Indian banks shine amid robust economic growth

THE banking sector has turned out to be the star performer in the Indian economy, even as global banking has been plunged into uncertainty with the collapse of several US banks serving the startup community. The economy itself represents an island of stability and robustness in a global environment marked by slowdown and uncertainty resulting from the Ukraine war. This is the burden of the RBI’s financial stability report released last month.

Before we find out why this has happened, first let us take a look at the numbers defining the performance. Banks have done well both in terms of assets and liabilities. Their assets in particular, represented by their loan books, have displayed impressive growth. This has reached 15.4 per cent, thus exceeding the 15 per cent benchmark, contributed to by both public and private sector banks. Within banks, the personal loan book has been the star performer, clocking a year-over-year growth of 22.2 per cent.

It is just not that banks have been lending aggressively, they have been doing this along with not just maintaining asset quality but actually improving it. Gross non-performing assets as a share of total assets fell to a 10-year low of 3.9 per cent in March. Even as the share of doubtful loans has gone down, banks have been assiduously providing for them. The share of net non-performing assets (gross assets minus provisioning) has improved to a mere 1 per cent in March.

The improvement in asset quality has partly contributed to a rise in the share of small or personal loans along with a decline in the share of loans by large borrowers. Typically, individuals try their level best to keep repaying their loans whereas large borrowers sometimes engage in diversion of resources to meet group liabilities.

While the performance on the asset side has been more impressive, liabilities or deposits have also given a good account of themselves. In June, deposit growth reached 11.8 per cent, thus exceeding the benchmark of 10 per cent. As incomes grow with economic growth, depositors typically try to save more. Thus, term deposits have grown faster than other forms of deposits like savings and current accounts.

Within this overall positive scenario, expectedly banks have done well on their bottom line or profits. Net interest margin (difference between interest paid and earned) has been higher, contributing to higher profit after tax (PAT). This has improved by 30 basis points (100 points make up 1 per cent) during 2022-23. PAT has grown by over a third, a healthy 38.4 per cent.

There are two broad reasons why banks are doing well. Just as a rising tide lifts all boats, as the overall economy does well, it takes banks along with it. The other is that banks have done well by setting their own house in better order.

Globally, the Indian economy has turned out to be the best-performing among all large economies. In the last fiscal (2022-23), the Indian economy is estimated to have grown by 7 per cent; it is projected to grow at 6.5 per cent in the current financial year, according to the Economic Survey. The global economy is likely to grow at 2.9 per cent during 2023, according to the IMF’s World Economic Outlook.

In the current year, the world economy has been hit foremost by the disruption in commodity supplies, particularly oil and wheat, as a result of the Ukraine war. The Indian economy has been largely insulated against this for two important reasons. One, it is still a relatively self-sufficient economy. What it lacks and needs to import to meet most of its consumption needs is oil. This it has been able to do from Russia, not being a part of the sanctions imposed by the West. Besides, so far the monsoon has held up, raising the hope that agriculture will be able to carry its load in achieving the projected economic growth.

As against this, the US and the European Union economies have been hit by both the negative global environment and rapid escalation in inflation. This has led central banks to raise interest rates, thus putting a further dampener on demand and growth. Even China is witnessing a serious slowdown in growth. In 2022, it grew by only 3 per cent against the official expectation of 5.5 per cent.

Now, let us look at what the banks have done to set their own house in order and pave the way for the current robust performance. In 2016, the RBI under Raghuram Rajan ordered an ‘asset quality review’ which sought to end the practice of window dressing whereby non-performing assets were not declared to be so. This was the first step towards cleaning up the balance sheets whereby a spade would be called a spade. Thereafter has followed ‘prompt corrective action’ through steady provisioning which has led to the writing off of irredeemable accounts (booking the entire outstanding as loss) and marking down those which have still some value left in them. This has led to a paring down of bank bottom lines so that balance sheets could be cleaned up. Gross NPAs of public sector banks first went up from 5 per cent in March 2015 to 14.6 per cent in 2018 as a result of asset quality review. Thereafter, with improving health, the figure came down to 5.5 per cent in December 2022.

Where do banks go from here? The government has asked banks to be wary of competition for deposits. As the economy grows robustly, there will be greater demand for bank loans and pressure on bank managements to fund them through higher deposits. These will be garnered by paying higher interest rates, thus affecting the bottom line.

In particular, banks have been asked to be wary of the consequences of the merger of HDFC with HDFC Bank. Housing loan customers of the former, who kept their deposits wherever they liked, will now be pressured to bring them to the bank. This matter could be serious as the post-merger bank is a behemoth, figuring among the largest banks in the world. With a market capitalisation of $108 billion, it is one of the 10 most valuable banks in the world. To put this in perspective, the State Bank of India, till now the largest bank in India, is valued at $57 billion.

A robust and healthily growing economy needs to be well served by a similarly healthy banking sector. By the same logic, a healthy and robust banking sector thrives best within a healthily growing economy. This is the scenario being played out in India today.