Banking transformation still in the works

Besides demonetisation, the Centre has given a major push to digital payments. But not much has been achieved on NPAs

Besides demonetisation, the Centre has given a major push to digital payments. But not much has been achieved on NPAs. ANUP ROY writes

From the ramparts of the Red Fort in New Delhi on August 15, 2014, newly elected Prime Minister Narendra Modi declared war on financial exclusion, throwing bankers into a frenzy of activity, and passing on a message that the financial sector — mainly banks — would transform in India.

This was quickly followed by a mass pension scheme, a dedicated nodal agency for small and medium enterprises and digitising payment services via the Unified Payments Interface (UPI) to enhance transparency and improve financial inclusion in India.

Three years hence, banks in India are still going through a lot of those changes. While the jury is still out on the importance of the measures and their value, the Indian banking sector continues to buzz with activity — from shifting the business model to digital mode and mergers to getting the necessary tools and protection to recover dues in an effective manner.

By amending the Reserve Bank of India (RBI) Act earlier this month, the government has also moved to protect bankers from being hounded by probe agencies when a commercial decision goes awry. Restructuring decisions will now be ratified by an oversight committee, and not bankers alone. This should make the bankers bold enough to take critical decisions to recover dues.

“While I am totally sympathetic to people wanting to have a government cover to be able to take decisions, fact is, it is very easy to not take decisions. We need to create an enabling environment,” said Axis Bank Managing Director (MD) and Chief Executive Officer (CEO) Shikha Sharma.

Public sector banks (PSBs), on the other hand, agree that the government doesn’t try to micromanage banks and that phone calls to bank chairmen to extend loans do not happen anymore.

“The Prime Minister has told bankers they will not get a call from even the Prime Minister’s Office,” the then Financial Services Secretary Hasmukh Adhia had briefed media in Pune after the first bankers’ retreat — Gyan Sangam.

Gyan Sangam was a brainstorming event, where bankers were asked to freely air their views. Gyan Sangam subsequently resulted in the Indradhanush. Here the situation got tricky for PSBs. Instead of allotting capital on a pro-rata basis on their balance sheet size, the government started insisting on capital-infusion, based on performance metrics. Many banks missed getting capital.

The government also set up the Banks Board Bureau (BBB), with a mandate to improve governance in PSBs. The BBB, it is expected, would morph into a bigger entity, perhaps a bank holding company that would hold shares of all PSBs. For the first time, the government appointed executives from the private sector to head PSBs. The bank chief’s position was split into chairman and MD (who would also act as the CEO) to enable fair decision-making.

Recently, the government shuffled two bank chiefs to other banks, which, according to sources, was without consulting the BBB. Since then, questions have been raised on the role of the BBB in bank management appointments. Bank consolidation and bringing down the government’s shareholding in PSBs is something the previous Bharatiya Janata Party government also mooted in early 2000s, but the Modi government moved decisively on that front. While the State Bank of India (SBI), the country’s largest lender, had absorbed two of its associate banks in 2008 under the United Progressive Alliance government, Finance Minister Arun Jaitley pushed the pedal — the five associates and the short-lived Bharatiya Mahila Bank melded with the SBI from April 1, 2017.

The merged entity is now in the top-50 global bank list. The government and the RBI top officials, including Governor Urjit Patel and Deputy Governor Viral Acharya, have been questioning the need for more banks instead of a few large and efficiently run banks. Bank unions, of course, are not amused. The divestment of IDBI Bank is now on the government’s agenda.

According to McKinsey & Company’s head of financial services Renny Thomas, there is no need for 21 PSBs in the country. McKinsey proposes creation of two-three large PSBs of global scale, and five or six regional banks that can focus heavily on retail and loans to small and micro enterprises. “That will also solve the problem of talent in the banking industry, as post-merger all the talents can come together at the management level. Now, the talents are scattered around PSBs,” said Thomas.

