PremiumWhen it comes to system- level changes which happen over a period of time, an old French cliché is often quoted: Plus ça change, plus c’est la même chose (the more things change, the more they remain the same).
One sector that this cliché doesn’t really apply to is Indian banking. Over the last decade, commercial banking in India has changed big time. From being a major lender to industry, banks are now a major financier of housing loans, vehicle loans, credit cards, personal loans and so on. From public sector banks carrying out a major part of lending to the country, to private banks gradually taking over. These and other changes have made the Indian banking sector very different from what it was 10 years back.
In this piece we look at these changes and how the situation is likely to evolve in the years to come.
Industry versus retail
Commercial banks in India broadly carry out four different kinds of lending: agricultural, industrial, services and retail. In the years gone by, a bulk of the lending by these banks was to industry. This has changed.
Take a look at Chart 1. It plots the industrial loans and retail loans given by banks as a proportion of non-food credit. Banks lend to Food Corporation of India and other state procurement agencies in order to help them buy rice and wheat, primarily, directly from the farmers. These loans are referred to as food credit. When these loans are subtracted from the total loans given by banks at any point of time, what is left is non-food credit.
What does Chart I tell us? Between 2007 and 2014, the banks gave more and more loans to industry. In fact, loans to industry as a proportion of non-food credit peaked at 46.1% in February 2013. From mid 2014 onwards, the lending to industry started to slow down and retail lending started to go up. Retail lending refers to the housing loans, vehicle loans, personal loans, consumer durables loans, education loans, etc., given by the banks.
Interestingly, only in March 2021 did retail lending cross loans to industry for the first time. Nonetheless, over the next three months, April to June 2021, the total industrial lending was higher than retail lending. The situation changed again from July 2021 onwards and since then retail lending has remained higher than lending to industry on a consistent basis. Hence, 2021-22, the last fiscal, was the first time when retail lending became higher than lending to industry.
In fact, as of March 2022 when the latest data was available, lending to industry by commercial banks was at 26.8% of non-food credit whereas retail lending was at 28.5%. Retail lending is now well and truly ahead.
How did this happen?
The years 2004 to 2013 were the go-go years of Indian banking. The Indian economy had grown by more than 9% in each of the years from 2005-06 to 2007-08 (as per the old GDP series), something that had never happened before (and hasn’t happened since). India was deemed to be the next China. Corporates were jumping in to set up big infrastructure projects—everything from power plants to steel plants—and bankers were falling over one another to give out loans to industrialists.
As former RBI Governor Raghuram Rajan said in a note to the Parliamentary Estimates Committee on Bank NPAs in 2018: “One promoter told me about how he was pursued then by banks waving checkbooks, asking him to name the amount he wanted."
Such was the prevailing zeitgeist that in many cases due-diligence went out of the window. Crony capitalism also seeped in. Further, banks hadn’t bargained on the infrastructure projects they had lent to getting stalled. The delays came from a lack of environmental clearances, a lack of non-environmental clearances, problems with acquiring land, roadblock on policy issues, as well as the inability of the promoters to bring in their fair share of capital into the project.
Basically, many projects which banks financed did not take off. When projects did not take off, there was no cash flow and without cash flow, there was no way a loan could be repaid.
In this scenario, the bad loans of banks started to go up, as can be seen from Chart 2. Bad loans are largely loans which haven’t been repaid for a period of 90 days or more.
From 2011 to 2014, the banks helped promoters to not default on the loans by giving them fresh loans. But these games couldn’t last forever and from 2015 onwards, the banks were forced to recognise their bad loans as bad loans.
As can be seen from Chart 2, as of March 2018, the bad loans peaked at ₹10.4 trillion or 11.2% of the advances given by banks (referred to as the bad loans rate).
In this scenario, the banks were reluctant to lend more to industries. At the same time, many companies were not in a position to borrow given that they were heavily leveraged. Further, the Reserve Bank of India (RBI) placed many public sector banks under the prompt corrective action framework, to allow them to heal and thus limited their ability to lend.
All this ensured that banks preferred retail lending to industrial lending. In 2014, the total retail lending by commercial banks was at around 18-19% of the non-food credit. This kept increasing and currently stands at 28.5%.
Meanwhile, the bad loans of banks have come down over the years and as of December 2021, the latest data available, stood at ₹7.7 trillion or around 6.4% of the total advances. This happened primarily on account of bad loans being written off after four years, the recurrent recapitalization of public sector banks by the government, the recovery of a few bad loans, and the banks being put through the prompt corrective action (PCA) framework by the RBI.
