Banking for growth

Financing of NBFCs must be monitored

The biggest takeaway from the “Report on Trend and Progress of Banking in India, 2022-23”, released by the Reserve Bank of India (RBI) this week, is that the Indian banking system is in its best position in the last decade, with gross non-performing assets (GNPAs) declining to a 10-year low. GNPAs of scheduled commercial banks declined to 3.9 per cent at the end of March 2023, and further to 3.2 per cent in September 2023. It is important to note that the Indian banking system came under significant stress in the early part of the last decade because of both broader macroeconomic conditions and lax lending standards. Banking sector stress, along with leveraged corporate balance sheets — often referred to as the twin balance sheet problem — affected private investment with implications for overall economic growth. Since both corporate and bank balance sheets are now in a healthy shape, conditions for investment revival have become more conducive.

In terms of business performance, the consolidated bank balance sheet grew by 12.2 per cent in 2022-23, the highest rate of growth in nine years. This was driven by fast growth in credit disbursement, the highest in over a decade. The pace of deposit growth also picked up but was slower than credit growth, which resulted in borrowing from the market. While the key banking sector indicators are in good shape, the regulator is somewhat concerned about growth in unsecured credit. According to the RBI, the share of unsecured advances has been increasing since March 2015 and reached 25.5 per cent in March 2023. The RBI, as a result, increased risk weightings in provisioning for some categories of consumer credit in November to moderate the growth. Non-banking financial companies (NBFCs) also witnessed significant expansion in unsecured lending. The share of unsecured loans, consequently, increased to over 30 per cent at the end of March 2023, compared to 27.6 per cent in the previous year.

Besides increased unsecured lending by both banks and NBFCs, the interconnectedness of the two also needs attention. Bank borrowing became the top source of funding for the NBFC sector in 2022-23. Notably, it is not just NBFCs borrowing from banks directly, but banks also buy debt instruments issued by NBFCs. The rising interconnectedness can increase systemic risks in times of stress. Interestingly, as the report highlighted, banks globally tend to be net borrowers from non-banking financial institutions and interconnectedness between the two is also declining. The situation in India is the opposite. To be sure, NBFCs play an important role in providing credit to businesses and consumers who are perhaps left out by the banking system. However, the financing of NBFCs needs to be monitored closely to contain systemic risk.

Another important aspect worth noting is that public-sector banks (PSBs) continue to lose ground. The share of PSBs in the consolidated bank balance sheet declined by one percentage point last financial year to 57.6 per cent. Meanwhile, the share of private banks inched up. Further, despite a much smaller share in the consolidated bank balance sheet, private banks manage to generate higher net profits in absolute terms. This suggests private banks are more competitive and would continue to gain market share in the coming years.