Banking Beyond Tomorrow
Speech by Shri Shaktikanta Das, Governor,
Reserve Bank of India
Delivered at the Bank of Baroda's Annual Banking Conference in
Mumbai on July 22, 2022
I am delighted to be here among such a distinguished gathering at
the Bank of Baroda Banking Conference. I wish to compliment the Bank
of Baroda for organising this event and for having chosen 'Banking
Beyond Tomorrow' as the theme of the Conference. Given that the
banking landscape is witnessing far-reaching changes in the backdrop
of rapid innovation, disruption and evolution of new business models, I
believe this theme merits active discussion.
2. In my address today, I propose to touch upon the current
macroeconomic situation, followed by highlighting the special role
played by the banks and the new trends in the banking sector. I shall
also attempt to highlight what banking beyond tomorrow may look like
and the opportunities and challenges it may bring along.
Macroeconomic Situation - where we stand today
3. We are living in turbulent times. The continuing war in Europe and
the pandemic have rendered the global macroeconomic outlook highly
uncertain. Countries are facing unexpectedly high inflation including
food inflation, supply chain disruptions and demand-supply imbalances
in product and labour markets. Central banks are tightening monetary
policy at a rapid pace, raising fears of imminent recession. Commodity
prices have eased somewhat from their June high, but remain elevated.
Higher interest rates in the US along with increased risk aversion
among global investors have fuelled safe haven demand and
strengthening of the US Dollar. Currencies of Emerging Market
Economies (EMEs) and even of some Advanced Economies (AEs) are
depreciating vis-à-vis the US dollar. Consequently, inflationary
pressures are building up and external funding conditions are becoming
tighter, posing financial stability challenges in emerging market
economies. Overall, the global situation remains grim amidst fluid
geopolitical situation while the war and the pandemic add to the forces
of disintegration and fragmentation of the global economy.
4. In such an environment, the Indian economy remains relatively
better placed, drawing strength from its macroeconomic fundamentals.
The financial system is well-capitalised, asset quality indicators have
improved, balance sheets are stronger, and banks have returned to
profitability. We are also seeing healthy pickup in credit demand. The
external sector is well-buffered to withstand the ongoing terms of trade
shocks and the portfolio outflows. The recently released Financial
Stability Report of the RBI highlights that the Indian financial system
remains resilient and supportive of the ongoing economic revival.
Banks are well-positioned to withstand even severe stress scenarios
without falling below the minimum capital requirement. The Reserve
Bank continues to remain watchful of the headwinds and shall be
proactive in taking measures as necessary to ensure financial stability.
5. Recent developments in the forex market have generated intense
debate, including predictions of the rupee dropping to record lows as
foreign portfolio funds exit India. I would like to address the issue in a
balanced and factual manner.
6. First, it is important to recognize that spillovers from the global
monetary policy tightening, the geopolitical situation, the still elevated
commodity prices - especially crude - and the lingering effects of the
pandemic, all coming together, have become overwhelming for all
countries the world over. Even reserve currencies such as the
Japanese yen, the Euro and the British pound sterling have not been
spared. Portfolio funds are selling off assets and fleeing to safe haven.
Emerging market economies (EMEs) are particularly affected by capital
outflows, currency depreciations and reserve drawdowns, complicating
macroeconomic management in these countries.
7. Second, the impact of these overwhelming spillovers on India has
been relatively modest. In fact, the Indian rupee is holding up well
relative to both Advanced and EME peers. This is because our
underlying fundamentals are strong, resilient and intact. The recovery
is gradually strengthening. The current account deficit is modest.
Inflation is stabilizing. The financial sector is well-capitalized and sound.
The external debt to GDP ratio is declining. The foreign exchange
reserves are adequate.
8. Third, in recognition of the fact that there is a genuine shortfall of
supply of forex in the market relative to demand because of import and
debt servicing requirements and portfolio outflows, the RBI has been
supplying US dollars to the market to ensure that there is adequate
forex liquidity. After all, this is the very purpose for which we had
accumulated reserves when the capital inflows were strong. And, may
I add, you buy an umbrella to use it when it rains!
9. Fourth, a predominant part of the outstanding ECBs is effectively
hedged. Let me elaborate. According to the June 2022 Financial
Stability Report (FSR) of the RBI, of the outstanding ECBs of US $ 180
billion, 44 per cent or US $ 79 billion is unhedged. This includes about
US $ 40 billion liabilities of public sector companies - mainly in the
petroleum, railways and power sectors - which have assets with a
natural hedge character. Besides, being public sector entities, their
foreign exchange risk - if any - can be absorbed by the government.
