Despite increasing robustness of banks and multipurpose liquidity provided by the Reserve Bank of India, there is no perceptible improvement in credit growth. K. Srinivasa Rao proposes a new approach to credit risk management policy of banks, whereby large commercial banks utilise their skills and risk appetite to focus solely on large-size credit, and the middle-tier and smaller banks serve the remaining retail community.
The Financial Stability Report released by the RBI (Reserve Bank of India) in July 2021, indicates that banks are on a stronger footing with the capital adequacy ratio edging up by 130 basis points1 during Financial Year (FY) 2020-21, reaching 16.03%, rising from 14.7% in FY 2019-20 (RBI, 2021). Gross non-performing assets (GNPA) fell to 7.48% from 8.2% in FY 2020-21, and amidst the severe disruption caused by second wave of Covid-19, the uptick is likely to be slower than FY 2019-20. The provision coverage ratio is close to 70%, up from 65.4% recorded in FY 2019-20.
Despite increasing robustness of banks and ample multipurpose liquidity provided by the RBI under the ‘Targeted Long-Term Repo Operations’ (TLTRO), there is no perceptible improvement in credit growth so far. A recent SBI (State Bank of India) report has shown that, the non-food credit growth2 of banks has gone down to 5.56% in FY 2020-21, to a 59-year low, as against 6.14% recorded in FY 2019-20.
Even amid such fragile credit growth, the recent Coalition Greenwich3 report indicates that big banks are gaining a larger share in corporate lending. SBI, ICICI (Industrial Credit and Investment Corporation of India) Bank, and HDFC (Housing Development Finance Corporation Limited) Bank have emerged as the “2021 Greenwich Share Leaders”, while Axis Bank was the “2021 Greenwich Quality Leader”. This is a positive development as these big banks would have to do the heavy lifting of reviving the economy.
The report further observes that the market penetration of SBI and private banks in corporate banking has improved during 2015-2020. Thirty-two percent of corporate firms were provided credit by SBI in 2020, up from 30% in 2016. Private banks provide 24% credit to corporate firms in 2020, up from 17% in 2016. It is beginning of good trend that large banks with sound capital base are developing a strong risk appetite to lend to large sectors and are moulding their risk management strategies accordingly.
A notable purpose of merger of banks is also to make them big enough to improve their lending capacity. According to the Bank for International Settlement (BIS), the credit to GDP (gross domestic product) ratio in India, though marginally improved to 56% in 2020, up from 52.4% in 2019,continues to be far behind its peers, and is just half of the G20 average and second lowest in Asia. It is down from 64.8% in 2015, indicating that banks have not been able to align the pace of credit flow with the rise in GDP. I look into the reasons for this below.
Credit risk is widely distributed
Logically, large banks with better capital base and credit risk management capacity should take up large-size loans. But RBI’s ‘Basic Statistical Report - 2020’ indicates a different phenomenon. According to the size-wise distribution of borrowers, out of 272.5 million bank borrowers, only 679,034 (much less than a million) borrowers borrow Rs.10 million or more from banks. A bulk of the borrower accounts are small loans of under 10 million, and 95.7%of bank borrowers have loan limits up to Rs. 1 million. Strikingly, 77% of borrowers have loans below half a million rupees.
The policy of assuming credit risk by commercial banks, is yet to align with the size of loans. There is no obvious connect between capacity to lend assuming credit risk, to the size of loans. As a result, small and tiny borrowers with lower propensity of credit risk are taking up the bulk of the time of banks and are adding to the intermediation cost, and this may not be the best use of the competence of large banks. Moreover, an almost similar loan dispensation procedure, loaded with paperwork, is adding to the turnaround time of loan processing. Recent adoption of automated lending systems has helped de-clutter the process and improve operational efficiency but there is a long way to go in optimising time utilisation in banks. More reforms in sector-specific credit risk management policies and procedures, and linking them to the size of loans, are needed.
