Banking for aspirational India

The Union Budget 2020-21 reaffirms the agenda to push bank reforms to foster a clean, reliable and robust financial sector for achieving the $5-trillion economy by 2025. To pursue wealth creation for ‘aspirational’ India, developing a sound and sustainable banking system is necessary. Accordingly, a robust mechanism to monitor the health of all commercial banks and evolve a strong and sustainable financial system is mooted. Having infused Rs 3.5 lakh crore in public sector banks in recent years, the next move will be to improve their efficiency.

As part of bank reforms, the government will divest its stake in IDBI Bank to private, retail and institutional investors through the stock exchange. The Banking Regulation Act will be amended to strengthen cooperative banks by increasing their professionalism and standard of governance so that they can augment capital from the markets and integrate with mainstream banking.

Better growth opportunities for banks have been opened up with higher allocations, concessions, remissions to reinforce growth in key sectors such as infrastructure, aviation, micro, small and medium enterprise (MSME), auto, agriculture, health, affordable housing, non-conventional energy, startups, tourism and other interdependent sectors. More money with people should be channelised to engage more actively with these invigorating sectors to harness growth synergy.

Bank Credit

But banks’ ability to increase the flow of credit is linked to capital adequacy ratio (CAR) and asset quality. Both are currently fragile. Asset quality continues to be stressed with gross non-performing assets (GNPAs) of the banking industry at 9.3% in September 2019. This is despite large-scale capital infusion in PSU banks through recapitalisation bonds. While shoring up the capital base, it has raised government ownership in some PSU banks close to 90% thus leaving little space to approach the capital market. Asset quality is better in private banks with GNPAs at just 3.9%.

CAR for PSU banks is 13.5% with a compound annual growth rate (CAGR) of credit at 6% in the last five years. Private banks enjoy better capital base with CAR at 16.6% with CAGR of credit at 16% in the same period. When the average lending rates are close to 8%, a credit growth at 6% tantamounts to negative growth. With profitability of many PSU banks lying too low, market capitalisation has been shrinking, eroding investors’ wealth.

With these fundamentals, it will be difficult for PSU banks to augment capital from the market on their own. Banks will also have to comply with enhanced capital standards under Basel-III framework by March 2020 adding to the challenge. Tackling the paucity of capital will be a challenge to accelerate credit flow. The agriculture lending target for 2020-21 is set at Rs 15 lakh crore while it languished at Rs 12 lakh crore in December 2019. Providing Kisan Credit cards to all the beneficiaries of PM Kisan Yojana may help accelerate credit growth.

Sops to MSMEs

The employment-intensive MSME sector always remains at the centre of policy initiatives. Having benefitted five lakh MSMEs in the past with RBI’s specially designed restructuring scheme, it is proposed to extend it by one more year up to March 31, 2021. Lack of adequate flow of working capital finance from banks has been causing a lot of hardship to entrepreneurs.
It is proposed to introduce a scheme to provide subordinate debt to MSMEs. Such subordinate debt granted by lenders would qualify to count as quasi-equity that is fully guaranteed by the Credit Guarantee Trust for Medium and Small Entrepreneurs (CGTMSE). The corpus of CGTMSE would be suitably broadened. An app-based invoice-financing product for MSMEs is to be launched by banks that will ease the flow of funds. Non-banking financial companies (NBFCs) will also join invoice financing to MSMEs after a suitable amendment to the Factoring Regulation Act 2011.

Deposit Insurance

The much-awaited move to increase deposit insurance coverage from Rs 1 lakh per bank depositor to Rs 5 lakh by the Deposit Insurance and Credit Guarantee Corporation (DICGC), a wholly-owned subsidiary of the RBI, is a confidence booster for banks. It will benefit more weak and vulnerable cooperative banks. The inadequate deposit insurance coverage comes up for debate whenever a fragile bank is put under a moratorium, like the recent failure of Punjab and Maharashtra Cooperative. Banks can now attract fresh deposits from other financial intermediaries that can flow back to accelerate credit growth.

The move can also pave the way to end the current uniform insurance premium of 10 paise per Rs 100 of deposits. A variable premium metrics could be worked out in terms of recommendations of the Jasbir Singh Committee report (2015). It proposed to levy premium on deposit insurance in sync with the perceived riskiness of the bank instead of treating all banks alike. As a next step, regulators can consider even allowing some really strong systemically important banks to opt out of the deposit insurance. It will be between the bank and depositors to develop mutual trust.

Capital infusion, consolidation, speedy debt resolution, enhanced deposit insurance and other game-changing policy initiatives should eventually strengthen PSU banks. The next task will be to ensure that the end state objectives of the budgetary measures and ongoing bank reforms are achieved. Well carved out implementation strategies should enable the PSU banks to accelerate credit dissemination to the ailing grassroots level economy in the near-term based on the current capital base.

Improved governance and thrust on operational efficiency should enable them to augment additional fresh capital in the long-term making substantial room for credit expansion. Innovation in monitoring and control will need coordinated efforts of the government and regulators to create the differentiating factor in governance through new-age reforms that are strong enough to pull PSU banks out from the abyss and to kick-start their proactive role in building aspirational India.