India’s macro-economic performance over the last few years has been positive with visible effort to strengthen the fundamentals of the economy. However, despite a growth of over 7% per annum in last three years, investment cycle has not yet seen a turnaround.
This remains the biggest challenge for India as it has severe implications on job creation. Other handicaps facing the nation include, (1) significantly low non-food credit off-take for the last few years; (2) stressed assets that are affecting banking sector’s health and ability to lend; and (3) high debt and low capacity utilisation adding to strains on the private sector.
All these issues require an equal attention to bring about an effective solution.
There is a pressing need to restore banking sector’s health both to augment investment and boost credit growth. Several steps have been taken to bring about structural reforms in the banking sector: the amendment of Banking Regulation Act and Insolvency and Bankruptcy Code that have set the overall framework for resolving the issue of stressed assets. These measures have been supplemented by the recent re-capitalisation to the tune of INR 2.11 lakh crore for public sector banks. Apart from speeding up the NPA resolution process and supporting the clean-up of balance sheets, bank re-capitalisation should spur revival in credit growth – especially to the MSME sector.
In addition to these efforts, the government and the Reserve Bank should consider other mechanisms for strengthening capital base and improving internal operations of the banking sector. These include:
1. Bring down government stake in public sector banks
To further enable banks to shore up capital, the government should consider bringing down its stake in public sector banks. This will allow banks to raise adequate capital from the market and help in reducing the fiscal burden from re-capitalisation. Government can in fact look at having 26% share as a floor and bring in the concept of golden share to exercise control over critical decisions.
2. Leverage technology and data
Strengthening capital adequacy of banks cannot alone solve the problem. There is a need for structural transformation and banks must put in place a robust mechanism to bring about internal reforms. Banks should reimagine their operating models through holistic transformation and leverage technology and data to improve efficiency, reduce costs and reposition the business for growth. Improving in-house credit appraisal and project monitoring capacity should be taken up on priority. Integrating data with key business processes also assumes importance as banks can leverage these data to make sound credit assessments using intelligent algorithms.
3. Develop robust bond market / Set up Development Finance Institutions
Another key issue weighing heavily on banking sector is the asset-liability mismatch that runs deep. Since large part of the infrastructure finance in India is dependent on banks, they have huge accumulation of long term assets many of which have come under stress. This in turn has implications on the ability of banks to transmit any easing of policy rates into lower lending rates. Government should thus look at innovative and alternative solutions to ease down the pressure of long-term financing on commercial banks. One way is to develop a robust bond market. Simultaneously, the Government should consider setting up of Development Finance Institutions (DFIs) to cater to the long-term funding requirements for sectors such as infrastructure. This would facilitate progression to a more mature and deeper financial sector and ease up the pressure of long maturity loan assets on books of commercial banks, in turn, moderating their asset-liability mismatch.
These measures above, will help address the supply side of investments issue. Addressing the demand side issues is equally important and there are two key concerns that require swift action to propel industry’s demand for long-term credit.
Reduce policy and lending rates by 100bps
Average capacity utilisation in Industry remains low, highlighting a need to push demand for domestic goods to scale up production to optimal levels and encourage expansion. Cost of finance has also been one of the biggest concerns for industry impacting their investment decisions. It has been observed that real interest rates in India continue to remain high. As per FICCI’s latest Business Confidence Survey, average lending rate by banks as reported by firms currently stands at 12%. This is a dampener not only for large corporates but also for MSMEs. A cut of at least 100 basis points in policy and lending rates is desired to propel demand for auto, consumer goods, housing sector as well as to encourage new investments by industry.
Bridge the trust deficit
Restoring business confidence and trust should be another priority. At present, there is a trust deficit between the industry, bankers, regulators and government and these need to be bridged. Bank funding has shrunk partly because the diminishing risk appetite of banks. While there is a definite need to take firm action with willful defaulters, there is also a need to distinguish between failure and fraud. There is a need to recognise that failure is integral to entrepreneurship.
Enhanced capital investment will be the key driver for sustaining India’s high growth. We are confident that banks will play an active role in supporting this investment recovery.
The author wishes to thank Anshuman Khanna & Pragati Srivastava for their inputs and writing this piece.