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Asia-PacificJune 23 2021

Digitisation helps Indian banks to survive pandemic stresses

Amid a difficult second wave of Covid-19, India’s banks have continued to evolve. With an improving picture on credit and bad loans slowly coming down, there is hope the sector will quickly bounce back.
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Digitisation helps Indian banks to survive pandemic stresses

The Covid-19 pandemic that has been sweeping across the world since early 2020 has had a particularly devastating impact on India. While the country was spared a health crisis in the first wave — largely because of an extremely strict and prolonged nationwide lockdown — the second wave proved catastrophic. From late March 2021, a highly infectious and virulent coronavirus variant has caused an exponential rise in infections, overwhelming the country’s health infrastructure in a matter of days, and led to an unprecedented number of Covid-related fatalities. 

The first wave of Covid-19 inflicted a steep cost on the Indian economy, which was already experiencing headwinds before the pandemic struck, with the gross domestic product (GDP) growth rate having dropped to an 11-year low of just 4% in the 2019-20 financial year. Data by the banking industry regulator, the Reserve Bank of India (RBI), shows that the stringent lockdown led to a drastic 24.4% decline in the GDP growth rate for the first quarter of the 2020-21 financial year.

Though the last two quarters showed a tentative recovery, the economy contracted by 7.3% for the financial year ending March 2021, the country’s worst performance since its independence in 1947. The economic picture in the wake of the second wave — which caught India unprepared and brutally exposed its weak healthcare systems — is grim, and includes a surge in urban and rural unemployment levels and subdued consumer sentiments. With a slow vaccination programme hobbled by vaccine shortages and chances of an imminent third wave, growth predictions remain uncertain.  

Revising outlooks downwards

In its June report on Global Economic Prospects, the World Bank cut India’s financial year 2021-22 GDP growth forecast to 8.3%, from the 10.1% estimated in April. India is experiencing the largest outbreak of any country since the beginning of the pandemic, according to the World Bank. It says: “The second Covid-19 wave in India is undermining the sharper-than-expected rebound in activity seen during the second half of financial year 2020-21, especially in services.”

Unlike the first wave ... in the second wave there is an element of predictability that builds confidence

Dipak Gupta

International rating agency Moody’s Investor Services has also revised down its financial year 2021-22 GDP forecast for India to 9.3%, from 13.7%. However, it expects the decline in economic activity to be limited to the April to June quarter, followed by a rebound in the second half of the year. 

“While it is too early to fully visualise the impact of the second wave, going by present trends, by the end of the first quarter there will probably be a demand resurgence,” says Dinesh Kumar Khara, chairman of India’s largest bank, the government-owned State Bank of India (SBI). Localised lockdowns implemented during the second wave have meant that business activity has not come to a halt like in the first wave, which suggests that the economic disruption may not be as severe. 

Vaccine brings hope

Dipak Gupta, joint managing director of Kotak Mahindra Bank, the country’s fourth largest private sector bank, notes: “Unlike the first wave, where we had no indication how long it will last and the implications, in the second wave there is an element of predictability that builds confidence. A key aspect is that we know that there is a vaccine available for this virus, so the expectation is that things will gradually come back to normal.”

Dipak Gupta1

Dipak Gupta, Kotak Mahindra Bank

He acknowledges the economic damage is very deep. “There are very few families that were not affected by the second wave. Many had to dip into their savings to pay for medical expenses. The underlying damage may last longer.” As a result, in the banking sector demand will return quickly, he says, but recoveries and debt payments may take longer this year.  

At the country’s third largest public sector bank, Bank of Baroda managing director and chief executive Sanjiv Chadha points out that while the Indian economy suffered because of the first wave of the pandemic, the banking sector was relatively unscathed.

He says: “In a fortuitous development, the corporate credit cycle — the source of much of the stress in the banking sector in the pre-pandemic years — had started to change even before the pandemic. Credit losses had started coming down. Anticipating loan losses, banks raised a lot of capital. So, when it came to the end of the year, paradoxically, what we found is that banks’ profitability was quite high and year-end capital ratios had improved.”

Mr Chadha says that the pandemic’s second wave may push back economic recovery by a few quarters, but with the improved corporate credit cycle continuing, he believes that banks will be profitable this year as well. 

Added pressures 

Nonetheless, Mr Chadha notes that the micro, small and medium-sized enterprise (MSME) sector has faced the maximum stress during the pandemic and needs to be nursed back to health. 

International rating agency Fitch Ratings agrees. In a May 2021 report, it said: “We believe risks to small businesses have risen, particularly as many would have balance sheets that have weakened since 2020. Meanwhile, many individuals face medical bills that will add to strains on their income and savings.” 

