing integration with the West through trade and investments ensured that India was not completely insulated from this financial tsunami. But India (unlike other emerging economies) still relies substantially on its domestic growth. It felt the after-effects of the downturn in the form of drying up of liquidity, sharp correction in capital and currency markets and moderate layoffs. Its liquidity crunch was rooted in the frozen international credit markets, which led foreign institutions to become excessively cautious and caused massive capital outflows from the emerging markets.
With comparatively stronger domestic growth drivers, Indian banks not only eluded the aftermaths of the global financial crisis reasonably but even progressed during the crisis.
Subjected to tighter regulations with respect to capital and liquidity, they proved resourceful users of capital when compared with other emerging market banks. The Indian banking sector is placed sixth after Malaysia,
Korea, China, Russia and Chile among the eleven emerging economies in terms of efficiency, productivity and soundness. A leading Indian trade organisations study suggests that the sector was the top performer among the Bric nations and rated second in terms of cost ratios and third in terms of profitability ratios.
The credit for keeping the crisis at bay goes to the financial regulator for adopting a far-sighted and conservative approach. The governmental steps taken to ensure adequate systemic liquidity, the contra-cyclical measures taken to soften the slowdowns impact and timely, well-coordinated stimulus packages for the industry need to be commended.
The global downturn has reaffirmed the position and importance of PSBs. We have witnessed substantial variance in the performance of public, private and foreign banks operating in India. New deposits have settled towards the PSBs post the financial turmoil. With the economic recovery looking favourably poised, banks should take a re-look at expanding their loan underwriting. RBI data reveals that aggregate deposits of scheduled commercial banks at end-October 2009 increased YoY by 19% as compared with 10% YoY increase in advances. The credit deposit ratio that was around 75% in October 2008 fell below 70% in October 2009, which is also reflected in the Indian banks continuing to remain invested in the safe harbour of government securities that witnessed a 34% YoY increase.
When pink slips were the order of the day for many private banks, PSBs continued to be in hiring mode, providing much-needed relief by creating employment during difficult times.
The robust capitalisation of Indian banks, with an average Tier-I capital adequacy ratio (CAR) of above 8%, is an optimistic element in their credit risk profile. However, the Indian banking sector does face formidable challenges in the present economic environment in terms of subdued GDP growth, restrained capital market conditions, and moderately high interest rates. The profitability is likely to be impacted owing to augmented borrowing cost, reduced interest rate spreads, and declining fee income as a result of the deceleration in retail lending. Profit levels are expected to witness continued pressure due to mark-to-market provisions on investment portfolios and consequent stress on trading gains.
Indias vast network of banking institutions consists of more than 61,000 commercial bank branches, 1,00,000 co-operative credit institutions and 12,000 NBFCs, besides a number of niche players such as the microfinance and financial institutions. However, despite such a wide network, there is much that still needs to be done as far as the coverage of masses is concerned under the organised financial services sector. Almost 40% of Indias population is un-banked and can be covered under financial inclusion, offering tremendous opportunity for the banking sector.
If Indias enormous un-banked population needs to be covered, the answer perhaps is to look beyond the conventional constituents i.e., banks, NBFCs, RRBs, MFIs, etc. The answer also probably lies in the development of low-cost delivery model covering the entire financial system which could reach out to the interiors of India. That being said, the regulators need to ensure a robust framework to supervise such new players i.e., telcos, technology companies, etc.
The Indian financial sector, particularly the banking system, needs to achieve size and scale to spread its reach, both within as well as beyond domestic boundaries. Consolidation will act as an enabler and an engine for growth to propel Indian financial institutions to compete against their more powerful global counterparts.
Given the limited size, Indian banks are not fully equipped to compete globally in terms of mobilisation of funds, investment and rendering services, credit disbursal, etc. The fact that nearly 80% of banks have a market share of less than 2% highlights the fragmented state of Indian banking. The top five Indian banks have garnered in excess of 50% of market share, but still they are small institutions by global standards.
It is a recognised fact that bigger banks are a more formidable force to compete against the foreign banks and serve the needs of larger Indian MNCs better. Moreover, eliminating weaker banks always augurs well in the long-run for the industry. There is a strong need to take this long-drawn process forward with renewed enthusiasm.
RBI and regulators across the world now need to synchronise their acts to balance between over- and under- as well as micro- and macro-regulations. The need to recalibrate the minimum requirements of capital has been widely recognised during the crisis. Banks will need to strike a trade-off between maintaining adequate capital liquidity and driving innovative and efficient growth. Regulators will have to develop qualitative and quantitative means to contain the risks posed by systematically important entities.
With some level of economic stability, the focus of governments and regulatory authorities will be on managing the recovery process. Withdrawal of expansionary policies will have to be precisely timed. There will be the risks of high inflation and upward bias in interest rates. Indian banks will have to sharpen their operational skills to overcome these challenges in 2010. While the worst may be over, Indian banks will have to do some deft navigating as world regulators try to strengthen prudential norms, world economies try to restore capital and investment flows, and world governments seek strong, sustained and balanced growth.
The author is director, Ernst & Young India Pvt Ltd