Deepak Mohanty: Perspectives on banking in India
Speech by Mr Deepak Mohanty, Executive Director of the Reserve Bank of India, at the
5th Indian Chamber of Commerce (ICC) Banking Summit, Kolkata, 18 May 2013.
* * *
The assistance provided by Rekha Misra and Pallavi Chavan in preparation of the speech is acknowledged.
I thank Shri Rajiv Mundhra, President Indian Chamber of Commerce (ICC) and Shri Rajeev
Singh, Director General ICC for the opportunity to be a part of this distinguished panel. The
ICC is making an important contribution to the development of banking by bringing together
the experience and expertise from the banking industry, corporate sector and financial
regulators through its banking summits year after year. In this year's Summit too, I see a
judicious mix of expertise from the relevant areas to deliberate on the Indian banking.
The decade of the 2000s was eventful for the Indian economy. We saw acceleration in GDP
growth: with India recording its highest average annual output growth of 8.7 per cent during
the period 2004-08. This was accompanied by a sharp increase in savings and investment.
At the same time, we had to contend with the fallout of the global financial crisis, the adverse
impact of which has been persisting. Economic growth has slowed down over the last two
years and inflation remained above the tolerable level, though there has been significant
moderation in the first month of the current financial year, 2013-14. These developments
have had an impact on banking.
Against this economic background, I examine the performance of the Indian banking sector
over the last 12 years as finance is inexorably linked with economic progress. I will then
touch upon financial inclusion, with a particular reference to the eastern-region, as it is a
major plank of the Reserve Bank's current policy thrust. I will conclude with some thoughts
on challenges for the banking sector in the way forward.
Finance and growth
Economic literature establishes a positive association between financial development and
growth. In the 1960s and 1970s, the pioneering work by Raymond Goldsmith, Mckinnon and
Shaw underlined the importance of financial liberalisation to step up savings and investments
in an economy, and thereby economic growth.1 More recent studies, carrying forward the
earlier work have reinforced our understanding of the ways in which finance could exercise a
positive influence on economic growth across time and across countries.2 Even the recent
global financial crisis, the causes of which are complex as they are, does not negate the view
that financial development commensurate with the requirements of the real economy is
essential for sustained economic growth.3 This is particularly important for a developing
economy like ours where the reach of the formal financial sector is still inadequate. Let me
now turn to banking in India.
Ours is a bank dominated financial sector: commercial banks account for over 60 per cent of
the total assets of the financial system comprising banks, insurance companies, non-banking
financial companies, cooperatives, mutual funds and other smaller financial entities.4 Banking
expansion as reflected in the growth of total assets of banks was rapid till the intensification
of the global financial crisis which affected the Indian economy through trade, finance and
confidence channels. Bank assets as a percentage of gross domestic product (GDP) rose
from 60 per cent in 2000-01 to 93 per cent by 2008-09, but there after it has plateaued.
Bank credit to GDP ratio more than doubled from 24 per cent to 53 per cent during this
period but has remained around that level in the following years (Chart 1).
The growth of the banking sector was influenced by the performance of the economy,
reflected in a co-movement between the growth in banking business and real GDP growth
(Chart 2). It is noteworthy that the period up to 2007-08 was also a period of fiscal
consolidation, with combined fiscal deficit of the centre and the states falling from over 9 per
cent of GDP in early 2000s to 4 per cent by 2007-08 (Chart 3). The consequent reduction in
government borrowing requirement opened up the space for expansion of credit to the
commercial sector in a non-inflationary manner.
While the financial expansion has slowed down in the post-crisis period, the Indian banking
sector has shown remarkable resilience and stability. During the global financial crisis, the
timely recourse to counter-cyclical prudential and monetary policy measures helped the
banking sector in transiting through this challenging period largely unscathed.
Most of the indicators of soundness bear out the stability of the Indian banking sector. The
capital to risk-weighted assets ratio (CRAR) at the aggregate and bank group-levels have
remained above the statutory minimum requirement of 9 per cent and international norm of
minimum 8 per cent since 2001 (Chart 4).
There was a steady improvement in the asset quality through the 2000s. For instance the
gross non-performing assets (NPAs) as per cent of gross advances had declined from
12.0 per cent in 2000-01 to 2.4 per cent in 2007-08. Thereafter it has increased to 3.7 per
cent by December 2012, first with higher NPAs in foreign and private sector banks and more
recently in public sector banks (Chart 5).
While Indian banks compare well with many other advanced and emerging economies
including BRICS in terms of NPA and CRAR, there is considerable scope for improvement
(Table 1).
