India’s banks adjust for growth

Amid ongoing global geopolitical tensions, India is one of the few countries which has maintained a relatively stable economic environment. The Indian banking sector too has remained largely shielded from the recent turmoil in the US and European banking sectors, and has in fact recorded strong performance. 

According to estimates from the country’s central bank, the Reserve Bank of India (RBI), the banking sector’s cumulative profit after tax nearly touched Rs2.4tn ($29bn) in the 2022-23 financial year (FY22-23), a healthy 38.4% above the previous financial year’s figure. Return on assets increased to 1.1% in 2023, from a low of -0.2% in 2018. Moreover, asset quality, which for long was a key challenge for Indian banking, is at its best in a decade. Gross non-performing assets (GNPA) as a proportion of total advances fell to 3.9% in March, a sharp drop from a high of 11.5% in March 2018, and is expected to moderate further. 

Indian banking is experiencing a “Goldilocks moment” where all parameters are looking good, remarks Dipak Gupta, joint managing director at the country’s fourth largest private sector bank, Kotak Mahindra Bank. This is echoed by Debadatta Chand, managing director and CEO at Bank of Baroda, the second largest public sector bank in the country. “The banking industry is in a sweet spot,” he says, and points out that state-controlled public sector banks have performed particularly well across all financial metrics, including profitability, margins and asset quality. 

According to data shared by the Indian finance ministry, in FY22-23 public sector banks earned a record aggregate net profit of around Rs1.05tn, nearly three times that of their net profits in 2013-14. Their capital adequacy was at a high 15.53%, while the GNPA ratio, which had reached a peak of 14.6% in March 2018, fell to 4.97% in March 2023. This performance is noteworthy because public sector banks struggled for much of the past decade under a mountain of bad loans caused by poor risk management and aggressive lending to corporates followed by an economic slowdown, leading to very weak earnings. 

In that same period, private sector banks, with lower exposure to the corporate sector, and better governance, were significantly less affected. From a 75% market share nearly a decade ago, public sector banks today account for slightly less than 60% of the assets of the banking industry.

Credit and risk 

A slew of initiatives by the banking industry regulator and the government over the long term, along with public sector banks working to improve their risk management processes at the regulator’s urging, helped public sector banks turn things around. RBI, for example, put many of them under watch, restricting their operations until their financial metrics improved, while the government infused Rs3.1tn between FY16-17 and FY20-21 to recapitalise public sector banks.

Further, in an effort to create efficiencies and economies of scale, the government merged weaker banks with stronger public sector banks, reducing the total number of government-owned banks to 12 from 27 in 2017. The 2016 Insolvency and Bankruptcy Code, enacted to resolve corporate insolvencies in a timely manner, has also helped rein in defaulters to an extent. 

Nonetheless, although the process of bad loans recognition, provisioning and write-offs has helped clean up bank balance sheets, low recoveries remain a matter of concern. According to local media reports, finance minister Nirmala Sitharaman informed parliament that public sector banks had recovered only 14% of the Rs7.34tn-worth of bad loans that were written off in the five years to March 2022, and recently urged public sector banks to improve their recoveries from written-off accounts. 

In a June press release discussing the Indian banking sector, global credit rating agency Moody’s Investors Service observed that credit conditions in India have gradually improved, with a significant reduction in banks’ stock of legacy problem loans over the past three years. “Banks globally are facing liquidity pressures amid tighter monetary policy, outflows of excess liquidity built up during the Covid-19 pandemic into more profitable investments and increased risk aversion among investors because of stress in the US banking sector,” commented Alka Anbarasu, associate managing director at Moody’s in a statement.

“Indian banks, however, have strong domestic funding franchises and ample liquidity to support growth in their loans in line with India’s strong economic conditions.” 

Moody’s Indian affiliate ICRA estimates that while higher interest rates will likely moderate the year-on-year loan growth for Indian banks to around 11% in the current FY23-24 from 15.5% in FY22-23, the incremental credit growth is expected to be between Rs15tn and Rs16tn, which would be the banking sector’s second-highest increase on record.

Notably, the corporate lending environment in India is muted at present, and most banks are now focusing on retail lending. RBI data shows that in the two years between to March 2023, retail loans grew at a compounded annual growth rate of 24.8%, almost double the growth rate for gross advances in the same period. Retail loans currently form around one-third of the total banking system’s gross advances. 

Retail focus 

The swerve towards retail is especially noticeable in public sector banks. Unlike private sector lenders, which have long had healthy retail portfolios, public sector banks were until very recently predominantly focused on corporate lending. Commenting on this development, Bank of Baroda’s Mr Chand says: “A structural change has happened over the past couple of years. Most banks have diversified into mid-corporate and retail accounts.

This offers two very clear benefits, a diversified portfolio, risk diversification and better return on investment because margins are healthier compared with some of the large corporates where the pricing is very fine.” 

Dinesh Khara, chairman of State Bank of India, the largest public sector bank in the country, refers to the retail focus as a “tectonic shift” in the loan books of scheduled commercial banks. “Retail loans are now somewhere in the range of more than 50%,” he adds. “It differs between banks but the corporate book has shrunk.” He expects this trend to continue: “There is a growing retail demand and a very strong middle class in the country which has huge aspirations. Retail is likely going to be a very major component in the loan book of banks.” 

