S S Mundra: Setting the priorities right
Keynote address by Mr S S Mundra, Deputy Governor of the Reserve Bank of India, at the
3rd SBI Banking and Economics Conclave, Mumbai, 28 September 2016.
* * *
Assistance provided by Shri Sanjeev Prakash is gratefully acknowledged.
At the outset, I would like to thank Ms. Bhattacharya and State Bank of India for inviting me
to speak at this important and eagerly awaited event on the annual calendar. It is a privilege
to speak before this august gathering.
In context of the theme of the conference i.e. "Laying the Foundations for India's Growth", I
would say that there are reasons to be optimistic on several fronts: Growth, inflation,
demography, entrepreneurship, democracy, political stability, innovation and establishment's
commitment. There are many eminent speakers & practitioners with better insights and
qualification who will speak on some of these issues. However, it is always helpful to also
assess possible constraints. The idea is that collective wisdom should be applied to find the
most optimal solution. With this objective, I intend to raise few questions for further
deliberations during the conference and beyond. For a change however, I would refrain from
much spoken area of stressed assets.
(A) Economics of banking
Since the Conclave is meant for both Bankers and Economists, let me begin with something
to engage the Economists.
- Credit is a necessary & probably most important ingredient for economic growth.
- Is there a measurable co-relation between credit growth and GDP growth?
I have been trying to seek answer to this question for some time now. Few explanations
which I came across are:
- The historical average credit multiplier to nominal GDP over FY01-14 is 1.6 x
(Source: CEIC, DB Research)
- Another model projects credit growth on the basis of GDP growth and inflation as
per following equation:
Credit = 2.36*GDP+ 0.36*CPI or Credit =1.93*GDP + 0.83*WPI
(Source: ICICI Bank Research)
A long run actual relationship between real GDP Growth and bank credit growth is depicted
below (Chart 1):
Chart 1
Real GDP growth1 and credit growth
Probably, the link between bank credit and GDP has weakened over the years as banks
started accommodating companies through other sources like CPs, bonds, etc. and other
non-bank entities also enhanced their share. But still "Banks" remain the main source of
finance for the economy. Perhaps the co-relation is more relevant between the banks' total
accommodation to companies and real GDP rather than only credit & GDP.
However, the composition of credit to the economy itself has been changing as depicted
below (Table 1). While Credit from banking system has gone up by 19.22% between March
14 and March 16, the credit from the non-bank system during the same period has gone up
by 37.4%.
Table 1
Total credit deployed - banks and non-banks
Then, do we see any co-relation with the total credit supply rather than bank credit alone?
(Yes/ No/ May be)
Added complications
- Trade credit plays an important role but not captured in a similar way as other
components
- Double count in respect of NBFCs/HFCs
- Migration from GDP to GVA may make it more difficult to analyse past trends and
establish new benchmarks at least in initial few years
A more stable multiplier of real GDP and bank credit may emerge in the medium term once:
- banks come out of the stressed assets worries and have more risk appetite
- private investment sentiment improves on a sustainable basis (creating higher
demand for project finance) and,
- inflation falls on a durable basis giving rise to lower lending rates
Obviously, an efficient credit supply strategy would be handicapped in absence of reasonably
accurate demand estimation. I urge the economists present here to work towards
possibilities of modeling such a co-relation.
(B) Supply side of credit
Broadly accepted estimations place credit growth need in the range of 12 to 15% to support
the projected growth in the intermediate term.
Questions to ponder over:
- Resources to support credit growth while being mindful of Asset- Liability
mismatches
- Capital needed- Quantum & Composition (CET1/Tier I/Tier II)
- Economic priority of the segment needing credit vis-à-vis bankers' inclination to
follow that priority
i) Resources
Gross domestic savings (Table 2) and trend in growth in bank deposits (Table 3) are
depicted below:
Table 2
Gross savings
Key observations:
- Decline in Household savings
- Stagnant net financial savings
- Household indebtedness increasing
Table 3
Growth rate of bank deposits
Key observations:
- Rate of growth of bank deposits has slowed down considerably especially in PSBs.
- In short run, any gap in deposit growth can be funded by leveraging excess SLR,
however, financial savings need to strengthen in the medium to long term
- ALM trend: A gradual increase in institutional saving is also probably contributing to
shrinking liability duration while the assets duration is expanding due to long term
funding by banks.
ii) Capital requirements
Table 4
Capital adequacy of banks
Overall capital position in the banking systems appears adequate at present; however, few
banks could be near the minimum prescribed threshold levels going forward. This is on
account of many moving components as under:
- Supporting RWA Growth for normal growth
- Provisioning Requirements (as explained below)
- Basel Framework (CCB, D-SIBs etc.) - As per agreed framework
- Large Exposure Norms- Guidelines issued recently
- Enhanced Market Risk -Credit enhancements to corporate bonds and increased
derivatives portfolio would entail higher market risk capital charge
- Higher Operational Risk - Recent episodes of KYC/AML violation, Cyber/FinTech
related security incidents have heightened operational risk for banks
- Pension Funding- Gaps could still be there
- IFRS - Fair value treatment would potentially enhance capital requirements for
banks
Provisioning requirements
Substandard, Doubtful and Loss advances constitute nearly 36%, 59% and 5% respectively
of the stock of non-performing assets (Rs. 611 thousand crore) of the banking system as on
March 2016. Though, I won't like to hazard a guess about the provisioning numbers due to
the dynamic nature, nevertheless due to ageing of non-performing assets and migration of a
certain percentage of standard assets to NPA category, the system as a whole could be
looking at significantly higher incremental provisioning requirements in coming year. Though
a better recovery and up-gradation in existing NPAs can support through provision reversal,
the expected provision would still be significant. This is against a Total Earning before
Provision and taxes of Rs. 2,46,067 for the sector as at the end of March 16. Incidentally,
there is considerable divergence between the earnings of different bank groups as can be
seen from the Table 5 below:
Table 5
Earning before provisions & taxes
Other potential factors with a bearing on capital requirement:
- Sovereign Risk Exposure (Risk Weight on Sovereign Bonds)
This is a very live issue with standard setting bodies. Even if a low 2% and 5% Risk Weight
respectively on the bank holdings of Central and State Government securities is assumed,
the banking system may be required to hold around Rs. 6000 crore of capital on this count
alone.
