Decade in review: How state-owned banks rose to the occasion amid crisis

The banking sector was the fulcrum of the economic agenda of the government in the past decade. It was one in which the state-owned banks rose up to the occasion, even in the face of drastic changes in their operating environment.

From 23 new bank licences to bank mergers, currency crisis-led surge in dollar deposits to demonetisation, massive frauds to digitisation, bank board governance reforms to departure of high-profile private bank chiefs, from record bad debts to the Insolvency and Bankruptcy Code (IBC), this decade has inarguably remained the most eventful for the banking industry ever — perhaps even more than the bank nationalisation drive in the Seventies.

The decade brought out an important realisation for the government as well. Banks needed to be recapitalised in a new economy — both for growth need, and for taking care of losses due to bad debts.

At the start of the decade, the government was busy infusing stimulus packages to revive various sectors affected by the global credit crisis. Banks themselves were still grappling with how to take care of the farm debt waiver scheme that the government had declared in 2008. The banks were repaid largely through bonds; most of it through longer dated papers.

Banks had to bear the price of the stimulus packages through subvention schemes and by booking losses. The same trend continues even now as the governments in the Centre and states engage in collateral-free loans under the Mudra scheme, and various agriculture loan waiver schemes, or schemes for small and medium enterprises.

The bad debts in these schemes are substantial enough for the Reserve Bank of India (RBI) to take special note of the issue in its policy document. On top of it, heavy bad debts caused by large corporate borrowers, as well as massive frauds, have destabilised the Indian banking industry, which now hopes for radical measures for recovery.

“There is overdependence on the banking system to push the economy. This is evident since the early part of the decade. After the global financial crisis, the stimulus packages introduced, the price was borne by the banking system,” observed Ashvin Parekh, managing partner at consulting firm Ashvin Parekh Advisory Services.

But there is recognition now that such dependence should come at a cost for the government as well. Not only do the banks need to be recapitalised, the boards need to be revamped too.

“There was recognition that that the bank boards are weak, and, in fact, are getting weaker by the day,” said Parekh.

Even as the government must reduce its stake in public sector banks (PSBs) below 51 per cent, merger of PSBs is unlikely to serve any meaningful purpose, said Parekh.

As large accounts started defaulting, bankers were hauled up for commercial decisions gone wrong. This rattled the bankers, and credit froze in the economy — part of the reason behind the acute slowdown witnessed by the Indian economy.

One important event that happened in the decade was how some top names in India’s private sector banking had to leave their bank.

Even as banks were always important for the government, it was the Narendra Modi-led National Democratic Alliance (NDA) government — which came to power in mid-2014 — that pushed its economic and social agenda from the platform of PSBs.

After demonetisation in November 2016, the banking system went into a tizzy as the government overnight invalidated 86 per cent of the cash in the system in the form of Rs 500 and Rs 1,000 notes.

Almost the entire money came back into the system, raising questions about the futility of the exercise. But what it led to was an increased digitisation drive. Mobile-based Unified Payments Interface, Immediate Payment Service, and now 24x7 National Electronic Funds Transfer have revolutionised banking in India, and only a handful of countries can boast of having such facilities. The groundwork for such digital infrastructure was laid during the United Progressive Alliance regime, but the NDA government took the initiatives to new heights.

RBI Governor Raghuram Rajan granted 23 banking licences since April 2014. Two were given universal banking licences in April 2014, 11 were issued payments banks licences in August 2015, and 10 were given licences for small finance banks in September 2015.

Prime Minister Modi called for a nationwide financial inclusion drive during his first Independence Day address to the nation. More than 125 million basic accounts were opened under the Pradhan Mantri Jan-Dhan Yojana, as bankers reached the hinterlands to include every family that did not have bank accounts. But more than half of those accounts remain inactive, say observers.

The account opening drive was followed by a Gyan Sangam — a two-day brainstorming event with bankers — which led to Indradhanush, in which the Centre resolved to revamp bank boards, created a Banks Board Bureau for that purpose, and decided to go for recognition of bad debts, and resolve them with adequate recapitalisation of banks.  This was also the first time that the government decided to hire from the private sector to head PSBs.

