India Banks April 2023

India’s banks are poised for growth on the back of healthier balance sheets, robust regulations and strong credit demand.

First-quarter global financial market narratives were dominated by bank failures, which reignited worries about a financial crisis in the US and Europe. In just a few weeks, there were four bank failures in the US, including Credit Suisse’s demise and UBS’s subsequent takeover.

While the crisis has been mitigated to a large extent with swift responses from the authorities, the current turmoil should be seen as a stress in the banking sector due to rising interest rates and lack of stringent credit policies. That said, the interest rate hike cycle continues, and hence, global banking institutions will have to be watched closely for any further, particularly the smaller banks.

However, the US and European banking systems are better capitalised and less leveraged than they were before the global financial crisis, and hence the possibilities of a larger systemic risk in the global financial markets remains low.

A balancing act

Even so, the Fed has a challenging task ahead of it. The Fed will have to prudently balance the objectives of price stability on the one hand, and financial stability on the other.

Raising interest rates too aggressively raises the spectre of high financial stress. In this situation, smaller banks will continue to remain susceptible to risks of a blowout. But slowing the pace of rate increases could also keep inflation at elevated levels.

On the positive side, the US Fed raised rates by just 25 basis points at its last policy meet, which has given emerging market some hopes that rate hikes will not be as aggressive in the coming months.

Another positive, the ongoing banking stress will curtail credit growth in the US. US banks are also expected to tighten lending standards in order to protect capital and create liquidity buffers. The will result in demand being squeezed which can support the Fed’s efforts to lower inflation.

Robust capital shields

In India, the banking sector is stable and financially healthy. The current challenges in the global economy notwithstanding, Indian banks have been have a far stronger and well-capitalised balance, and more resilient balance sheets.

Indian banks have, in fact, withstood several crisis over the past few years starting with the global financial crisis 2008, the taper tantrum of 2013, demonetisation of 2016, the covid-19 pandemic and its subsequent loan moratorium as the authorities have proactively managed these crises with timely regulations, demonstrating their commitment to maintaining a stable banking system.

The gross NPA ratio for the scheduled commercial banks (SCBs) stood 4.41 per cent at end December 2022, down from 5.8 per cent as on March 31, 2022 and 7.3 per cent as on March 31, 2021.

The CRAR at 16.1 per cent at end December 2022 is also much above the minimum regulatory requirement. Macro stress tests for credit risk indicate that SCBs would be able to comply with the minimum capital requirements even under severe stress scenarios, according to the RBI.

In fact, in a recent address on Future-Proofing the Indian Financial System, the RBI Governor said that the Reserve Bank has also put in place various prudential regulatory frameworks. These include capital adequacy requirements, asset classification and provisioning requirements, dividend distribution framework and liquidity management framework. In addition, the Reserve Bank also periodically deploys macro-prudential measures to address system level build-up of risks.

Growing credit demand

As a consequence of the measures taken by both the Reserve Bank and the banks themselves, the Indian banking system has remained resilient and has not been affected adversely by the recent sparks of financial instability seen in some advanced economies. Banks also have sufficient capital and liquidity buffers.

Demand for bank credit in India has been robust at about 15%. While demand for credit has improved from the retail credit market, there are also indications of a revival in the investment cycle as corporate demand for loans has been showing a rising trend.

That places Indian banks in an advantageous position. In fact, the Indian financial sector remains far more resilient than the global banks on account of a strong growth in the domestic consumption story. The RBI’s conservative stance since the last financial has been instrumental in keeping very high levels of financial health in the banking system.

Outpacing the market

Not surprisingly, the banking sector has demonstrated remarkable outperformance. Over the past year, the Bank Nifty, an index of leading banks, has surged by 25.2%, significantly outpacing the Nifty50 index, which increased by 12%.

India’s banking sector is poised to continue its growth trajectory in the coming years. The economy has been witnessing a strong credit demand in sectors such as infrastructure, manufacturing, and services. Consumption trends in India continue to remain positive.

Digital lending and fintech have revolutionised the banking sector in India, streamlining processes and making financial services more accessible. Innovative technologies have enabled banks to automate loan approvals, reduce turnaround times, and lower operational costs. As a result, customers benefit from a seamless experience, while financial institutions can reach underserved populations and expand their market presence.

That said, a solid deposit base, well-balanced asset-liability management, superior asset quality, sufficient capital, stringent regulations, and digitisation form the core strengths of the Indian banking sector. With all the foundations in place, India’s banks are on the cusp of an exciting new era of growth and expansion, will remain the key catalyst for economic expansion.

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