Is the Indian Banking Industry Heading toward a Crisis?

In the last 2 articles, we understood about the volume of Bad Loans or NPAs that are currently outstanding in the books of our Banks as well as why or how Banksmanaged to delay this declaration so long. Now, that we know we have over 6 lakh crores in Bad Loans, the question that is probably on your mind is – Is our Indian Banking Industry heading toward a crisis?

Hopefully, this article can help you get an answer to this question.

RBI Asks Banks to Make Regulatory Provisions for NPAs

If you remember the previous article about “Why NPAs went up sharply in 2016” I had talked about Banks having to make Regulatory Provisions of 15% of the loan amount for Bad Loans.

This Provision is nothing but liquid cash the Bank has to set aside for security purposes. If a Bank has 100 crores of Bad Loans, it has to keep aside 15 crores for the same. This 15 crores cannot be used for granting new loans. Now, imagine the plight of a Bank like IOB that has about 30,000+ crores in Bad loans. That means they have to set aside 4500 crores which is a lot of money. The same goes for all banks, 100’s of 1000’s of crores has to be set aside by these banks just to meet the Regulatory requirements set forth by RBI.

You may ask me why does RBI Set such rules – Simple: “To Protect Your (Depositor) Interest”. Let me explain a bit more. We all know that banks grant loans using the deposits made by other customers. If a loan defaults, does that mean bank will not repay the deposit done by another customer? Absolutely NOT. It is our hard earned money and the Bank has No Right to refuse payment. By asking Banks to set aside 15% of their NPAs, there is a pool of money that the Bank can use in case those NPA’s become defaults. Instead of impacting customer withdrawals from Deposits, this Regulatory provision money gets used instead. Get the picture?

Do Banks have Enough Money to make these Provisions?

There have been news/rumors floating around in the past few months that the central government would have no choice but to infuse fresh capital to meet these regulatory provisions because most banks did not have enough money to set aside 15% of their NPAs. However, with this Demonetization initiative started in November, Banks have seen an overwhelming amount of money being deposited by customers. Nearly 15 lakh crores worth of cash has entered into the Indian Banking System. That is nearly 3 times as much as the NPAs in total. This should give enough room for the Banks to set aside the requisite Regulatory Provisions without actually failing to meet RBI norms.

I had already talked about this topic in the article on Detailed Impact of Demonetization and want to reiterate that this Demonetization is actually a blessing in disguise for at least the Banks in India because, without this, they would’ve been facing really tough times in 2017.

Outlook for the Indian Banking Sector for 2017 (For People Keen on Investing in Banking Stocks)

I would say that, the outlook for the Banking Sector in India as whole is somewhere between Neutral to Positive. The tough times are actually past us because the bulging NPA numbers have already been declared and thankfully Demonetization has given enough cash for banks to handle the Regulatory Provisions. The profitability of Banks may not be at par with what we have seen in the past years but it wont be bad either. With the Governments push toward a Digitized Economy, banks are expanding and reaching more parts of our country where it never ventured before. This would help increase credit growth to the double digit % range (~10-12%) and boos business numbers as well.

In terms of volumes PSU Banks would probably post impressive figures but I feel that Private Banks will continue to outperform PSU Banks primarily due to superior fundamentals.

What do you think about this article? Do sound off in the comments section.