Banking at a crossroads: Why 2022 may well be another reset year

Pandemic-related regulations are set to run their course and an uptick in interest rates is in the offing.

Cheers to a decadal first!

Finance Minister Nirmala Sitharaman is of the view that state-run banks should raise funds from the bourses rather than depend on the Centre for recapitalisation. It is unlikely that funds will be earmarked for this purpose in the upcoming Union Budget to be announced on February 1. According to her, the “4R strategy” — Recognition, Resolution, Recapitalisation and Reforms — has resulted in an improvement in banks’ financials. In 2018, only two of the 21 state-run banks were profitable; in 2020-21, only two of them reported losses.

Their cumulative net profit was Rs 14,012 crore in the first quarter and Rs 17,132 crore in the second quarter of FY22. And the combined profit of these banks in the first half of FY22 is close to the total profit they earned in the previous financial year. In the Union Budget of FY22, the Centre had set aside Rs 20,000 crore towards recapitalisation. If funds are indeed not earmarked towards recapitalisation in the upcoming Budget, it will be a decadal first.

…but two cheers are enough

The Reserve Bank of India’s (RBI’s) Report on the Trend and Progress of Banking in India 2020-21 (T&P: 2020-21) released last week observed that the capital position of state-run banks improved — aided by both recapitalisation and the raising of funds from the market. That said, it cautioned that “incipient stress remains in the form of increased proportion of restructured advances and the possibility of higher slippages arising from sectors that were relatively more exposed to the pandemic.”

It would be prudent to read this along with the RBI’s bi-annual Financial Stability Report that was released last week. It said that macro stress tests for credit risk indicate that the gross non-performing asset ratio of banks may increase to 8.1 per cent by September 2022 under the baseline scenario, and to 9.5 per cent under a severe stress scenario, from 6.9 per cent in September 2021.

The emerging signs of stress in micro, small and medium enterprises (MSMEs), as also in the micro-finance segment, call for close monitoring of these portfolios, going forward. So, expect the pain to linger for some more time, even as the RBI introduces a gradual pull-back of its current accommodative monetary policy.

Bad-loan transfers to gain traction

The National Asset Reconstruction Company (NARCL) will be in full flow soon. Banks have identified the first tranche of dud loans of Rs 90,000 crore, involving 22 firms, for transfer to NARCL. This merits more appreciation, given that such sales to asset reconstruction companies (ARCs) have been poor in recent times. In FY21, their assets under management contracted by 100 basis points (bps) to Rs 1.07 trillion, and this came on the back of a 400 bps fall in FY20.

CRISIL Ratings is of the view that while NARCL will dominate the large corporate segment, ARCs with a relatively better recovery track record and stressed assets funds could be in play in mid-corporate assets. In the retail and MSME segments, ARCs have the opportunity to create niches. Tighter norms for bad-loan transfers are very much in the offing.

Another review of governance across banks?

In April 2021, the RBI issued instructions with regard to the Chair and meetings of the board, the composition of committees of the board, the age, tenure and remuneration of directors; and appointment of whole-time directors in private banks and small finance banks (SFBs). With two state-run banks set to be privatised, it may be time to bring the entire universe of such banks under the scope of the norms applicable to private banks and SFBs.

For, there’s nothing to suggest that more state-run banks may not be privatised down the years. The RBI has set in motion the process of aligning the regulatory and supervisory aspects of all regulated entities, and it may be opportune to align governance norms across banks as well. This is important to arrest the creation of even more bad loans on the books of banks, after existing such loans are transferred to the NARCL.

“Looking ahead, it is important for the credit cycle to gain traction and support the ensuing economic recovery. This will require policy initiatives that ensure effective risk management and sound corporate governance”, said the just-released T&P: 2020-21. It added that while NARCL is a major step forward in the resolution of large-value legacy assets, international experience suggests that for the experiment to succeed and to avoid perverse incentives, a few other conditions would have to be fulfilled.

These include clearly identifying the risks to banks’ balance sheets; ensuring transparent transfer-pricing for sale of assets; and ensuring that the management of the new entity is independent and professional. This is critical, all the more so for state-run banks, so as to avoid a situation where the Centre has to weigh recapitalisation all over again, going forward.

Green is good, very good!

Given India’s commitment to climate action at the United Nations Climate Change Conference in November 2021 at Glasgow, it is fair to expect the central bank to flesh out its stand on green financing and related issues. A Sustainable Finance Group was set up in the RBI in May 2021 to coordinate with national and international agencies on issues relating to climate change.

This group is tasked with  suggesting strategies and evolving a regulatory framework, including appropriate environmental, social and governance disclosures — which could be prescribed for banks and other regulated entities to propagate sustainable practices and mitigate climate-related risks in the Indian context.

A paper by Saurabh Ghosh, Siddhartha Nath, and Abhishek Ranjan of the RBI’s Strategic Research Unit of the Department of Economic and Policy Research had, in the January Bulletin, argued that “the major challenges could be high borrowing costs, false claims of environmental compliance, plurality of green loan definitions, maturity mismatches between long-term green investment and relatively short-term interests of investors.”