The Three Rs Of Public Sector Banking

In a recent conversation, Rajkiran Rai, managing director of Union Bank, has made an interesting remark. “When we started our career in 1980s, we were not in the business of banking. Since we were government owned (even now, they are), people walked into our branches and kept their money; we did not have to ask for it. Neither did we go out looking for borrowers. They came to us, seeking loans. On our own, we didn’t have to do anything,” he said with rare candour. 

Rai’s primary job these days is to teach his colleagues the business of banking. All public sector banking bosses seem to be doing this. They roughly have close to 70 per cent of the market share of banking assets in Asia’s third largest economy – disproportionately higher than most markets across the globe. To cut down the number of government-owned banks, consolidation is the new buzzword in the industry. Even if we are hugely successful in the consolidation drive, it will bring down the number of banks -- not their market share. 

The market share can shrink – and it has started shrinking – if some of the public sector banks become irrelevant because of their inefficiency. It is in this context, Rai’s observation is important. The government-owned mammoth banking industry in India is trying to reinvent itself. How?

Before we get into the details of their transformation strategy, let’s look at their performance in fiscal year 2019 that ended in March. This bunch of banks made a net loss of Rs72,952 crore in 2019 which is less than the previous year’s loss (Rs85,371 crore). In 2017, they made a measly profit of Rs474 crore after making close to Rs20,000 crore loss in 2016. Essentially, in past four years, their losses equal 1 per cent of India’s gross domestic product (GDP). 

Fourteen public sector banks made losses in 2019 and the amount of loss varied between Rs15,116 crore (IDBI Bank Ltd) and Rs543 crore (Punjab & Sind Bank). Of course, IDBI Bank is no longer owned by the government. The can is now being carried by Life Insurance Corporation of India, which is wholly owned by the government. 

Why did they make so much loss? Well, they had to provide for a pile of bad loans, created over the years. The provision for such loans in 2019 was to the tune of Rs2.57 trillion, less than Rs2.86 trillion in the previous year. A lesser amount of provision contributed to the shrinking of overall net loss of these banks in 2019. To be fair to them, their net interest income -- or the difference between what they pay for deposits and what they earn on deploying such deposits in the form of loans -- also rose, from Rs2.05 trillion to Rs2.30 trillion.

Overall, the pile of gross non-performing assets (NPAs) of such banks dropped from Rs8.96 trillion in 2018 to Rs7.68 trillion. However, at least 12 of these banks still have their gross NPAs more than 15 per cent of loan assets. Of these, two have at least 20 per cent and one 27 per cent gross NPAs. After setting aside money for bad loans or making provisions, their net NPAs dropped from Rs4.54 trillion to Rs2.92 trillion. At least two of them have 10 per cent or more net NPAs and 14 of them have between 5 per cent and 9 per cent net NPAs. 

Indeed, there is marginal improvement in the performance of some of the public sector banks. Recognising that, the banking regulator has taken a few of them out of the ambit of the so-called prompt corrective action quarantine which restricts their activities. But many are not out of the woods yet. 

What’s the game plan of these banks? How do they come out of the mess and create an ecosystem not to repeat the same mistakes again? The three Rs of public sector banking now are recovery, risk management and retail loans.

For most banks, the primary focus is on recovery of bad assets and not necessarily creation of new assets to earn interest. While the insolvency law is aggressive and bringing many of the defaulters to the discussion table, the time taken to recover bad loans through this route is much longer than what the bankers had anticipated. The woefully inadequate infrastructure is only one part of the story. The corporate India’s proclivity to game the system is adding to this. 

So, most bankers are using the insolvency law as a threat and trying to recover, whatever they could, outside it, through discussions. Since most banks have already provided for such bad loans, even after a relatively smaller recovery, they can be “in the money”.

While the recovery drive is aimed to clean up the books and make some money that can add to the profits, all banks are taking risk management seriously. The general manager, risk management, is now the most critical position among the senior executives in a public sector bank. 

For balance sheet growth, they are now focusing on retail assets in a big way. If you are driving down on the Western Express Highway in Mumbai from the airport to the business district of Bandra Kurla Complex, you can’t miss the bill boards of even weak public sector banks, screaming to sell home loans. Almost all managing directors want to de-risk their banks by paring the exposure to corporate loans and pushing hard for retail loans such as mortgage, auto loans and even personal loans. 

In every investor presentation, they are showing a graph – how corporate loans as a percentage of total loans is coming down and retail loans going up. Theoretically, the interest margin on retail loans is higher than corporate loans (that is if the bank is giving loans to highly-rated corporations) and most such loans are backed by securities. So, it’s a foolproof strategy. Right?

There are two key questions. If these banks stop giving corporate loans, where will the corporations source funds to invest? We do not have a vibrant corporate bond market.  

A more critical question is: Is retail business the next time bomb ticking away? Typically, the public sector banking industry has a herd mentality and not every bank has the expertise for retail loans; they have jumped onto the bandwagon as they need to de-risk their balance sheets. In the March quarter, the Indian economy grew at its 20-quarter low, dragging the overall growth for 2019 to a five-year low. If the slowdown is not arrested, we may start seeing cracks in the retail loan portfolio of banks. 

This column first appeared in Business Standard / www.business-standard.com

To read the author's earlier columns, please log onto www.bankerstrust.in

The columnist, a consulting editor of Business Standard, is an author and senior adviser to Jana Small Finance Bank Ltd. His latest book, `HDFC Bank 2.0: From Dawn to Digital’ will be released on July 10 in Mumbai

Twitter: @TamalBandyo