Thoughts on banking in the new decade

After reviewing the “current liquidity and financial conditions”, the Reserve Bank of India (RBI) last week announced yet another round of Operation Twist — a Rs 10,000-crore simultaneous purchase and sale of government securities on January 7.

Rest assured that the Indian version of quantitative easing is here to stay in the New Year to generate liquidity, manage the yield at both the shorter as well as longer end, pare the cost of government borrowing and help banks reap treasury profits. Among many new initiatives, the Indian central bank launched Operation Twist in December 2019.

Just ahead of the latest announcement on the last day of 2020, an RBI working paper, “Measuring Trend Inflation in India”, co-authored by a deputy governor and member of the central bank’s rate-setting body, Michael Patra, pitched for maintaining the inflation target unchanged at 4 per cent. There have been speculations on raising the flexible inflation target (4 per cent with a 2 per cent band on either side), against the backdrop of persistently high inflation.

For the record, the retail inflation has been crossing the upper end of the band since December 2019, barring just one month (March 2020: 5.84 per cent). Before declining to 6.94 per cent in November 2020, it rose to 7.61 per cent in October 2020, the highest in six years.

On the face of it, an ultra-loose monetary policy, despite rising inflation and green shoots of recovery, is puzzling. But globally all central banks have been doing so. Indeed, the RBI doesn’t want to rock the boat and will continue to buy time for growth in 2021 but one doesn’t need to be a soothsayer to say that unwinding of easy liquidity will be the biggest challenge for the Indian central bank in the New Year.

In 2008, after the collapse of iconic US investment bank Lehman Brothers Holding Inc, which plunged the world into an unprecedented economic crisis, the RBI was able to ward off its impact on India by flooding the system with liquidity and bringing down the policy rate to a historic low. The RBI was aggressive in loosening the policy but, for unwinding, it took “baby steps”, leading to a rise in inflation.

Another trend under all analysts’ lens will be the quality of loan assets. In the beginning of 2020, many believed that the worst was behind the Indian banking system — after bad loan recognition, the banks were entering into the phase of recovery. Since most banks have made hefty provisions for bad loans, every bit of recovery would add to their profits, strengthening their balance sheets and encouraging them to lend. But the Covid-19 pandemic has upset all calculations. A window of loan restructuring followed a six-month moratorium on loan repayment. Most bankers have been claiming a dramatic rise in repayments and very few loan recast proposals but it’s too early to feel excited.

The gross non-performing assets ratio of the banking system has been on a decline — from 9.1 per cent in March 2019 to 8.2 per cent in March 2020 and 7.5 per cent in September 2020. The heap of bad loans is bound to rise but how much is the question. Interlinked with this is the banks’ appetite for credit growth. From April 2020 till December 18, 2020, the credit growth has been a measly 1.7 per cent against 1.8 per cent in the year-ago period. Are the banks prudent or risk averse? We will know in 2021.

Beyond 2021, the theme of the new decade for Indian banking will be disruptions. In 2009, Paul Volcker, an American economist and former chairman of the US Federal Reserve, had said that the only relevant financial innovation in the previous two decades had been the ATM machine. Since then, a lot has happened. In India, demonetisation in December 2016 gave a big boost to digitalisation but the momentum was lost after some time. The pandemic has brought the digitalisation wave back to the finance shore, prompting Infosys Ltd Chairman Nandan Nilekani to say it has accelerated the digitalisation of the economy from years to weeks.

After five decades of bank nationalisation, the government, as the majority owner of a large part of the banking system, must decide on whether to run the banks as an agency for social good or a commercial entity

The bankers, so far, have not been afraid of losing relevance and becoming dinosaurs — something which Microsoft Corp Co-founder Bill Gates had warned in July 1994. In the new decade, the scene will change because the banks till recently had been challenged by the fintechs but the techfins have now entered the arena. Fintech is a space where financial services (such as mobile banking) are delivered through a better-use experience, using cutting-edge technology, while techfin refers to technology solution firms — such as Amazon, Google and Facebook, among others — launching a new way to deliver financial services.

Unlike fintech, the techfins have their own customers and hence they do not need to ride on a bank’s network, customer base and merchant relationships. Simply put, those banks that remain complacent, bragging about their captive customer base, may turn dinosaurs this decade.

It’s also time for both the RBI and the commercial banks to introspect: Has India let its banking system down or is it the other way round? Both must share the blame. The banking regulator has not encouraged competition on the banking turf and hence financial repression continues. The banks, too, have not explored the tremendous opportunities that Asia’s third-largest economy offers.

Finally, after five decades of bank nationalisation, the government, as the majority owner of a large part of the banking system, must decide on whether to run the banks as an agency for social good or a commercial entity. There are options. For instance, the government can allow “fit and proper” Indian private entities and foreign institutions, including private equity, to invest and own 26 per cent in banks. Anyway, such entities already own even higher stakes in the shadow banking system. It can also create a banking investment fund on the lines of the National Investment and Infrastructure Fund — an investment platform that has brought together the Government of India and international investors — for investing in banks.

Consolidation reduces the number of banks but not the government share in the banking industry. Unlike Air India, which flies people, banks deal with public money. They need to be treated differently. A few of them can be kept under the government control to address possible market failures, while the government stakes in others can be sold. The sell-off will also help manage the fiscal deficit beside strengthening the banking system.

The writer, a consulting editor with Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd | Twitter: TamalBandyo | His latest book is Pandemonium: The Great Indian Banking Tragedy