BS Banking Annual 2016: Challenges abound

Banks will need to address issues such as stressed assets, capital adequacy, competition from digital and new players. Time is running out

The repercussions of the shock effects and the surge in liquidity owing to demonetisation are the most important problems in the minds of bankers. While it is natural for the shock to remain centre-stage for some time to come, several other issues beg attention. 

Banks, especially from the public sector, face the monumental task of managing bad loans and getting adequate capital to meet regulatory norms and support growth. Competition from the new kids on the block — be it new banks, small finance banks or payments banks — are challenges. Plus, a strong digital presence is no longer something that banks can postpone any further.  

Burden of stressed loans  

After the Reserve Bank of India’s (RBI’s) Asset Quality Review (AQR) made banks recognise stressed loans on their books, banks have now firmly trained their guns on resolving problem cases, especially big ticket corporate loans.

Chanda Kochhar, managing director and CEO, ICICI Bank, said, “Banks are conscious of recovery and are going about it in a focused manner. In the past two years, lenders have seen sales of Rs 1.5 lakh crore finalised — the largest ever in any corporate history. The promoters have understood that they will have to sell assets in order to deleverage.”

These are sales of very large assets and very small assets across sectors such as roads, power, cement, etc. Their resolution takes a long time. The kinds of results that are visible now are probably the outcome of two years of working on those deals. Groups such as Jaypee group, Anil Ambani-owned Reliance Group and Essar group have sold assets to repay debt.

Banks have reported lower incremental addition of non-performing assets (NPAs) in the first and second quarters of FY17. But owing to demonetisation, the slippages may see an uptick in the third and fourth quarters. This could be the result of many small and medium-sized companies being hit by a sudden liquidity squeeze in the system after the government decided to scrap existing Rs 500 and Rs 1,000 notes on November 8.

The gross NPAs of 40 listed banks were Rs 668,825 crore at the end of September 2016, up from Rs 340,556 crore a year previously, according to data compiled by Business Standard Research Bureau.

Despite setbacks in the aftermath of demonetisation, it is necessary to stay on course to ensure that efforts continue to show results. 

Regulations are also creating an enabling environment for the resolution of cases. The Scheme for Sustainable Structuring of Stressed Assets (S4A) will be used for various cases. The RBI had also introduced other schemes such as Strategic Debt Restructuring and the 5/25 scheme to aid companies with high debt. The judicial system is also gearing up to become an enabler in strengthening debt recovery tribunals, its appellate tribunal and the focus towards arbitration or the Bankruptcy Act.   

Maintaining adequate capital base 

Closely linked to the problem of asset quality plaguing the banking sector is the issue of capital adequacy to support existing asset books and the future growth of loan books. As banks implement Basel-III norms over the next four years, they will be required to hold more capital, capping their return on equity.

Private sector banks are better placed in maintaining their capital adequacy ratio, but public sector banks (PSBs) face a stiff challenge in keeping up with increasing common equity tier-I requirements.

The burden of high credit costs — money set aside as provision for bad loans — has put limits on PSBs’ ability to generate internal capital. This trend is expected to remain over the medium term. Being saddled with the large NPAs, PSB shares are trading at a discount to their book value. And this works as a barrier in raising equity capital from the market.

Standard & Poor’s (S&P) said in a report on Indian banks released in November 2016, “We expect private sector banks and top-tier public sector banks with better franchises, profitability, focus on digital banking technologies and current capitalisation to meet the Basel-III capital requirements without lowering growth of their risk-weighted assets.” 

These banks may find it easier than others to tap the capital markets, given their franchises, better internal capital generation, and lower dilution risks, S&P added.

As a majority owner of PSBs, the government of India has committed about Rs 70,000 crore under the Indradhanush plan. It injected a sum of Rs 25,000 crore in 19 PSBs in 2015-16. For the current year (2016-17), a budgetary provision of the same amount was made. Of this, the government allocated Rs 22,915 crore to 13 PSBs in July, and a decision about giving the remainder was linked to performance. The remaining Rs 20,000 crore will be injected in 2017-18 and 2018-19.

Bankers and analysts say the amount committed so far is inadequate. The outlay was firmed up before the RBI conducted the AQR, which almost doubled the pool of NPAs. Consequently, all plans have gone for a toss. Now, the government has to assess capital requirements afresh.

The age of digital 

Digital banking is a reality and banks need to be aggressive in having easy-to-use, feature-rich products. Private sector banks such as ICICI Bank, HDFC Bank and Axis Bank, and State Bank of India have taken the lead in their digital offerings; other banks need to catch up. Besides mobile banking and apps, banks need to offer many transactions that exist in the physical world on their digital platforms, and also have products such as digital wallets and features such as unified payment interface. 

Competition and consolidation 

The RBI has issued licences for the establishment of payments banks and small finance banks (SFBs) to help improve financial inclusion and reduce reliance on cash transactions. Two SFBs have already commenced operations — one in Punjab and the other in the southern India — and Airtel’s payments bank started on a pilot basis in Rajasthan in November. All others will be up and running in 2017.

These new kids on the block do not pose an immediate threat to the established players over the next two to three years, but they will certainly influence the rules of the game and change the contours of banking. For example, the Airtel Payments Bank is paying an interest rate of 7.25 per cent on savings deposits, while most banks offer around four per cent.  

Payments banks will focus on remittances, payments, and the collection of small deposits. Small finance banks will focus on providing deposit and lending services to underserved parts of the economy. Some payment banks will collaborate with commercial banks, given the potential synergies. A few alliances have already materialised.

Coming to consolidation, the country’s largest bank (State Bank of India) has taken the lead at the behest of the government, as it merges five associate banks with itself this financial year. As for other PSBs, the precarious state of their balance sheets hardly gives them room for mergers.

The private sector banks will most probably see consolidation dictated by market and commercial dynamics.