Opinion: Towards better banking
The challenge for banks will be to sustain their performance and cope with risks stemming from institutional interconnectedness
Dr K Srinivasa Rao
During most of 2023, the banking sector had to experience the impact of the US banking crisis, elevated interest rates, stringent liquidity conditions, deposit growth lagging behind credit growth, and the gyrations of financial markets as and when the central banks in major economies had to act to fight the raging inflation amid fears of a slowing economy. Geopolitical risks, aggravated by the West Asia crisis, added to the ongoing war between Russia and Ukraine jeopardising the global supply-side dynamics. The slowdown in China too had its impact.
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Back home, the Reserve Bank of India (RBI) had to raise the repo rate by 250 basis points beginning May 4, 2022. Having quickly raised the repo rate to fight inflation and in sync with the actions of central banks of major economies, it kept the interest rates stable but at elevated levels at 6.5%t since February 2023. During 2023, the front-loaded rate hike worked its way to douse inflation. Following a wavering path month to month, CPI inflation came down from 7.79% in April 2022 to 5.55% by November 2023.
When the RBI is task-bound to bring down inflation to its mid-point target of 4 per cent, banks tend to experience elevated liquidity risks that push up the interest costs. Despite such daunting challenges, banks fared well in 2023 and are on stronger footing to perform better in 2024.
The Financial Stability Report–December 2023 and the Report on Trends and Progress of Banking in India, 2022-23, released by the RBI, pointed to the increasing strength and soundness of the banking and financial system. Thus, the pace of the post-pandemic revival of the banking sector and NBFCs has been noteworthy.
Performance Highlight
The consolidated balance sheet of banks in 2022-23 grew 12.2%, driven by the accelerated flow of credit to retail, services sectors and NBFCs. The rise in unsecured loans and credit card receivables was notable. Deposit growth also picked up, although it trailed credit growth. The capital-to-risk-weighted assets ratio (a measure of banks financial health) was 16.8% at the end of September 2023. Improvement in asset quality that began in 2018-19 continued during 2022-23 and up to Q2 of FY24 with a gross non-performing assets ratio at 3.2% at the end of September 2023. The most significant performance indicator in 2023 was the rise in net profit from Rs 1.82 lakh crore in FY22 to Rs 2.63 lakh crore.
Though credit growth increased from 9.6% in FY22 to 15% in FY23, one of its debilitating factors was the slowest credit growth to the industry at 5.7% in FY23 from 7.5% in FY22. Credit flow to the agriculture sector increased from 9.9% to 15.4% while for the service sector, it rose from 8.7% to 19.8%. The growth in personal loans jumped from 12.6% to 20.6%, prompting the RBI to alert against the built-up of credit risk. Accordingly, it increased the risk weight on personal loans to dissuade banks from increasing exposure to the unsecured credit segment.
Tasks in 2024
Going forward, banks should recognise that having fought inflation with successive rate hikes in 2023, most of the major central banks will now be shifting the interest curve and may start cutting the policy rates to push growth sometime in early 2024. The RBI may also change its monetary policy direction to cut rates in Q2 of FY25 onwards. This will lead to a reshuffling of foreign inflows to emerging markets and ease liquidity position to pave the way to push growth. The economy is estimated to grow at around 7% in FY24.
Given the impending shift in the macroeconomic landscape and lingering geopolitical risks, the challenge for banks will be to augment resources to lend particularly since the mutual fund industry, IPOs, and insurance sector are getting into aggressive mode attracting resources. Amid the stiff competition in raising resources, banks will have to continue to balance the sectoral credit flows to reach out to industry in a greater measure. MSMEs, the critical employment-intensive sector, will have to be prioritised in granting fresh credit.
The challenge for banks in 2024 will be to sustain their performance and cope with the risks stemming from institutional interconnectedness already pointed out by the RBI. Banks and NBFCs, including fintech, are increasingly coming together to work whereas their risk management ecosystem is diverse. Banks will have to be cautious in managing contagion risks. They can derive the synergy of the two new entities — National Asset Reconstruction Company Ltd (NARCL — Bad Bank) and National Bank for Financing Infrastructure Development (NaBFID). Both are likely to function on a full scale supplementing the efforts of banks in managing asset quality and enabling them to participate in large-scale coordinated funding of projects. With the general elections during Q1 of FY25, banks will also be exposed to many other forms of risks.
Apart from focusing on near-term business operations and improved risk management, banks will have to focus on long-term goals of reducing transaction costs by using digitally driven simplified work processes and creating ease of doing business. While joining the RBI and other peers, they will have to work aggressively to spread digital and financial literacy to increase the scope of delivery of services online and adopt app-based operations to redress customer grievances. They will have to institutionalise stronger cybersecurity architecture to ensure that the journey of digital banking penetration continues to reach out to micro sectors. Against the backdrop of better efficiency exhibited in 2023, banks will have tougher challenges to meet in 2024 on the way to accomplishing better performance goals. Views are personal