Such a contingency is unlikely to arise. The remaining US $ 39 billion
ECB represents 22% of the total ECBs outstanding. Even this includes
borrowings of those companies which have a natural hedge, i.e.
earnings in foreign currencies. This would leave a very small portion of
the total outstanding ECBs that are truly unhedged. Corporate entities
eventually face a trade-off: if they hedge their forex exposure
completely, the cost of borrowing goes up and the advantage of
cheaper borrowing in foreign currency is lost. On the other hand, to the
extent they do not hedge, debt servicing can go up when the exchange
rate is under pressure. This has led to the concept of the optimal hedge
ratio which calculates the proportion of hedging that mimimises the
variance of the portfolio. For India, our internal research estimates the
optimal hedging ratio at 63 per cent. Taking into account natural hedges
and the exposure of public sector companies, the optimal hedge ratio
condition is comfortably satisfied in the case of the stock of ECBs in
India's external debt.
10. Due to the RBI actions, including measures to encourage inflows,
the movements of the rupee have been relatively smooth and orderly.
By eschewing sudden and volatile shifts, we have ensured that
expectations remain anchored and the forex market functions in a
stable and liquid manner. We will continue to engage with the forex
market and ensure that the rupee finds its level in line with its
fundamentals. I would like to reiterate that we have no particular level
of the rupee in mind, but we would like to ensure its orderly evolution
and we have zero tolerance for volatile and bumpy movements.
Banks are Special - Expected to be Permanent Entities
11. Banks are special and not like any other commercial entity. They
are not just the custodians of shareholders' interest but more
fundamentally the trust of the depositors. Depositors are at the very
core of the banking system. Protection of depositors' interest is
paramount to a robust, reliable and stable financial system in the
country. It is important for banks to always remember that the funds
they deploy belong to depositors and this should reflect in proper risk
management, governance and internal control systems.
12. Banks are also expected to be permanent institutions after they
obtain the regulatory licence. They are governed by sound regulatory
and supervisory practices. The bigger responsibility lies with the banks
themselves to ensure robust governance and risk management which
are integral to the functioning of a bank. Going beyond regulatory
prescriptions in terms of capital, liquidity and provisioning norms, and
even exceeding them, would be a sign of good governance and robust
risk management. This will future proof the banks and enable them to
fall back on their own balance sheet during situations of stress.
13. It needs to be emphasized that while shareholders' interest is
important in the business of banking, even more important is the
interest of depositors. Shareholders of banks should focus on long term
profitability and market valuation. This would lead investors to look at a
banking entity for the value it would generate over the medium to long-
run. This approach will usher in a new paradigm of banking and will
stand in good stead for our economy.
Preparing Banks for Tomorrow
The Changing Landscape of Banking
14. The banking sector is going through a period of churning. The
future of banking would witness a major shift in customers' choices and
preferences with enhanced expectations from the banking industry.
Each of the developments would present unique opportunities and
challenges to the existing and newer players. It has to be borne in mind
that sometimes the disruptions can be so sudden that it is impossible
to anticipate them. To me, however, it seems reasonable that 'Banking
Beyond Tomorrow' would revolve around (i) the adoption of emerging
technologies, customisation of products and services, enhanced
business and process automation; and (ii) development of suitable
business models with strong governance frameworks, better
information management, changes in the mode of working, building of
enhanced resilience capabilities and a more responsible societal and
environmental role for banks. Let me dwell upon the above in some
more detail.
Increased Digitalisation, offering personalised services and
Collaboration with Fintechs
15. The Indian banking system has undergone significant changes in
terms of market structure and competition. The increased adoption of
technology by traditional banks through self-upgradation or
collaboration with Fintechs is resonating with the idea of new-age
banking. This is leading to innovative products and services and newer
business models. In this context, it is often cited that the banks will face
competition from Fintechs which are already making their presence felt
within the financial services space. Today's customers, especially the
retail customers, expect banks to provide them quick, reliable and
personalised services. Therefore, to stay relevant, banks would need
to embrace newer and tested technologies for effective and timely
business decision making, understanding the needs of their customers
and delivering personalised services to them. Banking beyond
tomorrow would necessitate significant investment in technology and
organisational capability.