While we are resisting the proposals during negotiations, the state governments have to
be extremely cautious as any irresponsible act on their part could have repercussions
both for our arguments and also for instruments that can be treated as eligible under
LCR framework.
- Climate Change Protocol
Discussion in the international forum is veering towards penalizing industries which add to
carbon emissions and banks may be forced to hold additional capital for loans to such
industries on account of increased risk weights.
Key takeaways:
- Every bank should estimate its own requirement of capital under different scenarios
including past average trend of slippages, recovery and up-gradation.
- They should carefully weigh optimum mode of raising capital and the extent to which
it can be raised.
- This should enable them to better design their business strategy and in setting the
risk appetite.
- I am not sure if this exercise is being done with full elaboration & scenario building
as part of the present ICAAP exercise.
(C) National priorities
a) Infrastructure
12th Five Year Plan (2012-17) projected an investment of Rs 55.74 lakh crore in
infrastructure with banks expected to meet 23% of this requirement. Though, there is still
some time to go before the end of the plan period, apparently, the investment target as well
as bank credit may fall short of the projection.
Assuming the current pace of credit growth & that the banks continue to meet 23% of the
infrastructure funding needs of the country between 2016 and 2020, they may be required to
lend between 17 and 26% of their total incremental bank credit to the sector. This raises few
issues:
i. Who can avail the infra credit going forward? Till recently, a handful of promoter
groups have captured the infrastructure sector and majority of them seem to be
"retired hurt".
ii. Even if new players were to come, whether the banks are equipped (both by way of
resources and capital) and willing to lend them within the existing models.
iii. Whether external flow can support major part of the infrastructure funding
requirements and if yes, whether the necessary enablers are in place.
b) Agriculture
As per the 2011 Agriculture Census,
•
- 60 per cent of the population depends on agriculture
- sector provides employment to 55 per cent of the work force
- contribution of agriculture to the national GDP is around 17%
- No. of farmers holding marginally sized land has increased substantially from
about 36 million in 1970-71 to 93 million in 2010-11 highlighting the continuous
fragmentation of lands which discourage mechanization, lower labour
productivity and increase costs.
• 35% of the agricultural households having less than 1 acre of land, another 35%
holding between 1 and 2.5 acres, and only 30% households with land more than 2.5
acres.
• 80% borrowing of large farmers (>10 hectares) is from institutional sources,
however, only 15% of the landless farmers receive finance from formal sources
• The land under agriculture has been practically constant at around 140 mn hectare
over past 4 decades with less than 50% being irrigated
Table 6
Agriculture loan outstanding
• While credit flow to agriculture sector has increased over the years, the long term
credit in agriculture or investment credit has shown a declining trend. With no
additional factors contributing to enhance the credit absorption capacity of this
sector, there is a need to take a look at how incremental credit is being put to use.
Few other issues in the farm sector worth noting:
• New generation is not similarly interested in farming and is inclined to migrate to
cities.
• Though many efforts are underway in form of improvement of rural road
infrastructure, e-connectivity, direct benefit transfers, provision of power
connectivity, water-bodies for irrigation, agriculture insurance etc. only the
incremental measures may not be sufficient to improve the state of agriculture in the
country.
• Attempts must be made to target the entire agriculture value chain financing
rather than on a solo level.
• Further, the PSBs need to take a hard look at their approach for posting their staff in
rural areas. Currently, there is a very high turnover in the staff in rural branches
which hampers a focused approach.
c) MSME
• 12th Five Year Plan (2012-17) highlighted a credit gap of 56 per cent in the MSME
(micro, small and medium enterprises) finance sector in India. In absolute terms, this
translates to approximately Rs. 16 trillion which is roughly 25 % of the total bank
credit.
• Outstanding credit to the MSE sector of all scheduled commercial banks as on
March 31, 2016 has shown a declining trend.
• RBI, in co-ordination with the Government of India and other stake holders has
initiated several measures to enhance flow of credit to the sector.
• Banks need to employ smart technology and innovative credit scoring to meet the
credit needs to especially the micro and small segment a large % of which are
outside the formal financial system.
• In the process, however, the banks must guard against creating over indebtedness
in the sector.
(D) Human Resources
Finance alone cannot ensure growth. Banking is still far away from being a driverless
car, hence human factor is crucial.
(i) Public Sector Banks
- More than 73% staff in DGM/GM cadre is above 55 years of age, while
another 23% are between 50 and 55 years.
• Reasonable leadership tenure is crucial.
Pipeline to replace the Top executives is also weak and may get better only after a
•
few years.
(ii) Private Sector Banks are witnessing very high rates of attrition at lower levels
hence low customer connect and acute performance pressure may result in
misselling. This area also needs urgent attention of the Top Management.
(E) Concluding thoughts:
• Cyber Risk/Frauds/Mis-selling/ Market misconduct have the potential to bring down
a financial institution as recent events have shown.
• Banks need to do 'value accretive' and 'value based' financing
I would like to end with a Chinese proverb which says, "The best time to plant a tree was
20 years ago and the second best time is now." The sector would do well not to miss
planting trees at the second best time.
Thank you!