No matter what the scale of the balance sheet, burgeoning bad debts are gnawing away at banks’ capital. As on December 31, 2016, the Indian banking sector had a gross bad debt of nearly ~7 lakh crore. Around half of the bad debts would not have come to light had it not been for the RBI’s asset quality review (AQR), which became very aggressive under Raghuram Rajan and continued to be so under Urjit Patel.

The government has been providing the ammunition to the central bank by amending the RBI Act.

With Modi at the helm, the RBI got quite aggressive in its approach towards loan defaulters. But first was the recognition of the extent of bad loans.

The central bank, under then governor Raghuram Rajan, imposed AQR on banks in the third and fourth quarter of financial year 2015-16. The idea was to recognise the extent of bad loans. Following this, the central bank brought out various resolution schemes like strategic debt restructuring, scheme for sustainable structuring of stressed assets, or S4A, and strengthening the joint lenders forum (JLF), which aimed at giving bankers more power over the assets pledged by the promoters. These schemes ensured banks got the power to convert debt into equity and, if need be, force-sell the defaulting companies to recover their dues. However, these schemes were not very successful for various reasons.

Naresh Takkar, group chief executive and MD, Icra, said, “They could have done better in managing asset quality, especially in administrative reforms, giving more room to bankers to take decisions.”

The Modi government earlier this month amended the RBI Act to enable the central bank to be in charge of the resolution process. The central bank quickly took some punitive measures that would punish banks if the resolution process was not finished in time.

The central bank can now draw up resolution plans on a case-by-case basis, against the earlier practice of being specific about an industry. The Modi government also tried to shield bankers from the glare of investigative agencies, should a commercial decision go out of kilter, by enabling an oversight committee of outside experts on loan recast decisions.

“The ordinance empowering the RBI and changes in rules for JLF will help in prompting resolution of stressed assets,” believes Takkar.

But more importantly, under Modi, the Insolvency and Bankruptcy Code was passed, which should make the asset resolution process a lot more efficient. The code merges all the overlapping Acts into one, enabling a time-bound resolution process.

“The Bankruptcy Code is a path-breaking legislation. It will not only help in recovery, but can be a deterrent to potential defaulters. Over a period of time, bond markets may also get added depth,” said Krishnan Sitaraman, senior director, CRISIL Ratings.

Krishnan said during Modi’s regime there have been other good pieces of legislation and reforms, such as increasing foreign investors’ limit in the insurance sector, the seven-step Indradhanush for PSBs for addressing their capital needs, among other issues, and increasing the investment basket for pension funds.

“The steps announced so far are well-intentioned. The challenge now is to effectively implement these. These measures will strengthen the system structurally, if implemented well,” said Sitaraman.

Modi’s legacy in the three years would be a major thrust for digitisation of services and introducing a number of cutting-edge technologies that bring banking at the fingertips via smartphones.

Said Icra’s Takkar, “The intent and commitment to reforms in the financial sector are high. These are reflected in the thrust on using digital medium, be it for financial inclusion or tax administration.”

The UPI is now fully integrated into mobile handsets and enables users to transact instantly. The push to digital, in right earnest, came after Modi announced on November 8, 2016, that all existing ~500 and ~1,000 notes — amounting to 86 per cent of the total currency in circulation — would be purged in favour of new denominations.

Six months on, the true benefit of the demonetisation drive has not been perceptible, but analysts say transparency in deals has increased manifold.

In April, the total number of digital transactions crossed ~1 lakh crore, an indicator the country is indeed moving towards a less-cash society.

“Technology in the banking sector is making quick strides. People are quick to adapt. This augurs well for the banking sector, in particular, and the country as a whole,” said Chandra Shekhar Ghosh, chairman and managing director of Bandhan Bank. The bank started operations in 2015 and is largely focused on financial inclusion. A large portion of its offering is leveraged on the latest banking technology such as the UPI.

There has also been significant movement in interest rates and currency. Since January 2015, the RBI has lowered its policy repo rate by 175 basis points, but credit growth in the banking system has remained in low single digits.

According to analysts, the chances of rates increasing significantly are bleak, considering the tepid economic growth. The rupee, which was at 59.30 a dollar when Modi became the Prime Minister, is now at 64.16 a dollar.