India’s banking sector is a study in contrasts: it supports the world’s fastest-growing large economy but is grappling with challenges that test its strength and resilience.
Primary among them is the burden of distressed loans. According to Reserve Bank of India (RBI) data, the value of banks’ gross nonperforming assets (GNPA) and restructured assets reached $150 billion in April 2016 and has been growing by almost 25 percent year on year since 2013. State-owned banks account for more than three-fourths of the stressed-asset load, which is now far higher than their net worth. Provision levels are inadequate because these banks hold only 28 percent of GNPAs and restructured assets as provisions. There is a gap of close to $110 billion between the system’s stressed assets and the provisions made. These problems are considerably less severe for private banks.
Yet headline numbers do not tell the entire story, and there are many layers to the changing face of banking and finance in the world’s second most populous country. Even as legacy banks continue to be under pressure from stressed assets and stagnant loan growth, the sector as a whole represents one of the world’s biggest opportunities to create value in banking. Macroeconomic fundamentals continue to be strong, the country is in the midst of a digital revolution, and the ongoing disruptive changes (including momentum on the regulatory front) point to possibilities for both new entrants and incumbent banks.
The Indian government’s twin thrusts—to encourage digital identification and cashless transactions—are driving change throughout the economy. These measures picked up steam after the Unique Identification Authority of India (UIDAI), a statutory body responsible for providing the country’s residents with a biometric identity and a digital platform to authenticate it, was set up in 2016. The UIDAI has issued more than a billion unique identity (Aadhaar) cards, covering most of the country’s adult population. The government is pushing the whole financial system to use this unified identification system, and that has major implications for the sector. The system, which can be used not only for verifying customers but also for loans, direct transfers of subsidies, and a host of other financial transactions, could change the contours of formal and informal business in India.
In addition to the push for digitization, new policies favor financial inclusion and promote competition by allowing new domestic players to set up payments banks (which can only accept deposits and cannot issue loans or credit cards) and small-finance banks (which provide basic banking services to underserved sections of the economy). The further easing of norms, such as permission to set up wholly owned subsidiaries, makes it easier for foreign banks to enter India’s banking sector. Although processes are evolving, regulatory interventions point to the emergence of a digital, inclusive, and interoperable financial-services market in India.
A difficult legacy for Indian banking
Public-sector banks are more exposed to industry sectors with a higher share of nonperforming loans than their private-sector counterparts are. These state-owned institutions have deep networks and control 70 percent of banking’s asset base. From 2009 to 2016, the government made capital infusions of $15 billion into them. But over the years, value has steadily shifted toward private-sector institutions, whose share of the sector’s assets has grown to 25 percent, from 21 percent, in the past decade.1(Foreign banks account for the remaining 5 percent.) The division is more apparent in the value banks created from 2006 to 2016: private banks have grown faster and generated far more value for their shareholders, with their share of market cap increasing from about 40 percent to nearly 70 percent in the same period.
Loan growth in fiscal year 2017 has remained anemic—the banks’ credit books shrank by 4 percent in the past quarter (Exhibit 1). With the balance sheets of major Indian companies continuing to be under stress, the volume of corporate loans fell by 3 percent from April to December 2016. Roughly 40 percent of the outstanding debt is to companies whose interest-coverage ratio is less than one,2making debt repayment difficult. Overall, the recovery of wholesale-banking loans seems difficult in the medium term.
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