Relevance: GS-3:Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.

Key Phrases: Financial Stability Report, NPAs, Scheduled Commercial Banks, Public Sector Banks(PSBs), Credit Off-take, new-to-credit segment, credit risk migration.

Why in News?

• RBI’s recently released ‘Report on Trends and Progress of Banking in India’ (RTPB) and the ‘Financial Stability Report’ (FSR). It provides for good-quality information and analyses on the state of the banking system in India.

Highlights:

• The report pegs the NPA of India’s Scheduled Commercial Banks (SCBs) at 6.9 per cent at end-September 2021.
  • Stress tests indicate that the Gross NPA ratio of all SCBs may increase to 8.1 per cent by September 2022 under the baseline scenario and further to 9.5 per cent under severe stress.
• There has been a slow revival in the credit off-take of banks in 2021.
  • The latest print being a 7.1 per cent y-o-y rise, most of which has been led by the retail side of their business.
  • The pace of growth of retail credit still remains below its pre-Covid level, though.

Reasons:

• The RBI’s research, as revealed in the RTPB, gives following reasons for the tepid credit growth:
  • Slowdown in industrial activity
  • Investment constrained credit demand,
  • Stressed balance sheets of banks causing limited credit supply.

Issues with PSBs:

• Within the bank groups, public sector banks’ GNPA ratio of 8.8 per cent in September 2021 may deteriorate to 10.5 per cent by September 2022 under the baseline scenario.
• The risk-adjusted return earned on corporate credit has been dismally low for a long time, particularly for PSBs.
  • PSBs current stressed segment of the wholesale credit at 12.5 per cent is way higher than private banks (PVBs) and foreign banks (FBs).
• Compared to when the pandemic appeared in March 2020, the financial performance of PSBs, PVBs and FBs has now significantly improved.
  • But in the case of PSBs, even a modest shifting of the reference point to 2015 or beyond suggests that as a group, they continue to be the laggards.
• The RoA (return on assets) of PSBs is not only much less than those of PVBs and FBs, but is a little over half of what was achieved, on average, during the five-year period to 2012-13.

• An important underlying fact in respect of RoE (return on equity) of PSBs is that they as a group are significantly more leveraged than PVBs and FBs, making them structurally more risky.
• On the business expansion front, they have fallen way behind:
  • Their (y-o-y) CASA growth in September 2021 was 11.6 per cent compared to 22.8 per cent for PVBs and 17.2 per cent for FBs.
• Further, the operating expenses of PSBs as a proportion of their total income have risen sharply from 18 per cent during the five-year to 2012-13 to 24.4 per cent currently, whereas this metric for both PVBs and FBs has remained more or less unchanged.

These developments bode ill for the ability of PSBs to compete on loan price, all else being equal.

Challenges:

• The credit risks of different types are not being assessed by the banks using the latest tools and further the corresponding remunerations are inadequate.
• During the period March’19 - September’21, the ratio of the number of rating upgrades to rating downgrades of a select group of non-PSU non-financial corporates fell from 0.66 to 0.35, with a low of 0.06 reached in June 2020.
• In general, the portfolio of such corporate borrowers has a propensity of more rating downgrades than upgrades, implying deterioration in the credit risk profile of the portfolio with the passage of time. This appears to be the experience with wholesale credit for a long time.
  • Banks are not getting paid for adverse credit risk migration propensities.
• The feature of adverse credit risk migration is now visible in the consumer credit portfolios of banks. It is not clear at the first sight if this is a consequence of the pandemic-related economic adversity or there is something more durable at work.

Way Forward:

• The myths like PSBs hold the savings of the common people in trust and, hence, their privatisation would be violative of the social contract that underlie the current arrangement, have been diligently nurtured over the years to justify the below par performance of PSBs needs to be debunked.
  • Supreme Court, in a recent order, has declined to accept the ‘trusteeship concept’.
• Policy initiatives to privatise most PSBs should be taken within a time-frame.
  • A capital-starved country like ours can ill-afford systematic inefficient use of financial savings and of taxpayers’ money.
• Government is planning to bring the Banking Laws (Amendment) Bill 2021 - which aims to privatise two public sector banks (PSBs).

Conclusion:

• The pandemic has left deep scars on India’s banking system, and it is highly possible that the imperatives of the pandemic-induced ‘new normal’ will impact and influence the risk-return landscape for most economic and business activities in the years to come.

Source: The Hindu BL

Mains Question:

Q. With global growth faltering, monetary tightening in the developed countries as well as the continued impact of pandemic, there is a grave risk to India’s Banking system. Comment.