The Indian banking sector is showing signs of a turnaround after many years. The latest “Report on Trend and Progress of Banking in India 2018-19”, released this week by the Reserve Bank of India, showed that the overhang of stressed assets has declined and fresh slippage in assets quality got arrested. Consequently, the consolidated balance sheet of scheduled commercial banks expanded at a higher pace for the first time since 2010-11. Further, the financial performance of the banking system improved and public sector banks (PSBs), after a gap of three years, reported profits at the net level in the first half of the current financial year.
But PSBs still have plenty to worry about. Apart from holding the larger share of non-performing assets (NPAs), they are rapidly losing business to banks in the private sector. For instance, during the period under review, private banks attracted 77 per cent of incremental term deposits. The average share of private banks in incremental term deposits improved from 19 per cent during 2011-15 to 81 per cent during 2016-19. Despite accounting for less than a third of the banking assets, private banks contributed 69 per cent to incremental growth in credit in 2018-19. The share of private banks is rising steadily in outstanding credit as well. The reasons for this shift are not very difficult to understand. Banks in the private sector are comparatively efficient and able to garner more funds with better services and attractive deposit rates. However, higher deposit rates are not affecting their margins. Private-sector banks maintain higher net interest margins than what PSBs do. Here’s another example that marks the difference. PSBs accounted for over 90 per cent of the amount involved in fraud during the year, “mainly reflecting the lack of adequate internal processes, people and systems to tackle operational risks”, noted the central bank in its report.
The trend of the rising share of private banks is likely to continue for a variety of reasons. Higher NPAs will remain a constraint for PSBs and the government is not in a position to indefinitely keep infusing large sums of capital. On the other hand, even though there have been problems in some private banks, they are still better placed. Top management can be swiftly changed, and private banks are in a much better position to raise capital and expand their balance sheets.
However, it is important to note that the shift in favour of private banks will also lead to a fair bit of value destruction in PSBs. At a broader level, inefficiencies in PSBs will also affect the flow of credit into the system and remain a drag on economic growth. Therefore, it is important for the government to introduce governance reforms and enable PSBs to compete with the private sector. In its latest report on India, the International Monetary Fund also highlighted the need for reforms in PSBs. It has rightly noted that in absence of reforms, mergers would not address the underlying issues and could potentially result in larger and weaker banks. Mergers could also divert attention from the core business and affect lending capabilities. Time is running out fast for PSBs and the government (read taxpayers).
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