And then, in December 2015, Rajan called for an asset quality review of banks. Within three years of that exercise, the banking system threw up more than Rs 10 trillion in non-performing assets, most of them lacking in adequate provision cover.

Clearly, PSBs did not have the capital to face this issue head-on. Apart from regular capital infusion, the recapitalisation exercise was brought upstream by the promise made in October 2017 of a recapitalisation drive of Rs 2.11 trillion.

The most important legislation for the banking sector that happened in this decade is the formation of the IBC in August 2016. Armed with a new set of laws, meek bankers became aggressive and started asking for their money back from big industrialists.

“While it dithered in its initial phase, the IBC and the National Company Law Tribunal (NCLT) have evolved in the right direction after November’s Essar Steel verdict. Now clarity has emerged that you need to empower the committee of creditors,” said Parekh.  

Using the legislation, even if banks manage to recover Rs 4-5 trillion of their bad debt, it would put the banking system on sound footing, said Parekh.

The total bad debt of 44 listed banks stood at Rs 9.27 trillion in June 2019, from over Rs 10 trillion in March 2018. This should have fallen even further, but a steep fall in economic growth meant bad debts have started piling up once again.

At the end of September, there were 10,860 cases pending under the IBC, even as resolution could be found in only 15 per cent of the cases.

“According to the data provided by the NCLT, a total of 19,771 cases were pending with the NCLT Benches on September 30, 2019, which include 10,860 cases under the IBC,” Minister of State for Finance and Corporate Affairs Anurag Singh Thakur said in a written reply to the Rajya Sabha.

This decade also saw the government moving decidedly towards bank mergers. State Bank of India started the trend with merging five of its associates and the Bharatiya Mahila Bank with itself. IDBI Bank was privatised and sold off to Life Insurance Corporation (LIC) of India.

From April 1 this year, Dena and Vijaya Bank merged with Bank of Baroda. In August, the government said it would merge Punjab National Bank (PNB) with Oriental Bank of Commerce and United Bank to create India’s second-largest lender, merge Canara Bank with Syndicate Bank, and will consolidate Union Bank of India, Andhra Bank, and Corporation Bank, and will merge Allahabad Bank with Indian Bank.

The Indian banking industry was rocked in January 2018, when it was found the two celebrity jewellers defrauded PNB of nearly Rs 13,000 crore through fake letters of credit. According to the RBI data, in 2018-19, frauds worth Rs 71,500 crore were detected, mostly in PSBs.

In 2019, one of the largest co-operative banks — Punjab and Maharashtra Co-operative (PMC) Bank — was found to have hoodwinked everyone, by giving more than 70 per cent of its loan to a real estate group, which later defaulted.

Crystal gazing into the next decade

If the Financial Resolution and Deposit Insurance (FRDI) Bill — withdrawn in 2017 — becomes operational in the coming years, this would pose new challenges for the banking system.

According to Ananda Bhoumik, managing director of India Ratings and Research, with the FRDI Bill, that will have a bankruptcy rule set for banks and financial institutions, the perceived notion that government-owned banks being safest because of implied government guarantee would be impacted as the government will have no moral obligation to bail out a bank.

“Thereby, the financial profile of banks will become more important than a perceived government guarantee. The liability pattern will change, and the preference would likely shift to safety in terms of numbers and the quality of services,” said Bhoumik.

The fight for efficiency, using technology for delivery of products will be a major differentiating factor and here, banks will likely face major challenges from the new age non-banking financial companies (NBFCs), as credit markets deepen and data analytics becomes more relevant. Banks that fail to adapt and differentiate will continue to lose their market share, and competition will increase manifold, forcing the merger of banks.

According to Parekh, the recovery and governance process has to be strengthened; otherwise the government, being the largest shareholder, will end up suffering.

“Somewhere there has to be a realisation that the RBI balance sheet should not be tinkered with,” said Parekh. So should be the case with LIC. Otherwise the government will end up holding the liabilities of the policy holders.

As for as NBFCs, only the performing and professionally managed NBFCs should be supported, and the authorities should let non-performing NBFCs fail.

“This may cause some pain to the system initially, but ultimately, it will be for good,” said Parekh.