Mr Gupta opines that while in the short term credit growth will be retail- and consumption-driven, in the medium and long term, corporate lending will start coming into play. “Capex-led growth, which has been muted over the past couple of years, will eventually pick up in 12 to 18 months and that will fuel the next level of credit growth,” he says. 

Amitabh Chaudhry, CEO of Axis Bank, India’s third largest private sector bank, agrees. “The change in relative share between retail and wholesale has evolved in the past two years,” he says. “My hope is that wholesale will start growing as private capex comes back and pricing returns to normal.” 

Axis Bank recently acquired global lender Citibank’s retail assets in India, which has given Axis’s loan book a strong retail flavour. Axis Bank will however retain its focus on wholesale lending, says Mr Chaudhry. “In India there are very few players who can play both the retail and wholesale game. There could be many players on the retail side. But, on the wholesale side there are limited players who can support a customer end to end, such as lending, trade finance, cash management, forex, debt and equity capital markets. So we do not want to let go of that space, but yes, the pricing has to make sense.” 

Despite the industry-wide focus on retail at the moment, Mr Chaudhry believes that, going forward, “retail will be a bigger part of the credit story, but not the dominant part”.

Regulatory caution 

In light of the focus on retail lending, India’s regulator has cautioned banks several times about growth in unsecured lending and the risk of delinquencies. “Empirical evidence suggests that a build-up of concentration in retail loans may become a source of systemic risk,” said RBI in a December 2022 report. RBI data shows that between March 2021 and March 2023, unsecured retail loans increased from 22.9% to 25.25%, while secured loans declined from 77.1% to 74.8%. At this point in time, retail loan asset quality is within manageable limits, with bad loans accounting for only 1.4% of total retail loans in March 2023. 

However, credit rating agency Fitch Ratings says that it expects tighter regulatory supervision to slow unsecured lending in the year ahead. In a recent note on the risk profile of Indian banks, Fitch stated that exposure of credit card lending and personal loans, two of the unsecured retail loan categories that are the most vulnerable to potential stress, rose to 10.2% of system loans by the end of FY22-23, from 7.5% at the end of FY17-18. 

“The regulator has been expressing its concerns and indicated that it is watching this growth of unsecured loans quite closely, and I think it is asking banks as to how they are mitigating risk,” says Mr Chaudhry. Delinquencies may arise more from smaller banks and non-banking financial companies, he adds. “As far as large banks are concerned, we are playing on the lower end of the risk curve. We give personal loans to existing bank customers and understand their financial behaviour.” 

At present there is a low risk of delinquencies arising from the retail sector, says Mr Gupta. “The retail lending boom is still in its early stages, but it has already gone through one clean-up cycle during Covid-19. At this point in time, banks are lending to a smaller business or retail individual who has not defaulted, delayed or restructured their loans and these are, hence, intrinsically good-quality customers.”

Challenges to the Indian banking sector, he says, can arise either from the economy suddenly turning less benign, or marketplace hubris when unnecessary adverse risk-return propositions may cause a deterioration in a bank’s financial profile. Technology, too, Mr Gupta cautions, requires close monitoring. “If through some technological breakthrough some fintechs or some of the big techs are able to reach customers for either their deposits or lending, that poses a big challenge to a bank and it may not be easy to counter that challenge,” he says.

Digital expansions 

While Indian banks have long been cognisant of the importance of technology, they are now taking their technology focus up by several notches. Technology is critical not only to enable them to stay ahead of their peers, but to fuel their next level of growth. At the second-largest private sector lender, ICICI Bank, the first bank in India to launch internet banking back in the 1990s, the digital focus is present across all its offerings.

In its latest annual report, the bank stated that its key technology priorities include creating an enterprise architecture framework across digital platforms, data and analytics, micro services-based architecture, cloud computing, cognitive intelligence and other emerging technologies. 

ICICI Bank’s technology expenses grew to 9.3% of operating expenses in FY22-23, compared with about 8.6% in the previous fiscal year. Axis Bank’s technology spend has gone up by more than 70% in the past two years, estimates Mr Chaudhry. “Four years back, almost 30% of our technology infrastructure was more than eight years old,” he says. “Now we have only 5% of tech infrastructure which is more than five years old.” 

Kotak Mahindra Bank’s digital investments have nearly doubled over the past two years, says Mr Gupta. Earlier, its technology focus was primarily to enable online customer acquisition and engagement, but now its efforts are focused on creating a robust technology infrastructure to ensure absolute resiliency. Mr Gupta explains why high resiliency investments are required at the back end: “Two years back it was acceptable if my mobile banking app was down for 15 minutes in a day. Today even 15 minutes’ downtime in a month is unacceptable.” 

In December 2020, following several instances of outages and poor online services, India’s banking industry regulator had temporarily banned the country’s largest private lender, HDFC Bank, from offering digital banking services for around 15 months. The bank improved its technology backbone and now after bringing its parent company HDFC Limited, the country’s largest housing finance company, within its fold, it has embarked on an ambitious technology transformation exercise.

In his message to shareholders in the bank’s latest annual report, HDFC Bank CEO Sashidhar Jagdishan said: “For me, the focus on technology upgrade and digital transformation is central to achieving growth as well as excellence in customer service.”