Factors that contributed to the stability of India’s banking sector

Source: The post factors that contributed to the stability of India’s banking sector has been created, based on the article “Banking sector continues to confound” published in “Business standard” on 12th July 2024

UPSC Syllabus Topic: GS Paper3 -Indian Economy -Indian Economy and issues relating to mobilization of resources.

Context: The article discusses the strong performance of India’s banking sector in 2023-24, as detailed in the Financial Stability Report (FSR) of June 2024. Despite past challenges and predictions of decline, banks maintained good health, showed improved profits, and effectively managed risks, contributing to economic stability and growth.

For detailed information on RBI’s Financial Stability Report read this article here

How has the banking sector performed recently?

1. Reduction in NPAs: The Non-Performing Assets (NPA) ratio declined sharply from 8.5% at the beginning of the pandemic in 2020-21 to 3.9% by 2022-23, showing effective management of bad loans during and after the pandemic.
2. Stability in Net Interest Margin (NIM): Despite predictions of a squeeze, the Net Interest Margin remained stable with a minor decrease of only 1 basis point, maintaining at 3.6% in 2023-24 compared to 3.7% previously.
3. Growth in High-Yielding Retail Products: Banks experienced strong growth in high-yielding retail products like credit cards and personal loans, which grew 7 to 14 percentage points faster than the overall loan growth rate of 15.4% in 2022-23 and 16.3% in 2023-24.
4. Increase in Return on Assets: The overall return on assets for banks increased from 1.1% to 1.3%, supported by factors such as higher loan growth rates, lower provisions, increased trading income, and higher fee income.
5. Financial Health of Public Sector Banks (PSBs): PSBs showed a return on assets of 0.9%, which is close to the international benchmark of 1%, indicating strong internal capital generation and less reliance on governmental support.

What factors have contributed to the stability of the banking sector?

1. Effective Regulatory Measures: The Reserve Bank of India (RBI) implemented various restructuring schemes and innovative regulatory measures during the pandemic. These helped maintain stability and navigate crises, contributing to a significant reduction in NPAs from 8.5% to 3.9% by 2022-23.
2. High-Yielding Retail Product Growth: Banks focused on growing high-yield retail products such as credit cards, personal loans, loans against property, and auto loans.
3. Improved Risk Management: Enhanced risk management at the bank level and better leadership selection through the Financial Services Institutions Bureau helped improve operational stability and reduce vulnerabilities.

What about the privatization of Public Sector Banks (PSBs)?

1. Delay in Privatization Plans: Privatization of PSBs has been consistently postponed, despite being announced in several budgets over the past years. The ongoing process for IDBI Bank, initiated in 2018, has yet to be completed.
2. Improved Financial Health Reduces Privatization Pressure: With the return on assets for PSBs reaching 0.9%, close to the international benchmark of 1%, PSBs have demonstrated the ability to generate sufficient capital through internal surpluses and market sources. This financial independence reduces their dependency on government capital injections, consequently diminishing the urgency for privatization.

What is the outlook for the future of India’s banking sector?

1. Sustained Credit Growth: The Financial Stability Report (FSR) forecasts credit growth of 16-18% for the banking sector, indicating strong future lending activity without harming asset quality.
2. Economic Growth Correlation: The Indian economy is set to grow at around 6.5% over the long term. This economic growth is supportive of and supported by the banking sector, reinforcing its stability and expansion potential.
3. Challenges in Deposit Competition: The decline in net financial savings to 5.3% of GDP from a higher average in previous years and notes the decreasing share of deposits in gross financial savings. This indicates ongoing competition for deposits in the banking sector.
4. Continued Focus on Retail Loans: The FSR expresses caution regarding the reliance on retail loans, especially given the high household debt relative to GDP per capita. However, the past performance and the growth in high-yielding retail products suggest that banks will continue to focus on this area.

Question for practice:

Examine how the reduction in Non-Performing Assets (NPAs) has contributed to the stability and performance of India’s banking sector in 2023-24.