FY 2024 Kicks Off A New Cycle for Indian Banking

On September 15, 2008, Lehman Brothers Holding Inc, the “too big to fail” fourth-largest investment bank in the United States, with 25,000 employees, $639 billion in assets and $613 billion in liabilities, filed for bankruptcy, triggering a global financial crisis.

The US government allowed the iconic investment bank to fail but bailed out AIG, even though both were involved in subprime mortgage financing.?Incidentally, AIG’s $182-billion bailout happened in the same week that witnessed the Lehman collapse.

A week before that, the government took over two troubled mortgage guarantee firms, Fannie Mae and Freddie Mac. This, six months after it had bailed out Bear Stearns, another struggling Wall Street firm, by loaning $30 billion to its buyer, JPMorgan Chase.

The Federal Reserve withheld an emergency bailout from Lehman Brothers since it lacked the legal authority to do so.

Lehman’s wounds “were self-inflicted”, whereas AIG’s collapse would have caused a worldwide “systemic macro event” with cataclysmic repercussions, an article in?Knowledge at Wharton,?a business journal from the Wharton School of the University of Pennsylvania, says, quoting?Madelyn Antoncic, the chief risk officer at Lehman Brothers between 2002 and 2007.

In an interview with?Knowledge at Wharton?and Jyoti Thottam, opinion editor for business and economics at?The New York Times,?Antoncic, an economist who later worked at the World Bank, traced Lehman’s bankruptcy to the top management’s “hubris” and its brushing aside of risk management principles.

March 2023 is a different season. The Silicon Valley Bank, a specialised lender to technology start-ups, collapsed on March 10. It was the largest bank failure in the US since the 2008 financial crisis. But all its depositors, both insured and uninsured, have been fully protected.

On March 12, the regulators abruptly shut down Signature Bank, a lender to law firms and real estate companies, again to protect its depositors and contain any spill over into the broader financial system. A week later, on March 19, elsewhere in Europe, Swiss banking giant UBS stepped in to rescue crisis-hit rival Credit Suisse.

March spoiled the party for the year. To quote Reserve Bank of India (RBI) Governor Shaktikanta Das, when supply conditions were improving, economic activity remained resilient, financial markets exuded greater optimism and central banks across the globe were steering their economies towards a soft landing; just a few weeks in March changed the narrative dramatically.

The global economy is now witnessing a renewed phase of turbulence with fresh headwinds from the banking sector turmoil in some advanced economies. Bank failures and contagion risk have brought financial stability issues to the forefront. However, inflation still remains enemy No 1 for most central banks. So, the monetary policies across the globe continue to be tightened, albeit at a reduced pace.

The RBI has not toed the line of the US Federal Reserve, European Central Bank and Bank of England. It pressed the pause button last week with a caveat that this is just a pause, not a pivot. Indeed, inflation continues to remain a worry in the world’s fifth-largest economy but, at the moment, no risk is seen for financial sector stability.

Yes, the treasury bill yields crashed both in the US and Germany and wild volatility gripped the bond markets in March, but no one is expecting a repeat of the 2008 global financial crisis now.

How has the last financial year been for the Indian banking system? Let’s take a look at some data points.

The policy rate, which was brought down to its historic low of 4 per cent in May 2020 to help the economy fight the impact of the Covid pandemic, rose by 250 basis points (bps) during the year to 6.5 per cent – last seen in February 2019. One bps is a hundredth of a percentage point.

In FY2019, inflation yo-yoed between 1.97 per cent (January 2019) and 4.92 per cent (June 2018). The comparable figures for FY2023 are 5.88 per cent (November 2022) and 7.79 per cent (April 2022). Of the 11 months of FY2023 (the latest inflation figures available are for February), it remained above the upper band of the target (6 per cent) in nine months.

Despite the stiff rise in policy rate, the 10-year bond yield didn’t react sharply. It had started the year at 6.9 per cent and ended 41 bps higher at 7.31 per cent. No wonder, then, that the record Rs 14.2 trillion gross government borrowing programme sailed through smoothly. The shorter end of the yield curve, however, stiffened considerably. For instance, the yield on 91-day treasury bill had risen during the year from 3.72 per cent to 6.88 per cent and that of 364-day treasury bills, from 4.2 per cent to 7.1 per cent.?

When it comes to equities, both Sensex and Nifty remained almost flat if we look at the levels in the beginning and end of FY2023, but the BSE Bankex and Bank Nifty, the banking indices, offered good returns.

Foreign exchange reserves during the year?shrank by around $28 billion to about $579 billion and the rupee lost 8.27 per cent vis-à-vis the dollar to close the year at 82.18 a dollar.

The bank credit growth in the year has been 15 per cent versus 9.6 per cent in FY2022, while the growth in deposits lagged behind – 9.6 per cent versus 8.9 per cent, although on a higher base. But, even in absolute terms, deposit growth has been lower than credit growth – Rs 15.8 trillion against Rs 17.8 trillion.

Most macroeconomic indicators are in good shape at the beginning of the new year. The current account deficit for the first three quarters of last year narrowed down to 2.7 per cent of the GDP, riding on lower merchandise trade deficit and growth in services exports. From a low of $524.5 billion in October, the forex reserves now are in excess of $600 billion, including the forward assets.

But the banking sector is staring at a tough time?in FY2024. Indeed, most banks are well-capitalised and have made adequate provision for bad assets. The challenges are on the business front. The war on deposits will?escalate?and, as the bulk of the deposits gets repriced, banks’?net?interest income?or, the difference between what they pay on deposits and earn on loans,?will shrink. Income from recovery, too, will come down?as the low-hanging fruits have all been plucked. Finally, the rise in loan rates may create fresh bad loans as it is hurting the borrowers’ ability to service debt, particularly in the retail segment.

The RBI’s pause does not signify the end of the rate-hike cycle, but for the banking system a new cycle starts in FY2024.?It's?fraught with fresh challenges on asset quality and profitability.

This column first appeared in Business Standard

The writer, a Consulting Editor of Business Standard, is a Senior Adviser of Jana Small Finance Bank?

His latest book?Roller Coaster: An Affair with Banking?

Twitter: TamalBandyo

Website:?https://bankerstrust.in