The Future of India’s Banking Sector
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Increasing privatization and digitization are the two themes that will drive India’s banking sector over the next several years.
In its current annual budget, the government specifically mentioned privatizing two public sector banks and set aside 20,000 crore (1 crore = 10 million rupees), or approximately $2.6 billion, for their capitalization. Determining which two banks these will be is underway, and the NITI Aayog, a government think tank, will play a role in the selection process.
In the last two years, the number of government-owned banks has been brought down from 12. The process started in April 2017 when six of these banks — five associate banks and the Bhartiya Mahila Bank for women — were merged into the State Bank of India. The upcoming privatizations, therefore, will come from the remaining private sector undertaking (PSU) banks: Bank of Maharashtra, Indian Overseas Bank, Punjab & Sind Bank, UCO Bank, Central Bank of India, and the State Bank of India. The latter two have a national presence and are relatively large; the other four are all regional players and smaller.
Despite assurances that employee wages and benefits will be protected, there is some resistance from labor unions regarding the privatizations, and a two-day strike already has occurred. Still, there is broad consensus that the moves are worthy and that reforming the banking sector is central to modernizing the Indian economy.
But privatization isn’t the only reform necessary. Among the government-owned banks that will remain, there is a crying need for operational autonomy and governance improvements, including the appointment of full-time directors. These PSU banks should become board-driven and regulated by the Reserve Bank of India, which has been recommending these changes along with the Indian Banks’ Association (IBA).
One area where reform is likely involves PSU banks’ bad loans. An IBA proposal that is being considered would transfer all of the 50 or so troubled loan accounts above 500 crore to a national asset reconstruction company. Lenders would have to agree to the transfer, but it is in their interest to do so since, for potential buyers of the troubled loans, dealing with just one holder would be easier and encourage a resolution to the problem.
On the digitization front, India is doing really well. It has many financial technology companies in the payment space and in the distribution of financial services products. One successful innovation has been the Unified Payments Interface, or UPI, developed by the National Payments Corporation of India. Regulated by India’s central bank, it’s an instant real-time payment system allowing mobile users to transfer funds between banks.
At all banks, digital is becoming core to all banking services as well as the lending business. Currently, for example, 67% of transactions at the State Bank of India are conducted through digital channels. Collaboration among banks and fintech companies is sure to produce even more innovation in the next few years as advances are made in artificial intelligence, machine learning, and data analytics.
As far as non-banking financial companies, or NBFCs, are concerned, the future is also bright, despite the effects of the pandemic and some of the problems that have shaken the sector. The way forward for them probably will involve greater collaboration with the main commercial banks.
One area of cooperation could be lending, where the strengths of the banks and those of the NBFCs complement one another. The relationships that NBFCs have with their end customers are much stronger than those of the commercial banks, especially those of public sector banks. This is because human resource policies in the bank sector encourage frequent transfers, resulting in personnel who are posted to bank branches not having sufficient time to develop deep knowledge of local conditions. The NBFCs have that local knowledge, which is especially valuable in underwriting.
While NBFCs face some of the same challenges as the banks, namely the need to digitize and improve their governance, as well as greater regulation, their advantages in the form of greater local market knowledge will continue to serve them well.
About Rajnish Kumar
Rajnish Kumar was Chairman of the State Bank of India from October 2017 to October 2020.
This India’s banking industry article is adapted from the March 23, 2021, GLG Remote Roundtable “Banking on the Future: India’s reformation.”