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India’s banks are no longer the financiers of the economy with capital markets and fintech firms grabbing all the attention.

The banks had a 34% share in the flow of funds to the economy in FY21 and the signs for FY22 are not also encouraging so far.

Bank credit flow during April to August has been negative, according to data from the Reserve Bank of India (RBI). This is despite some big private sector lenders such as HDFC Bank Ltd and ICICI Bank Ltd reporting double-digit year-on-year loan growth for the first quarter.

Several banks have also indicated a revival in loan offtake since the restrictions imposed to contain the second wave of coronavirus cases were lifted.

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On the whole, however, corporate loan growth is in the dumps.

“While there is a lot of discussion on the need for a capital expenditure-led demand recovery for loan growth for lenders, we are less certain of it," analysts at Kotak Institutional Equities wrote in a note.

In contrast, companies have raised a total of 1.8 trillion from the bond market, according to data from the Securities and Exchange Board of India (Sebi). Fundraising from the equity market has aggregated to nearly 1 trillion by August. Foreign direct investment has been growing every month and external commercial borrowings have stayed strong. The upshot is that the share of non-bank resources will remain high even in the current financial year.

That is not all. Non-bank financial companies seem to have bounced back from the collapse of Infrastructure Leasing and Financial Services Ltd (IL&FS) two years ago. The pandemic has been far easier to tackle than the funding crunch that followed the IL&FS collapse.

New-age fintech companies have joined hands with non-bank financial companies and are giving banks a run for their money on the retail front. Kotak analysts expect loan growth to be driven by retail, but banks may find it tough with increased competition here. Some banks are trying to tackle this by joining hands with fintech companies.

What are the implications of a shrinking banking sector?

The overall fund flow into the economy grew by 10% in FY21 despite the pandemic. The much-needed recovery in economic growth will continue as long as funds flow unhampered to industry. The massive and persistent surplus liquidity has ensured the flow of funds at a cheaper rate. Therefore, the economic revival has not stalled.

That said, the mix of resources has changed. Incremental bank lending shrank 1.6% in FY21, while non-bank sources grew 30%. At a time when cost control is a leading theme among companies, their borrowings have shifted to cheaper options.

For banks to bounce back, not only would they need to fix their capital needs but also leap ahead on the technology front. Partnerships with fintech companies are one way to go about this.

That said, the banking sector has a long battle ahead with multiple players in its bid to get a greater share of a growing economy.

One, public sector lenders will need to repair their capital. Two, banks in general will need to leap ahead with regard to technology when it comes to luring retail customers.

Banking and fintech partnerships are conducive as the former holds the licence to get public deposits, while the latter has the trump card of digital convenience.

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