Banking On Asset Quality

IF THERE IS ONE verb that best captures the Reserve Bank of India’s (RBI’s) recent actions, it’s ‘warns.’ In recent times, scheduled commercial banks, cooperative banks, non-banks, and fintechs have been frequently reprimanded for financial misconduct and regulatory violations.

Indeed, since the start of this calendar year, punitive fines have reached an all-time high of ₹65.32 crore, exceeding the previous record of ₹40.39 crore set in 2023. Although the amount is relatively small compared to the overall size of the sector, it underscores a glaring and persistent need to improve compliance standards across the banking spectrum.

Overall, the number of penalties nearly doubled between 2021 and 2023, with non-compliance of central bank directives (32.7%) and know-your-customer/anti-money laundering (22.2%) emerging as the top two violations, states a study by Signzy, a digital banking infrastructure provider (See: An ignominious high). Unsurprisingly, penalties on private and public sector banks accounted for the majority (60%) of total penalties (See: All in the family).

Coincidentally, compliance challenges have paralleled a sharp increase in retail credit, particularly personal loans, which surged from 10% growth in FY21 to 20% in FY23, and over 31% in FY24. This growth has been fuelled by significant digitalisation in the sector, led by credit bureaus enhancing data collation, validation, and decision-making processes, along with the rise of e-commerce transactions.

Vivek Iyer, partner at Grant Thornton Bharat and Fortune India’s knowledge partner for the Best Financiers issue, believes that the regulator’s concern isn’t with growth per se, but with the lack of sustainability. “The job of the regulator is to proactively identify themes of unsustainability,” says Iyer.

According to a Goldman Sachs report, since 2021, there have been approximately 30 million unsecured personal credit lines, which are projected to annualise to nearly 140 million unsecured credit lines in the system. “The growth in this sector has been parabolic. Driven by fintechs, NBFCs, and banks, this rapid expansion has prompted regulators to pre-emptively address potential issues to avoid future challenges. Thus, the regulatory actions we are seeing are focused on ensuring that compliance standards are maintained,” explains Rahul Jain, head of India equity research and co-head of Asia financials research at Goldman Sachs, during a recent interaction.

Amid declining compliance standards, the central bank has raised concerns over the lending practices of banks and NBFCs. Although retail credit has been a major driver for the sector, on May 3, the RBI mandated banks to set aside up to 5% of outstanding exposure as provisions during the construction phase of projects, a significant increase from the current 0.4%. This directive was anticipated, given that the total outstanding credit to the infrastructure sector, at ₹12.80 lakh crore, constitutes a substantial portion of the overall industry credit of ₹37 lakh crore.

Dinesh Khara, chairman of the State Bank of India, whose loan book amounted to ₹37 lakh crore as of March 2024, attributes the regulatory concerns to issues with loan pricing. “The RBI’s apprehensions seem to centre on whether some lenders are accurately pricing risk. When lenders price a 15-year term loan similarly to a T-bill, it naturally raises concerns for any regulator,” Khara explained to analysts during the Q4 earnings call.

Echoing similar concerns, the central bank has recently warned micro lenders and non-banks about charging excessively high interest rates. This caution comes two years after the regulator lifted pricing caps on microfinance loans. “We have observed that some microfinance institutions and NBFCs are charging high interest rates on small-value loans, which seem usurious,” stated RBI Governor Shaktikanta Das following the recent monetary policy committee meeting, where the key lending (repo) rate was maintained at 6.5%.

Jain of Goldman Sachs feels risk governance continues to be a priority for the RBI given the significant interconnectedness between the banking and NBFC sectors, with non-banks predominantly borrowing from the banking system to grow their portfolios. As of March 2023, banks accounted for 57% of NBFC borrowing. “This dependence may have prompted the RBI to acknowledge that any issues within the NBFC space could potentially impact the banking sector,” Jain explains.

