The Epic Shift

The numbers are staggering. In the next three years, the proposed Development Finance Institution (DFI) could have a lending portfolio of Rs 5 lakh crore, while the asset reconstruction company (ARC) for bad loans would have acquired Rs 3-4 lakh crore stressed loans from banks, releasing huge capital for banking sector expansion. That's not all. We might also get a few more banks, possibly a big corporate-backed bank or a large NBFC converting itself into a bank. Then there is acceleration of technology adoption by banks, NBFCs and Fintechs. The government, too, has again taken up the pending proposals for privatisation of public sector banks (PSBs).

The Rs 180 lakh crore banking industry's 'great reset' is well in progress after the Covid-19 outbreak that made banks trigger business continuity plans and raise capital to cushion any possible deterioration in asset quality. Though the year (FY20) under the BT KPMG Best Banks and Fintech study ended on a challenging note, the survey has captured many well-run banks churning out good numbers and rewarding investors and shareholders. After a long time, private sector ICICI Bank is back in the numero uno position. The new MD & CEO, Sandeep Bakhshi, has turned it around after the exit of former CEO Chanda Kochhar amid an uncertain business environment. South-headquartered Federal Bank is another surprise in the mid-sized category which showed rock-solid performance in growth, size and strength. The newest private sector bank, Bandhan Bank, emerged the top among small banks.

These and other winners have shown exemplary resilience in a sector that is up for exciting changes ahead.

Privatisation, Consolidation, Niche Banks

After over five decades of nationalisation of banks, the government has set the ball rolling for privatisation of PSBs by deciding to select two mid-sized banks out of the six left out of the earlier consolidation exercise. The two candidates could be from among Bank of Maharashtra, Bank of India, Central Bank of India or Indian Overseas Bank. "The consolidation of PSBs was triggered to achieve capital reallocation and efficiencies. A further consolidation would continue to be driven by the same principles whereas the private sector would be driven by event risks and ability to scale up," says Tarun Bhatia, MD and Head of South Asia in Business Intelligence and Investigations practice of Kroll.

Clearly, the objective is to not use taxpayers' money to fund inefficient banks. The government has pumped in over Rs 3.50 lakh crore into PSBs in the last five years. But valuation of these banks is at rock-bottom. State Bank of India, with balance sheet of over Rs 36 lakh crore, is valued at Rs 3.70 lakh crore. The country's second-largest bank, HDFC Bank, with half of SBI's assets, is at Rs 8.50 lakh crore. While selling a PSB during a slowdown will not fetch good value, the intent of the government is clear; it wants to put the PSB house in order.

The shift in government approach was clear when, for the first time, it allowed the handing over of an old private sector bank to a foreign bank; in November last year, RBI gave Singapore-based DBS Bank the go-ahead to acquire the failed Laxmi Vilas Bank. Experts say the government also didn't bail out failed Yes Bank and IDBI Bank directly. These steps - apart from the bad bank and the DFI - to make the system stronger are timely as Covid outbreak is threatening to create a new NPA cycle and constrain banks' ability to finance growth. However, as these will take time to hit the ground, banks will have to deal with the new stress in portfolios in the near future.

In addition, Small Finance Banks (SFBs) are growing fast to finance micro borrowers in rural and semi-urban areas. The BT-KPMG study has recognised the role of SFBs by including them in both quantitative and qualitative studies for the first time. Utkarsh Small Finance Bank has emerged as a winner in quantitative rankings whereas Ujjivan Small Finance Bank has scored high on qualitative parameters such as innovation, talent management and enterprise resilience. However, given the size and scale of the Indian market, we need more financial institutions to support growth.

In addition, an RBI working group has batted for allowing corporates into banking, a proposal which may change the banking landscape further by giving it access to a large pool of capital. "This may be a precursor to more banking licences to select NBFCs over the next few years," says Deepak Jasani, Head of Retail Research, HDFC Securities. A banking licence means better access to low-cost CASA (current accounts and savings accounts). Jasani says some NBFCs may not see any major benefit in becoming a bank.

Hidden Stress

A lot of stress in the banking system is not out in the open due to the initial payment moratorium followed by two-year loan restructuring benefit and government guarantee for MSME loans. "There might have been some degree of evergreening. One will know the real quantum of moratorium and stress after the June quarter," says Bhatia of Kroll. The Supreme Court has also ordered asset quality standstill on fresh NPAs till further orders. This means a lot of NPAs are waiting to come out in the open. For example, State Bank of India reported gross NPAs of 4.77 per cent in quarter ended December 2020 as against 5.44 per cent estimated without the court order. A recent RBI report has said that given the uncertainty induced by Covid-19 and its real economic impact, asset quality of the banking system may deteriorate sharply in future. Fresh slippages are likely to come from services companies and MSMEs, which have been hit badly by Covid.

