The year 2019 was an eventful one for the banking and financial services sector. We saw measures to revive credit growth and shore up bank balance sheets, i.e. capital infusion, relaxation of leverage ratio norms, reduction of policy rates, and the announcement of consolidation of ten Public Sector Banks (PSBs). And the sector did see key positive developments. Five banks were able to exit the Prompt Corrective Action (PCA) framework in 2019; only four banks now remain from the original eleven. The year also saw improvement in asset performance; aggregate gross non-performing assets (GNPAs) fell to 9.3% in September 2019 from a high of 11.18% in March 2018, as total stressed assets fell by ~10% to INR 9.34 trillion from INR 10.36 trillion over the same period.
We also saw measures aimed at addressing stress for faced by Non-Banking Finance Companies (NBFCs). These included a one-time partial credit guarantee scheme allowing PSBs to purchase high-rated pooled assets from NBFCs and Housing Finance Companies (HFCs), introduction of liquidity coverage ratio requirements for NBFCs for better liquidity management, empowering Reserve Bank of India to replace directors of non-government NBFCs or supersede their boards, and returning the regulatory authority over HFCs from the National Housing Bank (NHB) to the RBI.
Despite these measures, overall bank credit growth is expected to slow down to less than 10% in FY20 (down from 13.3% in FY19); this decline is largely on account of lackluster corporate lending. If corporates and small and medium enterprises (SMEs) come under macro-economic pressure, this is bound to have an impact on retail credit growth, unless headroom for retail credit penetration is feasible to realize in the near term. As things stand, retail credit growth fell marginally, i.e. to 15.32% in June 2019 from 18% in June 2018. This was even though retail loan accounts per 100 adults improved by 26% on y-o-y basis 11, indicating a higher growth in smaller ticket retail credit.
What is heartening though is that total deposits in the banking sector grew by 10% y-o-y in September 2019 with an improved aggregate CASA ratio (demand and savings deposits / total deposits) of 41%11, improving cost of funds for the sector. The overall credit to deposits ratio remained stable at ~75%, and the overall capital adequacy ratio improved to ~15% in September 2019 from 13.40% as on March 201811.
Sector outlook - 2020
While aggregate GNPA for banks improved in 2019, the worst may not be over yet. As per latest RBI Financial Stability Report 4, aggregate GNPA may increase to 9.9% by September 2020 because of changing macroeconomic scenario and sluggish credit growth in 2020. This GNPA increase is expected for not just PSBs but also private sector banks (PVBs) and foreign banks (FBs). In summary, while the sector somewhat recovered in 2019, subdued credit growth is expected to continue effecting affecting the financial health and topline of Banks (as well as NBFCs) banks and NBFCs in 2020.
With this overall outlook, let’s look at what to expect in 2020, and therefore what to focus on:
Overall sector theme – radical cost efficiency via productivity
As the sector grapples with sluggish credit growth in 2020, and as toplines come under pressure, banks and NBFCs will need to focus more on cost efficiency. This will need to be radical (not just incremental). The existing cost to income ratio of banks ranges from ~40% to ~60% across PSBs, PVBs, FBs and small finance banks (SFBs) . If ever there was a case to radically reset the ideal cost to income (C/I) ratio for banks and NBFCs, it is now. For instance, banks can aim to reduce their C/I ratio by as much as 10% in the near to medium term. Banks have been looking at ways to reduce cost to acquire/serve and achieve higher productivity/ economies of scale through collaboration, and automation. This will need much greater intent in 2020 (this should be more about productivity, and less about cost take-out). A radically reduced C/I ratio can, more than ever before, mean the difference between greater competitiveness versus gradual decline in market share.
Corporate banking businesses are now looking to catch up with their retail counterparts, and invest in automation i.e. from front-end (relationship management) to back-office processes. Areas such as trade finance, and foreign exchange are ripe for radical automation. Automation and analytics can help develop sector-specific solutions and increase wallet share from existing customers.
Retail lending (banks and NBFCs)
Four key factors are likely to require banks and NBFCs to refine their retail lending journeys in 2020, i.e. (i) RBI’s ban on use of direct selling agents (DSAs) for document verification, (ii) its blessing for video KYC (know your customer), (iii) the expected institutionalization of API-based electronic data sharing by account aggregators, and (iv) banking transactions increasingly originating and being fulfilled in non-banking channels (e-commerce, travel, other sites).
Retail mutual fund investments grew at a significant rate over the past five years, higher than the rate of shift from physical to financial assets, which suggests that some part of their growth came at the expense of other financial assets such as insurance. This has a direct impact on bancassurance and associated banks’ earnings; banks’ will need to respond to this trend with intent in 2020.
The author is Partner, Deloitte India.