As 2009 draws to a close, I looked back at some of my writings to revisit the recurring images of the year and find a common theme. There have been too many references to “recession” (for most part of the world) and “economic slowdown” (for India) in the first few months and different shapes of economic recovery (U,V,L,W) in the second half. The other oft-repeated phrases are “liquidity overhang”, the Reserve Bank of India’s “loose money policy” in the first three quarters of the year and “exit policy” in the last quarter, the government’s “stimulus package” and an “unprecedented global credit crunch” in the wake of the “collapse of the US investment bank Lehman Brothers Holdings Inc.”. They are the recurring images, but it’s not easy to find the theme for the year.
One senior banker told me it’s a year of exploitation of consumers—both retail as well as corporate, particularly small and medium enterprises, or SMEs—as banks refused to lower loan rates even though their cost of money declined drastically. Another banker went one step ahead and said 2009 rang the death knell for retail banking in India. He has reasons to back his observation. ICICI Bank Ltd, India’s largest private sector lender, is shrinking its retail balance sheet and Citibank NA has closed 338 of the 450 branches run by its arm CitiFinancial Consumer Finance India Ltd. Many consumers have seen their limits for credit cards drastically cut and banks are piling up non-performing loans as many consumer loans, not backed by any collateral, are going bad.
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But I would not agree with either of them. Banks’ exploitation of consumers is not a new phenomenon. They are always obsessed with a fat net interest margin, or NIM—the difference between the rate at which they lend and the expenses they incur to raise money—that ensures profitability. Retail banking in India is not dead and will continue to thrive as the opportunities are enormous. For instance, the mortgage market is just about 7% of the country’s gross domestic product, or GDP.
Then, what has been the dominant theme of 2009? Low growth in bank loans, the lowest in the past 12 years. Till the first week of December, the year-on-year credit growth has been 10.5%, sharply down from 26.4% in the previous year. Since the beginning of the current fiscal, the credit growth has been 5.2% against 11.9% in the first eight months of fiscal 2009. Low credit growth signifies that companies are finding ways to raise money from other sources. Technically, this is called credit substitution. This is the beginning of a new theme in Indian banking that will dominate the next decade. This has already happened in the developed markets. It will intensify in India and put more pressure on banks once the corporate bond market is developed.
There are many academic reasons behind the low credit growth, including bankers’ reluctance to lend money for fear of piling bad assets and companies going slow in raising loans for projects because of uncertainties surrounding the prospects for economic growth. A sharp decline in credit to petroleum and fertilizer companies has also contributed to the low credit growth. In fiscal 2009, oil prices rose sharply because of tight supply-demand conditions, geopolitical tensions and weakening of the dollar against major currencies. As the prices at which Indian oil marketing companies sell petrol and diesel are regulated, any rise in crude prices leads to huge under-recoveries and weak cash flows for oil marketing firms, forcing them to borrow heavily to meet their working capital requirements. With the drop in crude prices and substantial improvement in the cash flow of these firms, they no longer need money from banks. Also, there has been a sharp drop in the working capital needs of manufacturing firms. Commodity prices have come down and this has brought down the inventory valuation. Many firms have scaled down inventories by efficient inventory management and as a result of this their working capital need has gone down sharply.
But the main reason behind the low credit offtake is opening of other avenues for funds. The equity market and the qualified institutional buyers, or QIBs, have started substituting banks. Since April, there have been 20 public floats raising close to Rs19,400 crore. Indian firms also raised Rs33,781 crore through placements with QIBs. Besides, around Rs73,400 crore has been raised overseas through external commercial loans and foreign currency convertible bonds. Collectively, through these routes, Indian firms have raised about Rs1.27 trillion in the first three quarters of fiscal 2010. During this time, the credit flow from the banking system has been Rs1.44 trillion. As more companies are expected to raise more money through these routes next year, corporate dependence on the banking system will decline further. By one estimate, about Rs40,000 crore will be raised from the equity market and Rs1 trillion through placement with QIBs.
What should banks do to draw borrowers back to their doors? They will have to change their business model by lowering the price of loans, tap new consumers—both retail and SMEs—and focus more on advisory and fee income.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as Mint’s deputy managing editor in Mumbai. Comment at firstname.lastname@example.org