Credit growth has surged from a low of 5.6% in FY21 to over 16% by March 2024, significantly outstripping deposit growth. To bridge the funding gap, banks have utilised certificates of deposits, reduced surplus SLR investments, and accessed refinancing facilities from financial institutions. Despite challenges in deposit accumulation, the banking sector is in much better condition than in previous years. After experiencing negative returns in 2018 and 2019, the return on assets for banks climbed to 1.2% in the first half of FY24, as reported by the RBI. Additionally, according to a Care Edge report, non-performing assets (NPAs) have decreased from a peak of 6% in March 2018 to just 0.7% by December 2023.

Against this backdrop, Fortune India and Grant Thornton Bharat have released the 2024 rankings of Indian banks. This detailed evaluation encompasses a wide spectrum of institutions, including large, mid-sized, and emerging domestic scheduled commercial banks (SCBs), foreign banks, small finance banks (SFBs), and regional rural banks (RRBs). The analysis offers insights into growth, efficiency, asset quality, profitability, and digital engagement. Notably, this year’s study has expanded its scope to include non-bank financial institutions for the first time.

HDFC Bank continues to lead as the top large bank in the latest rankings, excelling in business growth, asset quality, efficiency, and profitability. The bank’s comprehensive strategy has consistently secured it the top position in these categories. ICICI Bank Ltd. is a close second, recognised for its robust asset quality and positive investor perception. Additionally, the jury honoured CEO Sandeep Bakhshi as Banker of the Year for his role in driving a sustained turnaround and growth at the bank during some of its most challenging times.

Among foreign banks, Citibank, which sold its retail business to Axis Bank, is sitting pretty, while among SFBs, Ujjivan Small Finance Bank took the honours, recognised for its business growth and digital engagement. The RBI recently issued a notification outlining the eligibility criteria for SFBs wishing to voluntarily transition to a universal bank structure. Based on these criteria, analysts believe that both AU Small Finance Bank and Ujjivan SFB qualify for this transition as of March 2024.

The rankings were determined through a methodology that incorporated both quantitative and qualitative parameters. Key performance indicators included business growth, asset quality, efficiency, profitability, capital adequacy, and investor perception. The data was sourced from financial reports, investor presentations, and market data covering FY22 and the first nine months of FY23. Additionally, special categories like financial inclusion and digital engagement were assessed using specific criteria tailored to those areas.

Among unlisted NBFCs, HDFC Credila Financial Services led with a score of 833, distinguished by consistent growth in revenue and loans, a low net NPA of 0.1%, and strong returns with an RoA of 2.16% and an RoE of 11.33%. However, due to RBI directives, HDFC was compelled to sell this subsidiary to a private equity fund. In the B2B NBFC segment, Indian Railway Finance Corp. excelled with a score of 858, marked by a revenue of ₹23,933 crore and a loan portfolio of ₹2,50,080 crore. It maintained no NPAs, high profitability with RoA of 1.29% and RoE of 13.94%, a low cost-to-income ratio of 2.29%, and strong capital adequacy. It was closely followed by Power Finance Corp, with a score of 662, and REC, with a score of 652, both demonstrating steady growth, good asset quality, high profitability, and robust capital adequacy.

Crisil forecasts that assets under management of non-banks will grow by 14-17% in FY25, driven by robust demand across retail loan segments. However, the rating agency anticipates this growth to be slightly lower than the 16-18% observed in FY24. This moderation is expected due to the slower growth in unsecured retail loans, influenced by the RBI’s revised risk weight norms.

CareEdge projects that credit growth will range between 14-14.5% during FY25. However, factors such as elevated interest rates and global uncertainties could negatively impact this growth. Additionally, a potential decrease in inflation could reduce demand for working capital. While deposit growth has lagged behind credit growth in FY24, it is expected to play a crucial role in FY25. Banks are likely to enhance efforts to bolster their liability franchise to prevent deposit growth from constraining credit offtake. The escalation of global geopolitical tensions and a slowdown in external demand could pose further risks to the external sector. Looking ahead, CareEdge emphasises the importance of monitoring broad-based improvements in consumption growth. Despite the Centre forecasting an overall growth rate of 8.2% for FY24, the economic outlook remains uncertain.

What remains certain is that the 2024 listing by Fortune India and Grant Thornton Bharat will continue to highlight the resilience and innovation within India’s banking sector. As the industry landscape evolves, these rankings will provide essential insights into the prevailing trends and directions of the market.