Acknowledging the pandemic-induced-stress, over the past 12 months the RBI has put in place measures such as loan moratoriums and state-guaranteed refinancing schemes for small business borrowers and individuals. These schemes offer borrowers additional time to resolve repayment stress and may provide some relief to lenders in the next 12 to 24 months, allowing them to spread credit costs over a longer period, says Saswata Guha, senior director, financial institutions at Fitch Ratings. He cautions, however, that the forbearance measures may merely lead to lenders postponing the recognition and resolution of underlying asset quality problems. 

Banking industry consultant ƒ, founder of the Ashvin Parekh Advisory Services, shares these concerns, and says: “The present restructuring package announced by the RBI may help conceal some severe deterioration in loans that small businesses may have experienced during the pandemic. The true extent of the problem will be revealed only two years down the line in 2023-24.” 

Problem loans 

The overarching problem in Indian banking over the past half decade has been that of mounting bad loans weighing down bank profitability, especially that of the state-owned public sector banks. Loans given mostly to large corporates during the boom years of the mid-2000s had soured as economic growth slowed down, but remained hidden as banks resorted to evergreening these loans.

The issue came to the fore in the financial year 2015-16, only after the banking regulator initiated an asset quality review exercise forcing banks to recognise and recover their non-performing assets (NPAs). Since then, public sector banks have consistently reported gross NPAs of more than 10% of total advances. While private sector bank NPAs have risen as well, their gross NPA ratio largely stayed at around 5%. However, during financial year 2020-21, most public sector banks reported slightly improved NPA levels. 

“Banks, especially public sector banks, have largely recognised and provided for stressed assets in their legacy books, but new stress is building up in the MSME segments,” says Mr Guha at Fitch Ratings. “Most public sector banks have been very guarded on future projections, which raises some concerns.” He predicts that the banking sector’s NPA levels could increase from 8.5% to 9% in the financial year 2020-21, to touch 13.5% to 14% by the end of March 2022, if a substantial portion of the imminent stress were to be recognised in the near term.

Credit growth in India has been tepid over the past two years and remains another key challenge for the banking sector. RBI data reveals that credit growth hit a record low of 5.7% in the financial year ending March 2021, as against 6.8% in financial year 2019-20, and 12.2% in the year before that.

Apart from the economic slowdown, one of the main reasons for the low credit offtake is that corporate credit growth has been flat since the 2015 asset quality review. Facing intense scrutiny, banks have developed a “risk aversion” to giving corporate loans, says Abizer Diwanji, head of financial services at Ernst & Young (EY) in Mumbai. This is especially evident in public sector banks, as they account for more than 80% of their NPAs.

He says: “Public sector banks need to take a long-term view and restart lending, with the aim to revive economic activity. Sectors such as construction and hospitality will need significant funds in the coming months.” 

Growth sectors 

While corporate loan growth has remained flat, retail loans have maintained year-on-year growth of more than 12%. The composition of bank credit has therefore changed. In 2010, corporate loans accounted for nearly half of all advances while retail loans formed around 18% of total advances. 

Today, both retail and corporate loans account for nearly 30% of total bank advances in the country. At SBI, corporate credit declined by more than 3% in the financial year 2020-21, but a strong 16.5% growth in retail personal loans led to overall domestic loan growth of 5.7%. Bank of Baroda was also able to show domestic credit growth of 5% despite low demand from the corporate sector, which forms more than half of its loan portfolio, by targeting a few key retail segments, says Mr Chadha. He adds that keeping growth trends in view, Bank of Baroda plans to increase the share of retail loans in its portfolio.

Public sector banks need to take a long-term view and restart lending, with the aim to revive economic activity

Abizer Diwanji, EY

On the other hand, the country’s second largest private sector bank, ICICI Bank, posted above industry 18% year-on-year credit growth for financial year 2020-21. While retail loans, which account for 67% of the bank’s total loan portfolio, grew 20% year-on-year, even corporate loans showed a healthy 13% year-on-year growth. According to ICICI Bank, corporate credit growth was “driven by disbursements to higher rated corporates and public sector undertakings across various sectors to meet their working capital and capital expenditure requirements”. 

Public sector banks continue to lose market share to their nimbler private sector counterparts, and RBI data shows the share of public sector banks in total lending has dropped from a high of nearly 75% in 2010 to around 55% in 2021. In the same period, their share in overall deposits dropped from around 75% to 60%.

Weak governance, low capital, asset-quality issues and their quasi-policy role in supporting distressed sectors at the government’s behest are some of the key reasons behind their weak performance. Given the strong fundamentals of private sector banks, Mr Parekh predicts that in five years their share of the banking industry’s assets, which takes a combined look at deposits and advances, will grow from around 30% today to over 45%. 

Shifting structures 

In recent years, public sector bank growth has also slowed as they focused on streamlining operations following the three successive rounds of mergers that brought down their number from 27 in 2017 to 12 in 2020.

