Banks are gaining traction and becoming increasingly robust and resilient, but we need to be cautious
Recently, the strong framework and resilience of the Indian banking system came on the radar after a series of reports expressing concerns and apprehensions about banks' exposure to a particular business house came into question after the Hindenburg report.
The banking regulator, the Reserve Bank of India, quickly intervened and stated that the size and resilience of the Indian banking system are too large and strong to be affected by an individual incident. The regulator issued a statement, saying that the banking sector remains stable and that the various parameters of banks relating to capital adequacy, asset quality, liquidity, provision coverage, and profitability are healthy.
RBI Governor Shaktikant Das also said that the banks lend to a company on the basis of its fundamentals and not on its market capitalisation.
Limited exposure
The country’s largest lender, the State Bank of India, said that its total outstanding exposure to the Adani Group is Rs 27,000 crore, which is 0.9 per cent of its total loan book size of Rs 31.33 lakh crore. Axis Bank’s exposure was 0.94 per cent as of December 2022. Another state-run lender, Punjab National Bank, has an exposure of Rs 7,000-odd crore. So, the exposure is not significant across all the banks and non-banking financial companies (NBFCs).
Most recently, Bank of Baroda chief executive Sanjiv Chadha said that the bank is willing to consider lending additional money to the Adani group, and its exposure is about a quarter of what is permitted under the Reserve Bank of India framework.
What is the exposure limit? A bank can lend up to 20 per cent of its net worth or Tier-1 capital to an individual entity and 25 per cent to a group. This is in accordance with the global norms. Earlier, it was a bit higher, and for the infrastructure sector, there were special norms entitling them to a higher limit. The current exposure limits also include connected lending. For instance, if an automaker buys parts from a supplier to the extent of more than half of what the supplier produces, a bank’s exposure to the automaker is combined with that of the auto parts supplier.
The 250-year-old modern Indian banking system has weathered many storms. The credit portfolio of the banking system is over Rs 130 trillion rupees. So, the exposure of the Indian banks to the group is less than even 0.5 per cent and hence insignificant by any standard. But the story does not end here. During the last 75 years, Indian banks have embarked on a rather tumultuous path. There have been occasions when leading banks have faced liquidity crises.
Following the Lehman Brothers meltdown and the subsequent asset quality deterioration crisis seven to eight years ago, the prompt corrective action (PCA) framework led to the huge capitalisation of public sector banks (PSBs). During the last five-seven years, PSBs have been adequately recapitalised. The memories are fresh in mind.
Bold policy initiatives
The last five or seven years saw some bold policy initiatives on the part of the Government:
1. The enactment of strong recovery laws, the insolvency and bankruptcy code (IBC), and the setting up of the National Company Law Tribunal (NCLT) and the Insolvency and Bankruptcy Board of India (IBBI), all in 2016
2. Massive amalgamation of PSBs in 2017-18 and in 2019-20. This has resulted in reducing the number of PSBs from 27 six years ago to 12 now.
3. Policy relating to the setting up of the National Assets Reconstruction Company Limited (NARCL), the India Debt Resolution Company Limited (IDRCL), and the National Bank for Financing Infrastructure and Development (NAB-FID)
Budget 2021-22 has also envisaged the privatisation of a couple of PSBs.
All these measures and a massive recapitalisation of PSBs to the extent of about Rs 5 trillion during the period of reference have had a positive bearing on the functioning of the banking sector in general and PSBs in particular. Notwithstanding the pandemic and geopolitical woes, the banking sector has been consistently delivering better numbers in each successive quarter and financial year during the last three years. As of the end of December 2022, the net profit of PSBs was approximately Rs 95,000 crore and their net NPA was 1.37 per cent, one of their best performances in the last decade.
Does that mean we need not be concerned about the recent developments in the capital market post-Hindenburg? The answer is perhaps "no." The fallout from the Harshad Mehta-led crisis in the early 1990s or the Lehman Brothers-related issues 15 years ago cost the industry dearly in terms of results and reputation. Banks, in general, should move away from high-risk infrastructure finance for the simple reason that the assets at their disposal, although huge, are of short to medium-term maturity.
Corporations will do well to mobilise their initial funding requirements through the bond and/or equity routes. They may also take recourse to external commercial borrowings. For that, we need to develop a bond market. The present size of our bond market is Rs 40 trillion, which is less than one third of scheduled commercial banks' outstanding credit. The Indian companies’ outstanding debt overseas is to the tune of approximately $12 trillion at the current exchange rate.
Globally, for infrastructure projects, the setup and construction risk is borne by the bond market. Banks do extend their helping hands, but at a later stage when there is cash flow, be that in the form of working capital and/or for ancillary works. The deterioration of asset quality in 2015 was largely on account of the huge exposure Indian banks had to infrastructure and real assets.
Need to shift focus
Banks will do well to focus on retail, agriculture, and micro, small and medium enterprises or MSMEs. We do need infrastructure—more roads, railways, ports, and airports—to become a $5-trillion developed economy at the earliest, but our corporations should mobilise their initial requirements more through the bond, equity, and external routes. Banks will be there to meet their working capital needs at a later stage.
Some individual banks in India have failed in the past, but the regulator and the Government have always come to the rescue of the depositors. We could withstand the partition of banks at the time of Independence, the subprime crisis in the West, the asset quality crisis, and the pandemic and geopolitical crises. Banks are gaining traction and becoming increasingly robust and resilient. The saga will continue, but we need to be cautious and focus on core sectors.
(The author is a senior advisor with the Indian Bankers Association. Views expressed are personal)