Now, since the balance sheets of banks have been gradually healing and corporates are less leveraged than they were in the past, bank lending to industry has started to pick up again.
Housing loans
The rise of retail loans has been driven by the rise of housing loans given by banks. Take a look at chart 3, which plots housing loans as a proportion of non-food credit.
Chart 3 shows that housing loans as a proportion of overall bank lending has gone up over the years. It was at less than 10% of non-food credit through 2012 and 2013. It started rising from around mid 2014 onwards, at a time lending to industry was slowing down. Housing loans crossed 13% in late 2017 and has largely stayed there since.
This tells us two things. First, the lack of lending to industry was made up for, to some extent, by giving out housing loans. Second, the fact that housing loans as a proportion of overall non-food credit has stayed flat for more than four years now tells us that the residential real estate sector hasn’t been doing well.
Other than banks, housing finance companies also give out housing loans. A look at the data for the last decade suggests that banks give out close to two-thirds of housing loans.
Privatization of banking
The accumulated bad loans made the situation worse for public sector banks, limiting their operations and their ability to compete. This gave an opportunity to private banks, particularly new generation private sector banks, to grow their share of the overall bank lending in India. Take a look at Chart 4, which plots the share of loans given out by public sector banks and private banks at different points of time over the years.
The share of lending of public sector banks peaked in March 2010 at 75.1%. It stayed in the range of 73-75% between then and early 2014, when the share started to fall. As of December 2021, the latest data available, it stood at 55.2%. The share of private banks during the same period has gone up from 17.4% to 36.5%.
What this means is that incrementally private banks are giving out more loans than public sector banks. Between the end of 2016 and the end of 2021, the outstanding loans of public sector banks have gone up by ₹14.4 trillion whereas the outstanding loans of private banks has gone up by ₹22.8 trillion, which is almost three-fifths more.
A similar trend can be seen even when it comes to deposits. Take a look at Chart 5 which plots the share of public sector banks and private banks in deposits.
The share of private banks in deposits hasn’t risen at the same fast pace as loans. This tells us that many individuals and corporates still prefer to deal with public sector banks when it comes to deposits, given their government backing.
In the last five years, the outstanding deposits of public sector banks have risen by ₹22.4 trillion whereas that of private banks have risen by ₹26.9 trillion, which is around a fifth more.
Hence, of the ₹26.9 trillion of deposits raised by private banks, they have managed to lend ₹22.8 trillion or around 85%. When it comes to public sector banks, of the ₹22.4 trillion of deposits raised over the last five years, they have managed to lend ₹14.4 trillion or around 64%. This clearly shows how public sector banks have been losing market share and privatization by stealth is quietly on.
How does the future look?
Data from the Centre for Monitoring Indian Economy suggests that in 2021-22, new projects worth ₹14.3 trillion were announced. This was around 40% lower than new projects announced in 2014-15 and 47% lower than new projects announced in 2008-09. These are absolute numbers which do not take inflation into account or for that matter the rise in size of the Indian economy. A major reason for this fall lies in the weak capacity utilization of the existing infrastructure to make things.
In this scenario, banks will get fewer opportunities to give out industrial loans. Also, what does not help is the fact that corporates now have more ways to finance their projects. Further, the rise of intangible intensive firms will make things more difficult for banks to give out industrial loans.
As Jonathan Haskel and Stian Westlake write in Restarting the Future—How to Fix the Intangible Economy: “Once upon a time, firms invested mostly in physical capital: machines, buildings, vehicles, computers." Banks could lend against these tangible physical assets. If the borrower defaulted, the bank could take charge of the assets, sell them and try and recover their loan.
But this becomes difficult with intangible intensive firms. As Haskel and Westlake write: “Today… most business investment goes to things you can’t touch: research and development, branding, organisational development, and software." This is true for most start-ups and unicorns operating in India. How does a bank lend against their assets or their cash burn for that matter?
Economists refer to this situation as the tyranny of the capital. How do banks overcome a situation like this?
Also, many unicorns in India are in the fintech space. These firms are looking to break the conventional banking business model of having a physical presence through branches and personal visits to raise deposits, carry out lending and offer wealth management services.
To conclude, the business model of banks has changed over the last decade. The more things change, the more they will change and not remain the same.
Vivek Kaul is the author of Bad Money.