Banking efficiency
It has been a key objective of financial sector reforms to improve the efficiency and
profitability of the banking sector. In this regard, the interest rate structure has been fully
deregulated. The statutory pre-emptions of bank resources through statutory liquidity ratio
(SLR) and cash reserve ratio (CRR) have been substantially reduced. Banks' access to
central bank liquidity through export credit refinance, marginal standing facility (MSF) and
liquidity adjustment facility (LAF) has been enhanced. Furthermore, branch licensing norms
have been relaxed and prudential norms have been strengthened. In addition, banks have
increasingly adopted technology and accorded greater focus to human resource
management. These changes have helped improve efficiency as borne out by various
indicators.
The profitability of the Indian banking sector has been maintained at about 1.0 per cent in
terms of Return on Assets (RoA), even in the post-crisis period. The banks have also shown
significant improvement in other efficiency indicators such as cost to income ratio, business
per employee and business per branch. However, net interest margin (NIM) has gone up
indicating deterioration in allocative efficiency (Table 2). Let me now turn to financial
inclusion with a particular reference to the eastern-region.
Financial inclusion
In order to sustain a higher economic growth, it is important to bring the excluded segment of
the society into the fold of the formal financial sector. In recognition of this, the Reserve Bank
has taken a number of steps to take formal banking to door steps of habitations with
population over 2000 through the business correspondent (BC) model where the BCs
provide basic banking functions acting as agents of banks. Simultaneously, a number of
initiatives such as incentivisation of branch authorisation scheme for banks to open branches
in unbanked centres, simplification of Know Your Customer (KYC) norms, technological
interventions and financial literacy-oriented programmes to increase awareness have been
taken. While the initial impact of these initiatives has been positive, it has created a huge
potential for expansion in banking business once the level of activity is scaled up and
government social benefit transfers increasingly take place through the banking sector.
While we have our own data source to gauge financial inclusion, the Census of India
provides useful information on access to banking. It shows that about 59 per cent of
households had access to banking services in 2011 as compared with only 35 per cent in
2001. Increase in access for the eastern-region has also gone up significantly from about
29 per cent in 2001 to 47 per cent in 2011, though the region still lags behind the all-India
average (Table 3).
In 2001, the all-India average population per bank branch was 15,600, which has fallen
steadily to 12,500 by 2012 again suggesting an increased penetration of the branch network.
For the eastern-region population per branch has declined from 19,500 in 2001 to 17,300 in
2012. While the eastern region has witnessed an increase in banking outreach since 2001,
its average has remained lower than the all-India average underlining considerable scope for
expansion.
Conclusion
Let me conclude with some thoughts on the challenges ahead.
First, weakening asset quality is an immediate concern for the banking sector. This is more
so as the banks' credit composition in the recent years has changed towards longer term
assets such as infrastructure and housing. While improvement in macroeconomic policy
environment and expected revival in economic growth should help mitigate risks to some
extent, banks would have to make concerted efforts to improve asset quality.
Second, while on many efficiency parameters, Indian banks compare favourably to their
global peers, the net interest margin (NIM) remains relatively high. The banks need to further
enhance their productivity so that the intermediation cost between depositors and borrowers
is minimised. This, coupled with containment of NPAs, will help improve monetary
transmission.
Third, as the Indian economy reverts to its high growth path, the demand for credit will go up.
The consequent expansion of the banking sector will require more capital. Additionally, as
the Basel III norms are made applicable, the capital requirements would increase further.
The preliminary assessment by the Reserve Bank made in June 2012 showed a comfortable
position of Indian banks at the aggregate level to meet the higher capital norms. As per the
broad estimates from the Reserve Bank, public sector banks would require a common equity
of Rs1.4-1.5 trillion in addition to Rs 2.65-2.75 trillion as non-equity capital to meet the full
Basel III norms by 2018. Banks, therefore, need to design appropriate strategies for meeting
these capital norms.
Fourth, a key factor that accentuated the global financial crisis was excessive leverage.
While the Indian banking system is currently moderately leveraged, according to the
guidelines issued by the Reserve Bank, banks should strive to maintain a minimum Tier I
leverage ratio of 4.5 per cent pending the final proposal of the Basel Committee. It would be
prudent for banks not to dilute their leverage position in the interim period5.
Fifth, there are proposals for expansion of the banking sector with new entrants. The
Reserve Bank has already invited applications for new banks. Further, as indicated in the
annual policy statement of May 2013, the Reserve Bank is preparing a policy discussion
paper on banking structure in India which would be placed in the public domain. The
expansion of the banking sector commensurate with the growth of the economy would not
only enhance competition but also facilitate financial inclusion.
With these remarks, I wish the conference all success.
Thank you.
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