Similarly, a big chunk of unsecured personal loans, credit card dues and micro loans may turn bad because of hit on incomes of both salaried and self-employed. "The share of unsecured credit card loans is up from 3.1 per cent to 5.2 per cent within a span of five years. This does not augur well for their risk profile," says a recent RBI report. "There are parts of microfinance book in specific geographies and occupations where we have seen stress," says Nitin Chug, MD & CEO of Ujjivan Small Finance Bank. Apart from loss of incomes, things such as microfinance loan waiver talks in Assam have created uncertainty. The real picture will emerge after the restructuring (which reduced EMIs for next two years) period is over. NPAs rose in last five years because of RBI's drive to clean up banks' books. After touching a high of 9.5 per cent, gross NPAs slipped to 7.5 per cent in September last year. They are now expected to reach a high of 12-15 per cent in a worst-case scenario. In fact, the sector reported profits in FY20 after two consecutive years of losses. Higher provisioning going forward may push them back into the red. PSBs are likely to be hit the hardest.

At the system level, banks' return on assets and return on equity turned positive in FY20. The only silver lining is the high provisioning coverage of over 65 per cent.

Acceleration of Digitisation

"Apart from consolidation, digitisation is another theme playing out in the banking industry. But in any journey, there is always going to be space for high quality service providers," says Shyam Srinivasan, MD & CEO of Federal Bank Ltd. Clearly, digitisation has accelerated after Covid outbreak. Banks are looking at virtual relationship managers and complete digitisation of savings and loan products with video KYC. Digital banking is no longer a way to save costs but a necessity to offer a superior customer experience. "Banks have embraced new-age payment systems by readying people, technologies and processes that guarantee humongous transactional volumes at breakneck speed with dependable security and counterchecks built around them," says Jasani of HDFC Securities.

Banks have also taken steps to rationalise the number of branches and reduce human interactions as much as possible. "Use of data analytics, artificial intelligence and machine learning will enable banks to reduce time to market, bring down wasted efforts and enable targeted marketing," says Jasani.

The banking space is opening up. "The good news about the new world is that information is democratic. Whoever executes brilliantly will matter," says Srinivasan of Federal Bank. In fact, competition from new-age NBFCs and fintech players is gradually intensifying in certain products, especially consumer durable loans, small-ticket loans and payments. Then, there are aggregators offering loans of all banks. Aditya Puri, the former CEO of HDFC Bank, says technology is allowing banks to provide better service to customers. Under him, the private sector bank transformed banking by offering everything a fintech or an app could provide, in a frictionless manner.

Challenges Ahead

The banking landscape is set to change with consolidation, privatisation, new banking models, digitisation and proposals such as DFI. But there are challenges too. For one, there is no guarantee that consolidation will arrest the decline of PSBs' market share. Despite some path-breaking measures taken by the NDA government like setting up a Bank Board Bureau, splitting the post of chairman and MD & CEO, linking capital infusion to performance and action against non-performing CEOs, PSBs remain laggards in terms of customer service, market share gain and valuation. "This may be due to governance issues and lack of motivation for right employees," says Jasani. They need capital, autonomy, market-linked compensation and better governance, HR policies and training. "There should be mandatory reporting on HR in annual reports like it is done for governance. It will also put responsibility on board and top management to take concrete initiatives," says Anil Khandelwal, former Chairman of Bank of Baroda and also a former member of the Bank Board Bureau.

Private sector banks have their own challenges. With star CEOs like Aditya Puri (HDFC Bank) and Romesh Sobti (IndusInd Bank) gone, the new leadership has to show results. Digitisation in an environment of fast-changing technology and asset quality issues can also be difficult to handle. Many banks are also expanding in rural and semi-urban areas with micro, consumer durable and affordable housing loans. "These are untested territories," says a banker. Similarly, digitisation and security issues have to be handled very carefully as any laxity can cause an irreparable damage to the reputation.

The setting up of the ARC for bad loans and DFI will be keenly watched by the market. "We had introduced the concept of ARCs about twenty years back but unfortunately they didn't make the impact that was expected. Hopefully, we would have learnt from our past mistakes to ensure that the new instiution is structurally stronger and more efficient," says Bhatia of Kroll.

And finally, there is a lingering risk due to RBI's exit from counter cyclical measures under which the regulator has provided a number of relief and relaxations in the last two years. A reversal or normalisation of regulatory reliefs will create its own challenges.

Over to banks.

@anandadhikari