Recovery Mechanism: Biggest Challenge Of Rural Banking - P Jayarama Bhat, MD & CEO, Karnataka Bank

In an uncertain economy with forces are acting against the financial system, maximisation of shareholders value is a serious management concern, says P Jayarama Bhat, MD & CEO, Karnataka Bank

How will the entry of new banking players change the banking landscape in India?

The banking industry in India has a huge canvas of history, which covers the traditional banking practices from the British era to the reforms period, nationalisation and privatisation of banks and now the increasing number of banks that operate in India. Banking in India has been through a long journey. The general banking scenario has become very dynamic these days. New players in the sector will generate huge employment opportunities, along with improving efficiency and increasing capital base to meet the credit needs of the economy. Developing countries like India still have a huge number of people who do not have access to banking services due to their scattered and fragmented locations. India is an underpenetrated market and we thus believe that the new banks too have enough space and scope to grow without posing a major threat to the existing ones.

From the time the last banking license was granted, the new private banks have still not been able to gain meaningful ground (individually their market share is nearly one per cent). Indeed, the new banks will make many more customers bankable, which even the existing banks can tap. We do not expect the new banks to acquire the existing small regional private banks as the RBI may not allow that initially. The RBI wants to increase the universe of banking and does not intend the consolidation of existing banks. We believe that the new banks may not act as major game-changers initially as is expected, but in the long run, they will lead to financial penetration. However, these banks will add to the Human Resource woes of the existing players, as the poaching of experienced and trained managerial personnel may increase.

What is your take on allowing a hike in Foreign Direct Investment (FDI) in the banking sector?

Although FDI is a non-debt inflow that will directly solve the problem of capital base of Indian banks, there are several reasons why such a move is fraught with dangers. When domestic or foreign investors have a large shareholding in any bank, they exercise proportionate voting rights. It is expected to create potential problems not only of elusive concentration in the banking sector, but can also expose the economy to more intensive financial crisis at the slightest hint of panic. At the same time, FDI in banking assures better capitalisation, technology transfers, information sharing, training programmes and other forms of technical assistance, effective risk management techniques and financial stability in the sector.

As far as PSU banks are concerned, it will not be of much use initially, as FII/FDI interest in these banks is very low at the moment and this is reflected in their holdings, which is much below the regulatory cap of 20 per cent, leaving enough room for more inflow. Private banks are already having a higher FDI limit of 74 per cent subject to the RBI approval, which we believe will not be increased further.
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Are Indian banks adhering to the prudential risk management norms followed globally? What are the steps we need to take to strengthen our risk management?

We believe that a large part of the focus in Indian banks is on credit risk management. The global financial crisis has dramatically changed the perceptions of risk function, giving it unprecedented power over the lines of business. The main challenge is to balance growth aspirations and compliance requirements, including risk management.

The enthusiasm for a large-scale overhaul of risk management in the banking industry has created a human capital shortage as banks scramble to acquire suitable expertise. Data and information management systems remain significant impediments to an overall understanding of risk exposures.

Going ahead, investment in risk management is increasing almost across the board, with risk processes, data, information systems and training being key areas of focus for majority of the institutions. Aligning risk management practices with that of global standards will be a major focus area.

How do you see the interest rate scenario panning out in FY14?

We expect rate cuts to be gradual or they even might not occur in the next three quarters if the rupee continues to depreciate or oil prices go up, thus increasing the risk of higher inflation. Considering the latest actions by the central bank to attract investments in the debt segments and to discourage speculative positions in forex by controlling liquidity and increasing the interest rates, a policy rate hike can also be completely ruled out. The interest rate scenario is looking hawkish in the short to medium term. In the long term also, the risks of reversal in the accommodative monetary policy stance adopted by other nations might put pressure on the domestic markets. By and large, for regulators, it will continue to be a tough task to balance growth and inflation.

What corrective measures can be adopted to reduce non-performing assets (NPAs) for banks?

A healthy banking system is essential for any economy striving to achieve growth and stability in a competitive global business environment.

The present credit processing system has a few flaws. Beginning from sourcing, many a times the availability of collaterals and the relationship with the prospective borrower takes precedence over cash flows. The processing system tends to ignore industry related issues, present stage of growth cycle and leveraging within specific sectors. Also, economic downturn and CDR packages sometimes prompt companies to default on their financial commitments.

Like the CIBIL database for retail lending, banks should have similarly active databases for corporate loans. Further, they need to strengthen preventive management steps like early warning systems, which should be sensitive to signals from financial, operational, management, and banking on credit deterioration. Grading of the bank’s risk assets is an important internal control tool. It serves the need of the management to identify and monitor potential risks of a loan asset.
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Banks should also strategise curative measures such as onetime settlement schemes, lok adalats, Debt Recovery Tribunals, Securitisation, SARFAESI Act and sale to asset reconstruction companies designed to maximise recoveries so that banks’ funds locked up in NPAs are released for recycling.

In a situation of liquidity overhang and the enthusiasm of the banking system to increase lending, may compromise on asset quality, raising concerns about their adverse selection and potential danger of addition to the stock of NPAs. It is necessary that the banking system is to be equipped with prudential norms to minimise if not completely avoid the problem of NPAs even in adverse market conditions. It also necessitates organisational restructuring, improvement in managerial efficiency and skills up-gradation for proper assessment of credit worthiness, so as to mitigate NPA risk.