Consolidation of the fragmented banking sector is a welcome exercise. However, merged banks take a few years to stabilise, during which time the top management focus tends to move away from profitability to operational issues, says Mr Guha. Consolidation, he cautions, should not be regarded as a panacea. “Merging weak banks only creates a big bank that remains weak. Public sector banks are lacking capital. It has made the banks very risk averse, as they are lending only to sectors that require the least risk capital.”

In a recent note, Fitch Ratings said the Indian government’s plan to privatise two state-owned banks in the current financial year, announced by the Indian finance minister, Nirmala Sitharaman, during her February Union Budget speech, could face delays. There is considerable speculation in the domestic media about which state-run banks are under consideration. Fitch, however, states the privatisation exercise could face hurdles, including political and trade union opposition, weakened financial performance of the banks due to the pandemic and cultural differences between public and private sector banks. 

Bank of Baroda’s Mr Chadha says the structure of the Indian banking sector is evolving, with fewer and larger public sector banks on one side focused on enabling industry growth, and increasing numbers of private sector banks on the other side providing an array of niche services.

Regarding private sector banks’ growing share of the market, he says: “To my mind it may be argued that possibly even more competition is something that may be required, to ensure that the banking industry is able to support the growing needs of the Indian economy. So long as that happens, any realignment of market share is perfectly fine.” 

Global banks bow out 

While banks vie for a bigger slice of the Indian banking sector, global giant Citigroup announced in April that it was exiting the consumer and retail banking space in India (as well as in 12 other countries in Asia and Europe). Citi said it did not have the scale it needed to compete in the retail segment, but it plans to continue its wealth management and institutional business in India.

Operating in the Indian consumer banking space since 1984, the bank has made considerable investment and innovations over the years. Nonetheless, it appears to have followed in the footsteps of the other global banks such as Barclays, Deutsche Bank and the Royal Bank of Scotland that have exited India either wholly or in part. Mr Diwanji at EY says: “Globally, banks are facing a lot of capital crunch. Citi’s moving out of consumer banking in India may be part of its global strategy; however, it is also a fact that competition has intensified over the years.” 

The highly personalised retail banking service that foreign banks could charge a premium for is now commoditised. All Indian private sector banks offer this service, while the top public sector banks are also entering the fray. Domestic banks enjoy the added advantage of having a much larger branch presence across the country.

There are two parallel strategies being played out in the foreign banking space. It remains to be seen which will be more successful

Ashvin Parekh

India’s strict regulatory guidelines mandate that foreign banks are allowed to readily open branches only if they operate as wholly-owned subsidiaries (WOS), although that comes with strict priority sector lending requirements. Despite having been present in India for more than a century, Citi has only 35 branches. By comparison, HDFC Bank, the country’s largest private sector bank, which was established in 1994, has over 5600 branches, while SBI has more than 22,000.  

Domestic media reports suggest that both Indian and foreign lenders, including Singapore’s DBS Bank, are in discussions with Citi for its Indian retail banking assets, which includes its much-coveted credit card business.

Digital gains

DBS Bank is among the two foreign banks out of 44 currently operational in India that have taken the WOS route. Recently, DBS took the unconventional step for a foreign bank of acquiring troubled mid-sized lender Lakshmi Vilas Bank, thus gaining a footprint of nearly 600 branches in smaller towns and cities where the competition is low and market is not yet saturated. Mr Parekh says: “There are two parallel strategies being played out in the foreign banking space. It remains to be seen which will be more successful.” 

Digitisation, one of the most remarkable developments in India in recent years, has received a strong fillip because of the pandemic. The strict lockdown and the subsequent social distancing norms that gained prevalence have resulted in consumers rapidly adopting digital payments and digital banking. United Payments Interface (UPI), which has emerged as the most popular mode of retail digital payment by enabling instant funds transfer between two bank accounts using a mobile device, grew well over twice in volume and value terms. According to the RBI, there were 2.73 billion UPI transactions in March 2021. The total value crossed the Rs5tn mark ($68.3bn) for the first time. 

Overall, the total digital transaction volume in 2020-21 grew 27% year-on-year to reach 43.7 billion. SBI’s Mr Khara says 67% of all bank transactions were digital in March 2021, compared with 55% in March 2020. Today, all banks in India are investing in digital products and fine-tuning their digital strategy.

Technology is at the heart of banking today, says Mr Gupta at Kotak Mahindra Bank, where nearly 90% of retail transactions are digital in nature and retail customer acquisition is predominantly digital too. “Going forward, competition will not be from banks or even non-bank financial companies. Competition will come from technology and e-commerce firms,” he says. “Digital trends have a unique way of operating. They grow exponentially in the blink of an eye. Today UPI payments, for example, are so much higher than normal payments. We cannot afford to be complacent.” 

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