Indian Banking: On The Cusp Of Change

The Growth

The banking sector has seen unprecedented growth in the last decade. Consider this; at the end of March 2002 deposits at Indian scheduled commercial banks stood at Rs 1131187 crore. Compare this to the total deposits as of March 2002, which stood at Rs 6453700 crore. Over a period of 10 years, deposits have grown by 5.7x.

At the same time, bank offices have increased from 66208 in March 2002 to 101261 in March 2012. Along with this increase in business, even the profitability of banks has improved significantly. The return on assets that banks have seen has jumped from 0.82 in March 2002 to 1.08 in March 2012.

The Potential

Now looking at these numbers, along with other data, one gets the scale of the kind of growth India’s banking industry has seen. It builds the perception that Indian banking has been growing fast, and efficiently. But even after scaling these heights, India stands low at financial inclusion when compared to the rest of the world.

According to a World Bank report in 2011, 38 per cent of India’s older adults (age 25+) held an account at a formal financial institution. This figure stands at 91 per cent for the USA and 98 per cent for UK. Compared to these markets, India’s far underpenetrated.

For better comparison, let’s consider the BRICS nations. Financial inclusion stood at 62 per cent for Brazil, 52 per cent for Russia, 63 per cent for China and 59 per cent for South Africa. Even, when compared to a similar market, India’s statistics seem very low.

In fact, India is lower than the world average of 55 per cent. Apart from bringing out the clear fact that India is lagging behind the world when it comes to banking, it brings out the potential that the sector holds.

Talking of potential, all of nine per cent use a debit card, 17 per cent use an ATM for withdrawal of cash and two per cent have credit cards. Moreover, a mere 13 per cent saved money at a financial institution and nine per cent took a loan from a financial institution. With a population of 1.2 billion, there is a mammoth picture that the Indian banking industry is yet to see.

The Framework

Now to aid growth, bank the unbanked and under-banked, bring system to the country’s finances, transform the service offerings of banks, improve efficiency, mobilise funds and all this in a sustainable and efficient manner, taking certain structural measures becomes necessary.

In the financial liberalisation of the 1900s, India’s banking system went through significant structural transformation. De-controlling interest rates, reduction in reserve ratios, loosening of government control and establishing a firm regulatory framework all added up to efficient resource mobilisation.

Similarly ongoing efforts like the branch authorisation policy help in delivering growth to rural areas, thus working on cost efficient financial inclusion. Banks were advised to allocate at least 25 per cent of the total number of branches proposed to be opened during a year to unbanked rural (Tier V and Tier VI) centres.

Moreover, the RBI has encouraged banks to provide for all banking services, viz., remittances, recurring deposits, entrepreneurial credit in the form of KCC and GCC, life and non-life insurance to all the residents of the village through a mix of brick and mortar branches and a business correspondent network.

To further ensure the apt channelisation of funds, several initiatives like focussing on agricultural lending, extending the interest subvention relief to farmers to post-harvest operations, taking measures to enhance credit flows to micro and small enterprises have been regularly taken.

The New Entrants

In the latest move to work on boosting the Indian banking sector, additional banking licenses to private sector players and non banking financial companies would be provided. This does function on the basic premise of the need of more banks to cater to the large population of the country that is not covered under the regulated system.

While the larger need is met by the decision to increase the number of players, a few questions about this move do arise. Are the ‘fit and proper’ tests for new entrants good enough? Considering the fact that mobilisation of funds is a bigger issue than the availability of funds, are the new entrants equipped with adequate resources? Would they really serve the purpose of cost-effective inclusion?
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The Larger Canvas

The global economy has been showing signs of stress and macroeconomic conditions have seen fluctuations. From loss in growth momentum to deterioration of the value of assets, we have seen turmoil in the global economy. Domestically too, the situation isn’t eased out with high inflation, erratic and unfavourable cross-currency fluctuations and a deficit problem.

Amid this situation, where the banking system has become rather global and is vulnerable to external shocks to an extent larger than ever before, it is important for the domestic banking regulation to be prudent and congruent to the standards maintained internationally.

In line with this, the RBI has given five years for banks to gradually achieve Basel III global banking standards. Although it is true that this will require large amounts of capital infusion, which can be a little dodgy for the government, which holds a majority share in public sector banks, on account of the deficit situation and that the adoption of these norms will negatively impact the profitability of banks and cap their lending abilities, the fact that the RBI is taking initiatives towards developing higher defence mechanisms for improved financial stability and higher resilience.

Here, the focus is on improving the sector’s ability to absorb shocks arising from global economic stress and thus reducing the risk of a negative impact on the domestic economy. A reduction in systemic risk thus ensures that the goal of financial inclusivity is taken care of in a rather sustainable manner, as far as the larger picture is concerned. Ensuring a safe operating environment by reducing the risk of spillovers does turn out to be a healthy step towards an efficient future.

The Micro Level

With large opportunity standing upright in front of the industry, an increase in scale can lead to inefficiency, mismanagement or difficulty in operational ability. Here, an important aspect is to ensure delivery of funds in a manner that makes operations scalable and efficient.

According to the International Telecommunication Union, there were 5.9 billion mobile subscriptions around the world. This translates into a reach of 87 per cent, which is, wait, higher than the banking penetration. Globally, the use of technology, the mobile specifically, has been increasingly popular as a delivery method. A good example of a success story in delivering solutions is that of the banking industry in Kenya.

M-PESA is a mobile based banking service in Kenya, which enables users to use financial services without having to visit branches in an extensive network. According to Safaricom, the system covers 14 million people in Kenya. To give you a better judgement of scale, Kenya has a population of 41.61 million. While it is apparent now, how big a success M-PESA has become, it has disrupted the banking industry in Kenya to quite an extent.

According to The Kenya Financial Sector Deepening programme, in 2009, two years after launch, M-PESA had a market share of 26 per cent in Kenya’s banking industry. How much share did commercial banks have? 20 per cent!

So much to say that technology can aid inclusion in a big way and can be used to leverage existing resources and infrastructure to a large scale.

The Safety

But with a scaling up of volumes and operations comes the risk of managing it well. To have risk management systems in place, to converge services and integrate platforms, stringent monitoring of assets to ensure the minimisation of NPAs, the financial system has to be in place to cope with the load. While the implementation of CBS (Core Banking Solutions), a platform for the integration of communication and IT needs of banking, the functioning and interaction of banks has been transforming.

UCIC (Unique Customer Identification Code), a customer identification process is increasingly being adopted by banks. This according to the RBI will help banks to identify a customer, track the facilities availed of, monitor financial transactions in various accounts, improve risk profiling, take a holistic view of customer profiles and smoothen banking operations for the customer. Banks would thus reduce risk of fraud and money laundering.

As the banking system moves towards greater inclusion, making the growth sustainable will have to consider the implementation of robust mechanisms to minimise fraudulent incidents and at the same time ease operations.

Conclusion

The Indian banking industry has great potential indeed. It has progressed tremendously in the past, and yes, in a profitable manner. New initiatives like the issuance of new banking licenses will only help go towards the goal of financial inclusion in the country.

But this goal will be a success only if the central bank manages to put forth a rigid framework, ensure adherence to international standards, develop technology to aid both, penetration and security and maintain the standard of norms it has. Having looked at the initiatives taken in the past and as we move forward towards this goal, it seems the path of financial inclusion is being taken up in a sustainable manner where the benefits of expanding the sector will be reaped.