India's Best Banks

The country's bankers have been battling one challenge after another ever since the 2008 global financial meltdown - deteriorating asset quality, digitisation, disruption from new financial sector players and, now, demonetisation. It wouldn't be wrong to compare them to performers juggling balls in a circus. "You are bound to drop some eventually," says a FinTech player. "Or, you may end up focussing too much on the juggling and lose sight of things around you," he says.

Despite juggling to the best of their ability, most of the country's banks are not in the pink of health. Credit offtake has been poor due to over-leverage in the corporate sector, excess capacity and economic slowdown. Deposit growth was poor, a mere 4 per cent in public sector banks, or PSBs, in 2015/16. Also, higher provisioning for bad assets affected profitability. The banking sector as a whole saw a 60 per cent drop in profits. Punjab National Bank, for instance, reported its highest-ever loss of Rs 5,376 crore. The Reserve Bank of India, or RBI, said in its recent financial stability report that risks to banks remained elevated due to continuing deterioration in asset quality, falling profitability and liquidity issues.

All these challenges no doubt tested banks. But they also brought out the best in them. The 21st Business Today-KPMG Best Banks Study zeroed in on those that, in spite of the enormity of the challenges, managed to weather the storm by growing robustly, embracing technology, innovating and, most importantly, reaching out to people at the bottom of the pyramid.

The year 2017 is expected to be full of challenges, some old, some new. Competition is set to increase and leave some behind in the race. The biggest sources of disruption will be new differentiated banks such as payments banks and small finance banks, non-banking financial companies, digital wallet companies and peer-to-peer lenders. For instance, PayTM, whose founder got the RBI's approval for a payments bank last week, has already created a big name for itself in small-value transactions. In a very short period, it has built a user base of over 177 million and plans to cover five million merchants to give users a hassle-free shopping experience. The aggressive stand of the new banking candidates is also evident with Airtel Payment Bank offering an interest rate of 7.25 per cent on savings deposits, way higher than the 4 per cent being paid by the traditional banks. Now, imagine the bloodbath when close to two dozen payments and small finance banks storm the low-cost deposit market and put further pressure on cost of funds of banks, which are anyways struggling with low deposit growth (See New Age Banking, a report on payments banks, on page 80).

Though demonetisation has given banks some respite by pushing the issue of deteriorating asset quality to the backburner, beneath the surface, things are worsening. The total stressed loans have now crossed the 12 per cent (of advances) mark and now stand at Rs 10 lakh crore-plus.

The RBI recently noted that the large borrowers have seen a significant deterioration in asset quality. Many blame banks for the reckless lending that is haunting them now. Banks, however, say they are not at fault. "We are in the business of trust. We are taken for a ride sometimes, but we have to move on," says Arun Tiwari, Chairman and Managing Director of Mumbai-headquartered Union Bank of India.

Loans turning bad, however, isn't an India-only phenomenon. Banks all over the world see a spike in bad loans whenever economic cycles take a turn for the worse. But what is bothering Indian bankers is the weak resolution framework. Asset reconstruction companies, or ARCs, have limited capital to support large stressed loans. The resistance from promoters when lenders try to take over stressed assets is strong and causes delays. The country's largest bank, State Bank of India (SBI), did sell a lot of bad loans to ARCs three years ago, but the latter haven't got any big returns from these assets so far. "We dont see them doing a quicker job. This is the reason sales to ARCs have come down," says SBI Chairman Arundhati Bhattacharya. Banks are now looking at other options. The new Strategic Debt Restructuring (SDR) route, under which banks can change managements, is also turning out to be a damp squib because of promoters' resistance, difficult operating environment and shortage of buyers (See Jinxed!).

There is some hope from S4A (Scheme for Sustainable Restructuring of Stressed Assets) but this involves conversion of debt into equity and so shifts considerable risk to banks' books. The new bankruptcy law that came into force from December last year could be a saviour. But as they say, the proof of the pudding is in the eating - the law is yet to be tested in the market.

Finally, the industry has been hit by the demonetisation tsunami. The cash crunch has the potential of derailing economic growth for a long time. Banks will be hit badly if that happens.

For now, banks have moved to cut interest rates sharply, which could give a fillip to consumer demand. They can do this as they are flush with deposits due to demonetisation. But this could change after the withdrawal limits are removed. But banks are positive. "We expect 20-25 per cent deposits to stay in the banking system," says Tiwari of Union Bank.

Still, there are some concerns related to demonetisation that the banks have been staying away from discussing. One is the cost incurred to facilitate demonetisation. This ranges from staff to ATM calibration costs, apart from transportation/logistics costs. "There is also a cost of pushing digital banking and a cost of lost business. My people were helping the demonetisation drive and not doing any other business," says the CEO of a bank, on condition of anonymity. Secondly, the government's push towards making India a less-cash economy has put a lot of responsibility on banks' shoulders.

The digital push, say bankers, will not be easy. They say the government has to first accelerate the process of setting up digital infrastructure. "There is an issue of connectivity, faster processing and cyber security. Digital transactions have gone up by two-three times but banks have limited processing capacity. They will have to invest more on upgrading systems and processing capacity. Why have only four banks taken up the responsibility of putting up point of sale machines?" asks a private banker.

Last, but not the least, the bankers are worried about cyber risk and say digital push without strong cyber security capabilities and regulations will be a disaster. The cyber attack on Bangladesh's central bank shows vulnerability of even big institutions. Back home, the recent compromise of debit card data also made users nervous. Fortunately, losses weren't high, as in a big country such as India, it will not take much time for the digital gravy train to derail if there is a big cyber attack on banks.

It seems there is no early end to the challenges for the fast-changing banking industry.

@anandadhikari