How financial reforms can quicken pace for India to become a $5-trn economy

In the Union Budget for FY22, no funds were earmarked for recapitalising state-run banks. This was a decadal first, and will temper their eagerness to lend

Road map on bank privatisation

Fiscal year 2023-24 (FY24) may see us get more clarity on the privatisation of state-run banks and the finer aspects of the scope and role assigned to private capital in the process. The government had proposed privatisation of two such banks (along with one general insurance company) in the Union Budget for FY22. But so far, the sale of IDBI Bank is yet to go through even as the second bank is yet to be identified.

A wider public debate may also be in the offing.

In August 2022, a paper by Snehal S Herwadkar, Sonali Goel and Rishuka Bansal of the Reserve Bank of India (RBI) titled Privatisation of Public Sector Banks: An Alternate Perspective was erroneously interpreted by the Opposition as being reflective of the central bank’s opposition tothe idea.

The paper authored by the trio who work in the RBI’s Banking Research Division (Department of Economic and Policy Research) had actually complimented the government’s approach: “A big bang approach of privatisation of these banks may do more harm than good…such a gradual approach would ensure that large-scale privatisation does not create a void in fulfilling important social objectives of financial inclusion and monetary transmission.”

Going green for planet blue

A big inflexion point in the credit markets will be the taxonomy for green finance. This will help lenders to better assess climate risks in their loan portfolio, scale up green and sustainable finance and mitigate “green-washing” risks.

In November last year, Union Finance Minister Nirmala Sitharaman had finalised the Sovereign Green Bonds framework. The build-up on this front has been rapid: the RBI had come out with its Survey on Climate Risk and Sustainable Finance in July 2022, which was followed a month later by the Securities and Exchange Board of India’s reporting architecture on sustainable finance.

A hint of what’s in store was offered by RBI Deputy Governor

M Rajeshwar Rao, speaking at the Business Standard BFSI Insight Summit in Mumbai last week. “A formal definition of green finance along with a taxonomy is the need of hour, as it would enable more precise tracking of finance flows to green sectors in India, which in turn would help design effective policy, regulations and institutional mechanisms directed towards increasing both public and private investments,” he said.

Incidentally, the Hong Kong-based Asia Securities Industry & Financial Markets Association (ASIFMA) released its first Green Taxonomy Survey in December on the common themes and issues in sustainable finance in the Asia-Pacific region and beyond. According to it, 75 per cent of the respondents had started using a taxonomy with the EU Taxonomy of Sustainable Activities being the dominant one.

RBI and the HDFC twins

The RBI’s response to the request for regulatory forbearance in the HDFC Ltd-HDFC Bank merger will be closely watched. This was with regard to HDFC Bank’s investments in the subsidiaries of HDFC Ltd (post-merger) — the investments of HDFC Ltd are to be transferred to the bank. The bank has also sought relaxation on the timelines for compliance with the cash reserve ratio, and statutory liquidity ratio requirements.

In the ICICI Ltd-ICICI Bank (2001) and IDBI Ltd-IDBI Bank (2005) mergers, regulatory exemptions were in order, since ICICI and IDBI were transiting from development finance institutions. But the RBI did not oblige.

The RBI’s Report of the Internal Working Group to Review Extant Ownership Guidelines and Corporate Structure for Indian Private Sector Banks (November 2020) did not touch upon forbearance in instances of a regulated entity’s offspring merging with the parent. The RBI’s eventual stance has implications for potential mergers between non-banking financial companies (NBFCs) intending to seek a banking licence, or merging with banks.

Ind-AS and banks: A reset moment

The RBI is to soon release a discussion paper on expected credit loss (ECL)-based loan provisioning by banks under Ind-AS (Indian Accounting Standards). When operationalised, this will force banks to proactively provision at much earlier stages of stress. As of today, all listed companies (other than banks), including NBFCs with a net-worth of more than Rs 250 crore, follow ECL (Ind-AS 109). Banks were expected to adopt Ind-AS from April 1, 2018, but on April 5, 2018, the RBI deferred its implementation by a year to FY19; and on March 22, 2019, it was put on hold indefinitely.

While banks have been submitting proforma Ind-AS financial statements to the RBI from H1 FY16 onwards, coming on a par with listed entities may bring about far-reaching changes.

In the Union Budget for FY22, no funds were earmarked for recapitalising state-run banks — a decadal first. With capital at a premium, it will temper their exuberance to lend. Ind-AS will also call for better coordination between ministries on the policy front, as banks of all hues, in general, may turn reluctant to lend — for example, lending to a power project without a viable fuel-pricing arrangement in place.

Mixed signals

The 26th edition of the RBI’s Financial Stability Report (FSR) said that banks’ gross non-performing asset (NPA) ratio fell to a seven-year low of 5 per cent, with net NPAs at a decadal low of 1.3 per cent. The FSR said that while the Indian economy is confronting strong global headwinds, sound macroeconomic fundamentals and healthy financial and non-financial sector balance sheets are providing strength and resilience and engendering financial system stability.

But the latest round of the Systemic Risk Survey (SRS) was also sobering. It said risks from global spillovers and financial-market volatility rose further and remained in the “high-risk” category. And almost all surveyed respondents expect a medium-to-very-high probability of a global recession in 2023.

What comes through is that Indian companies and banks may not be enthusiastic about taking on risk. Take infrastructure financing — the financial crisis of 2008 led to growing NPAs, which called for a huge NPA clean-up later. And in recent years, it is retail lending which has emerged as the go-to area for banks. Again, if a recession is looming on the horizon (going by the response to the SRS) plus inflationary concerns, it would be reasonable to assume that we may be heading for a period of caution.

This message also comes through in the Report on Trend and Progress of Banking in India 2021-22 released last week. It observed that banks and non-banking financial institutions will have to remain prepared to face new challenges and reap emerging opportunities in this dynamic environment, keeping their focus on appropriate business models, adoption of new technologies, sustainability, stability, consumer protection and financial inclusion.

The RBI said “its forthcoming initiatives are expected to guide the progress of regulated entities in this direction, secure and preserve financial stability and enhance efficient functioning of markets.”

The MDR muddle

Just how are banks to make up for the absence of a merchant discount rate (MDR) on RuPay-Unified Payments Interface (UPI) credit-card transactions of up to Rs 2,000?

The fixing of the MDR on such transactions had become a sticking point. Unlike debit-card transactions linked to UPI, on which there is no MDR for ticket-sizes of up to Rs 2,000, it is central to the credit cards’ business.

This is because of its unsecured nature with a 45-day interest-free period; and liquidity has to be maintained as well.

To begin with, card-spends on RuPay credit cards (not linked to UPI) are far lower than on cards issued on Visa and MasterCard networks. And now banks also have to make up for the nil-MDR on transactions of up to Rs 2,000 on RuPay-UPI credit cards.

We may well have a lot of transactions of up to Rs 2,000 (with merchants asking customers to split transactions in lots of up to Rs 2,000), but issuers on Visa and MasterCard will be laughing all the way to the bank, as they have an MDR to carve out on all swipes!

Incidentally, zero-MDR RuPay debit-cards meant that fiduciary support had to be provided for the industry; and the Union Cabinet had in December 2021 approved a Rs 1,300-crore package — as compensation to banks for the zero MDR and to give a fillip to digital payments. Will the government extend the same support to RuPay-UPI credit cards?