Open Banking
16. Globally, banking is becoming more 'Open' facilitated by the
availability of newer technologies and application programming
interfaces (APIs) that allow interoperability among banks as also
Fintechs. This development presents unique opportunities for
collaboration among various participants for faster and improved
delivery of products and services suited to the customer. Unlike other
developed countries, India has embraced a hybrid model where both
the regulator and the market have collaborated for the development of
Open Banking. UPI marked a watershed in the commencement of
Open Banking in India. With the success of UPI, implementation of the
account aggregator (AA) framework and the mass adoption of digital
banking services, India is witnessing an emergence of new business
models. More and more banks are opening up for collaboration with
new age service providers for facilitating customers to make better use
of their data and avail a wider and richer set of services.
User Friendly Apps, Website Navigation and Enhanced Customer
Service
17. Given the digitisation wave in the banking world and with the new
tech-savvy customers, banks must also strike a fine balance between
digital and paper based forms of communication. While the apps and
websites of banks have grown in leaps and bounds over the years,
there is still substantial scope for facilitating easy navigation for
customers. Simplifying disclosures and access to information and
innovative deployment of tools such as chatbots to help customers
navigate through the websites and mobile applications will greatly
enhance the banking experience.
Financial Inclusion
18. Financial inclusion has been pursued vigorously with steady
improvements as reflected in the Financial Inclusion Index introduced
by the Reserve Bank. Receiving digital payments such as wage
payments, government cash transfers and domestic remittances are
catalysing the financial inclusion drive. The push provided by the JAM
trinity has resulted in increased access to banking services to the
unserved and the underserved. While digital technologies are also
offering a powerful way to overcome barriers to access banking and
financial services, we also need to be sensitive to the requirements of
our people to avoid digital divide. The presence of human touch in
traditional branch banking would still be relevant for customers in many
respects. There is also a need for providing timely and seamless credit
to agriculture and MSME sectors. While the RBI is engaged in
encouraging initiatives in areas such as MSME lending through its
Regulatory Sandbox, other stakeholders such as banks and fintech
companies are also collaborating to provide digital credit delivery
mechanism in cost-effective and hassle-free manner.
Increased Use of Social Media and Information Mediums
19. Social media is an alternative platform for reaching millions of
customers. Indians, on average, spend about 2.4 hours daily on social
media1. Further, the number of social media users has been growing
steadily. The analysis of social media use has the potential to help
banks in reviewing their strategies in terms of customer segmentation,
customer acquisition and furthering financial inclusion plans. Social
media can also be used in customer grievance redress management.
Cybersecurity
20. With advancement in digital banking, cybersecurity will remain an
important challenge for all stakeholders. The increasing use of IT
systems by banks, remote working arrangements, accelerated
adoption of digital banking services by customers, along with increasing
dependence on third parties for various services would warrant
enhanced resilience capabilities to ensure business continuity. This
would include building strong defences against cyber-attacks and
malicious attempts at disrupting, disabling or destroying a computing
infrastructure or stealing confidential information and data. Banks
would need to undertake constant upskilling of personnel. Continuous
knowledge acquisition and staying ahead of the curve would become
even more crucial.
Comprehensive and Strategic Approach to Climate-Related Risks
21. Climate-related risks will be a focus area in times to come. Such
risks will impact the business models of banks. The increased
requirements of funding businesses and industry for tackling climate
change would be greatly influenced by the global move on climate
related risk management. Various stakeholders already consider
environmental, social and governance (ESG) as an important aspect
while making investment decisions. Banks are also increasingly
aligning their businesses, including assessment of financing assets,
with the global climate sustainability agenda. The need for banks would
be to develop appropriate business strategies and strengthen the
governance framework to gauge the associated risks. In line with
international best practices, a forward-looking, comprehensive and
strategic approach would be required to address climate risks.
Concluding Observations
22. Going ahead, the world of banking is expected to be more
collaborative as well as competitive, with newer players offering
innovative financial products. Banks need to prepare themselves for
facing the dynamic environment, while keeping their focus on
appropriate business models, sustainability, stability, and consumer
centrality. More importantly, good governance remains fundamental to
success and should not be compromised. Due care needs to be taken
to protect the stakeholders from digital frauds, data breaches and
cybercrimes. At the end of the day, banking is a service, and enhanced
customer protection and experience should be given the primacy it
deserves. From the regulator's perspective, the Reserve Bank is fully
committed to build an enabling environment for accommodating the
new disruptive innovations in a sustainable manner, while preserving
financial stability. History suggests that when technology, market
participants and regulators join hands, revolutionary innovation and
growth would follow. I hope our banks of tomorrow make it come true.
Thank You.
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