Universal lending system
Indian banking – working on universal banking system – has banks as large as SBI with huge credit risk appetite on one side, and small cooperative banks with low risk appetite and operating predominantly in hinterland, at the other end of the spectrum. There is no defined policy of what kind of borrowers can approach which kind of bank branch. The universal lending policy creates an ecosystem where any kind of borrower can borrow any amount from any bank branch and there is no way to encourage them to choose a ‘suitable’ bank as per their requirements in terms of loan size, and inherent risk appetite of the underlying bank. Proximity to a bank branch is the only guiding factor as of now.
A three-tier banking structure is gradually evolving with the recent spate of mergers in the banking space. Large banks with an international presence, and asset size exceeding Rs.10 trillion are operating in both the public sector and private sector. There are some banks with medium asset size such as national-level commercial banks, and there is a third rung of banks that includes regional rural banks, small-finance Banks, payment banks, cooperative banks, and cooperative credit societies that have a strong presence in the hinterland. These categories of banks are in keeping with the recommendations of the Narasimham Committee-I (1991). These banks have, over a period of time developed different capabilities in terms of credit risk appetite that can be harnessed for faster credit expansion. While small loans can be template-driven, different skill sets for credit appraisal are requirement in the case of medium and large loans. The sheer volume of the borrower base along with the large number of small loans can impact the quality of lending, and there is a need to appropriately handle bad loans in this segment. Every kind of bank catering to all loan sizes may therefore be counterproductive, when considered with their credit risk management skills and risk appetite.
Time for strategic policy response
It must, therefore, be assessed whether large commercial banks should focus only on loans above a million rupees, while the second set of banks serve the rest of the retail community. The purpose is to improve the quality of credit growth, and ensure equitable use of credit risk management skills, and risk appetite. This approach can create concomitant resources for closer post-sanction monitoring of credit to address asset quality woes in the long term. The banking system, on the cusp of transformation, can consider the idea of big banks shedding low-ticket lending to its other peers, and use the time and effort saved to concentrate on developing robust large-size credit portfolios better. This can be done by using their credit risk management skills for this purpose instead of wasting their competence in handling every size of loan that drops in their branches.
According to analysts, bank credit growth is a key indicator of economic growth and a credit-to-GDP ratio of 100% is ideal, which indicates robust demand for credit without the fear of a bubble in the making. A higher credit-to-GDP ratio indicates aggressive and active participation of the banking sector in the real economy, while a lower number indicates the need for more formal credit.
If the Indian banking system is to reach a credit-to-GDP ratio anywhere closer to its peers in Asia, a new way of thinking will be needed. Age-old lending practices cannot serve a growing economy, especially in the midst of a demographic dividend. Mining the capacity of banks by allowing them to choose the right size of lending activities aligned with their innate specialised credit-risk management capacity, in place of the present implied ‘one-size-fits-all’ approach, can be a possible solution to the sluggish credit flow.
Though it may not seem feasible given that every bank has presence in every location – metro, urban, semi-urban and rural – but to begin with, an informal agenda can be put in place so as not to load large banks in metros and urban areas with low-ticket loans, but rather allow them to take up large lending projects by pooling credit-risk management experts at these prime centres. The present arrangement of lending to all segments can continue in the semi-urban and rural branches of the same banks.
There is no point in exceptionally large banks (which figure in the top-100 global banks) in metros entertaining home loans of Rs. 1 million. Eventually, such mega banks should be used to fund large projects of Rs.10 million or more. There are a sufficient number of compatible institutions to take care of the lower segment of borrowers to fund MSME (micro, small, and medium enterprises) and other small businesses. Credit risk management policy and using of risk appetite need to be scaled up differently to support the revival of the economy. Fintech and non-banks can also use technology and collaborate with middle-order banks to provide funds in the hinterland.
Views expressed are personal.
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- In finance, basis points is a common unit of measure and refers to 1/100th of a percentage point.
- Non-food credit includes credit lent to various sectors in the economy (agriculture, industry, and services), and personal loans.
- Coalition Greenwich is a division of CRISIL (Credit Rating Information Services of India Limited).
- Financial Stability Unit (2021), ‘Financial Stability Report, Issue No. 22’, Reserve Bank of India.