Lenders get to work as India aims to become a $5 trillion economy

How lenders are balancing growth and governance to empower ambitions of 'Viksit Bharat'

The overarching theme for the Reserve Bank of India’s (RBI’s) regulated entities (REs) will continue to be around governance — be it housekeeping, the role of independent directors, or business models. The recently released RBI report, titled ‘Trend and Progress of Banking in India (T&P: FY24)’, gives a clear indication of what is in store. Under the process of supervision of banks, non-banking financial companies (NBFCs), and other REs, the focus is now on early detection and pre-emptive correction. The enhanced offsite assessment framework is more analytical and forward-looking with the introduction of macro-stress tests, early warning indicators, fraud vulnerability index, micro-data analysis, and the use of artificial intelligence (AI) and machine learning (ML) techniques.

 

The larger setting in which it has to be read is in what RBI Governor Sanjay Malhotra articulated on taking over at the central bank’s helm: Fostering economic growth, ensuring stability in policymaking, and expanding financial inclusion would be among his key priorities. While significant progress has been made in financial inclusion, much more remains to be done, he said, stressing the importance of collaborating with all stakeholders in the financial system to further advance these efforts. “Ours is still an economy that needs to develop as we enter ‘Amrit Kaal’ and to realise the vision of ‘Viksit Bharat’ by 2047,” he said.

 

Or, in a nutshell, it can’t be business as usual: the idea is to prepare REs as India seeks to become a $5 trillion economy, even as the capital needs intensify. 

 

Governance, governance, governance

 

State Bank of India (SBI) Chairman C S Setty is of the view that efforts at enhancing governance in REs have focused on three aspects — customer centricity and protection; technology preparedness (as more and more financial transactions happen on digital platforms); and operational resilience: continuous improvement and increase in the capacity to manage scale and complexity. “There is definite change across the ecosystem to focus on various elements of governance. Banks, finance companies, and microfinance institutions are seriously working to improve governance,” said Setty. The focus is now shifting to internalise the steps and continue on the path. “The regulator expects the boards of banks and NBFCs to have better oversight on governance instead of looking for directives from RBI,” Setty added.

 

This was evident when the RBI informed private banks at the second edition of its interface with their boards on November 18 under the theme ‘Transformative Governance through Sound Boards’. The first with the boards of the state-run and private banks on May 22 in New Delhi and May 29, 2023 in Mumbai respectively, was seen as a one-off; a novelty. And how different was the version 2.0? It built on the ten-point charter outlined in the ‘Conference for Boards of Banks’ in the summer of 2023. These included governance and stability; requisite qualifications and expertise in the board; objective and independent board; role of the chairperson, board committees, and top executives. Other aspects were corporate culture and value systems, quality of information, effective oversight of senior management, business model and conduct, integrity and transparency of financial statements, and independence of assurance functions: risk management, compliance, and internal audit. The second interface with the boards of the state-run banks never came through during the stint of then-Governor Shaktikanta Das. It is speculated that it may happen soon.

 

The interactive approach finds a mention in the T&P: FY24 report. It refers to the central bank’s frequent and wide interactions with supervised entities (SEs), including with the managing directors (MDs), and chief executive officers (CEOs), as well as directors. This is to be carried forward. Engagement with SEs is also being strengthened through the DAKSH portal – a SupTech initiative with an end-to-end workflow solution to streamline and strengthen various supervisory processes. Additionally, direct interactions with statutory auditors have further strengthened the oversight framework. This consultative approach is also being followed in the revision of various regulatory guidelines including Basel-III standards. Mint Road is also working on issuing final guidelines on the disclosure framework for climate-related financial risks. 

 

CD ratio in the plot

 

An intersection point of governance and the operations was the credit-to-deposit ratio. The runaway growth in some segments was just not sustainable on two accounts: there was no organic liquidity in banks (that is deposits) and growing the book through costly certificates of deposits was not sustainable. The central bank asked several banks to take a hard look at their credit-deposit (CD) ratios.

 

The CD ratio of banks – the amount they give loans out of every Rs 100 in deposits – had inched to as high as 80 per cent during 2024. This is playing out on the credit side. ICRA has revised its credit growth estimate downwards to 10.5-11.0 per cent for FY25 from its earlier estimate of 11.6- 12.5 per cent for the period. In a recent report, the rating agency highlighted that with the banks focusing on reducing their CD ratio and reducing their exposures to unsecured retail and NBFCs, the overall credit growth has moderated in the past few months. Consequently, credit and deposit growth almost aligned with each other and this trend is expected to continue. For FY26, credit growth may ease to 9.7-10.3 per cent, weighed down by the persisting high CD ratio and implementation of the proposed changes in the liquidity coverage ratio (LCR) framework.

 

“In the backdrop of revision in the LCR framework, banks may not be keen to tap into wholesale deposits. Instead, they would tend to increase dependence on retail customers as they are more durable,” said Anil Gupta, co-group-head (financial sector ratings), ICRA. This is expected to lead to moderation in interest rates for wholesale deposits while rates may stay elevated in the retail segment. Deposits are estimated to grow at 10.75-11.25 per cent in FY25 and the pace may moderate to 10.5-10.9 per cent in FY26.

 

Deposits grew by 11 per cent in mid-December 2024, down sharply from 20 per cent a year ago. The CD ratio is estimated to be 79.4 per cent in FY26, down from 79.8 per cent in FY25.

 

According to the RBI data, the CD ratio was 77.92 per cent in mid-December 2024, almost the same level as 77.44 per cent a year ago (mid-December 2023). But comparatively, the incremental CD ratio at 75.98 per cent had turned softer from 95.75 per cent.

 

Banks’ deposit profile has been changing, with a decline in the share of low-cost current account and savings account (CASA) deposits in favour of term deposits, especially for higher interest rate buckets, indicating growing competition for savings and investor preference for financial products offering higher returns. For instance, term deposits formed 82 per cent of incremental deposits mobilised in H1FY25. They also raised more funds through higher-cost certificates of deposits. The Financial Stability Report of December 2024 observed that cost of funds had risen by 148 basis points (bps) since March 2022. As a result, banks’ NIM (net interest margin) and profitability face pressure from stiffer competition for funds.

 

The fight to garner deposits is the reason why the RBI revised the definition of bulk deposits (single rupee term deposits of Rs 3 crore and above for banks and small finance banks or SFBs). This is critical because banks have the discretion to offer differential rates of interest on bulk deposits as per their requirements and asset-liability management projections. This aspect will be of particular interest to SFBs.

 

“The liabilities side will be in focus as we grow the secured book. Collections and the microfinance portfolio will continue to get prime attention. Plus, the roadmap for SFBs to be a universal bank,” says Ajay Kanwal, MD and CEO, Jana Small Finance Bank. All of these are interlinked issues for SFBs.

 

So, how is FY26 going to look? T&P: FY24 sums it up: “Going forward, there is a continuing need for banks to strengthen their ri­sk management standards, IT governance arrangements, and customer onboarding, as well as transaction monitoring systems to che­ck unscrupulous activities, including sus­p­i­ci­ous and unusual tra­nsactions”.  That is, governance!

 

What to look out for

 

> Focus on governance - be it housekeeping, the role of independent directors, or business models

> Monetary Policy Committee meeting in the first week of February

> RBI guidelines on liquidity coverage ratio framework