Going ahead, which sector do you think would put pressure on asset quality? How is your bank handling the demand in these sectors?

The infrastructure sector, including power and road/port projects, poses maximum risk in terms of asset quality even though the concentration of lending is less in this sectors as compared to that in agriculture, service and industrial sectors. There is hardly any demand in this sector for new projects and it is also under huge burden due to delays, cost overruns and higher moratorium period on realisations.

Our bank is presently concentrating on Micro, Small and Medium Enterprises (MSME) and other mid-sector companies for their financial needs. Our focus has never been on wholesale funding and such we have kept ourselves insulated from some of the over-heated sectors in the past and continue to do so. However, we target handsome growth on the asset side, by identifying sectors which are on a growth trajectory such as fertilisers, agriculture auxiliary units, rural housing and consumer loans, professional loans, midsize traders etc.

As a banking sector player, what are the opportunities and challenges that you foresee going ahead?

Banks, despite a strong presence in rural areas, have not been successful on asset growth in these areas. They typically focus on agricultural loans, but not on other auxiliary business opportunities such as tractor lines, competing with Non-Banking Financial Companies (NBFCs). We believe that rural areas are bustling with cash flows and banks have big opportunities to tap these cash flows. With the basic technology adoption being complete in banks, there is a need to move from a transaction processing system to an information processing system. Banks will now have to make use of this infrastructure and leverage it in areas like Management Information Systems (MIS), overall risk management, financial inclusion, customer relationship management (CRM) etc. They need to augment their innovation capabilities in terms of new products, services and strategies, human resources, technological advancements and operational efficiency, which would enable them to maximise gains. Challenges lie ahead in terms of margins (pricing power, rising cost of funds), rising salary cost and asset quality (NPAs/restructuring), lack of talent at various critical operational areas and meeting stringent BASEL III capital adequacy norms.

In addition to the above, the proposed new CSR requirement calls for innovative approaches and initiatives in responding to the various social requirements.
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Do you believe that there still is an unlocked potential in the rural sector? What are the specific challenges in these areas?

Yes there is a lot of unlocked potential in the rural sector. Development in rural infrastructure, supplemented with development of employment that harnesses resident skills and assets in rural areas is imperative to rural prosperity and good business opportunity for financial institutions. There is resurgence in rural India. Penetration of formal finance in rural areas should start from supporting rain harvesting methods to warehousing of the produces, for realising the real potential in agriculture and other auxiliary businesses. The biggest challenge in rural areas is the recovery mechanism, which is a big reason for higher NPAs.

Due to the lack of infrastructure in rural areas, proper manpower with commitment and dedication to work is not forthcoming. Thrust is also required to empower rural youth by proper education and skills and entrust responsibilities in line with the business correspondents. Further, the financial inclusion agenda needs to be broad-based with effective leveraging of technology.

What kind of potential do you see in the online banking business?

This line of banking business potential is unlimited. The internet has changed the way consumers do business. In the present day, individuals have the opportunity to purchase products, acquire services and conduct transactions from their computers. Businesses have the opportunity to track cash flows on real time and do cost effective transactions. Online banking is increasing in popularity due to the convenience it offers to consumers and small businesses. Further, innovative introduction in the form of analytics using historical data, futuristic cash flow analysis, automated fund forecasting tools, scenario-based planning, cost measurement and management, cash management and optimisation and balance and transaction alerts, will make this method popular among corporates too. Although banking online has many advantages, the nature of information shared through the web also gives rise to potentially dangerous risks.

Many banks have created unique digital banking teams to cater to the online banking business and tackle the risks arising from this technology. Increasingly, footfall in branches is falling, raising the question on the size of branch premises, as customers seldom visit branches. They prefer to transact online in urban as well as semi-urban areas as mobile penetration has been significant.

What is your outlook on loan book growth for FY14? Which are the sectors that will spearhead this growth?

We believe that loan book growth of the banking industry could be around 13-14 per cent. Our bank has projected growth of over 25 per cent for this financial year and we are quite optimistic of achieving the same. We believe that rural and retail will be the key growth sectors for this financial year as we have a strong presence in semi-urban and rural areas too. A good monsoon has also been instrumental in turning the agricultural sector’s growth trajectory into positive one. However, macro level issues in the domestic and international economies will put some pressure on the performance of the existing corporate units and availability of funds for capex expansions.

Finally, what are your thoughts on value creation for shareholders?

In an uncertain economy with forces are acting against the financial system, maximisation of shareholders’ value is a serious management concern. Dramatic changes need dramatic actions. In order to increase shareholder value, banks need to adapt their business models to the changing environment. Banking business in the Indian context has got social responsibilities along with other objectives, by which it has not been able to create meaningful value for shareholders in the recent past.

Incrementally, banks should focus on risk-adjusted return for individual product portfolios to improve profitability at the overall bank level. It is also important for banks to focus on value drivers from an operational and strategic angle; the objective being to permeate the bank with a strategy that is centered on shareholder value creation and overall socio-economic responsibilities, both in terms of decision making and resource allocation.