Problems Of the Indian Financial Sector

The Indian Financial sector has a major challenge to meet the demands of an economy growing at 7 to 8%.

It has strong and globally competitive processes but is shackled by old eeconomiclawseconomic laws, culture, and governance impeded by the government. The  Indian economy was hurt by Demonetisation and GST introduction but has regained its growth.

The positive signs are factors like digitization of transactions, expansion of banking to the rural areas, UIDAI and credit rating, GST, and its database.

The major players in the Indian financial system are:

1. Financial Institutions: – Banks – public and private sector aNon-Bankinging Financial Institutions
2. Financial Markets
3. Other financial services Mutual funds and Insurance.
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Financial Institutions – The Banking sector is a major player at around 85% as compared to 15% for NBFCs and the Public sector banks have been in the news and need to be examined for fragility.

As per https://www.theglobaleconomy.com/rankings/Bank_credit_to_the_private_sector/ the banking credit to private sector credit to GDP ratio for India is a low 49% as compared to China at 156%.

If we factor in the 7 to 8% growth we can see large growth potential in Credit to the private sector.

Even total domestic credit is 73% of GDP whereas it is more than 130% for most OECD countries.

There is a huge potential to lend in India and this will be the driver for the growth of the Indian financial sector.

The credit to the rural areas is today met by private money lenders to an extent of 40%. With the opening of more than 330 million Jan Dhan accounts in the past few years, with a deposit of 84000 Cr, it opens a huge potential for lending to the institutions.

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The new systems like UIDAI low-income would strengthen the Bank’s ability to lend to low-income borrowers. This would not only free them from the extortion of private money lenders, but it would also help them grow, thereby growing their credit.

Is the sector strong enough to master the growth? Mckinsey & Co report highlights the stressed assets in the government-owned banks as around 7 trillion INR, and are stressed, they are hopeful that most of the initiatives listed above would continue to expand the retail market for lending which is growing at 11%, and the corporate lending( which is the major contributor to the 7 trillion stressed assets reducing) they see a way forward in retail and corporate lending to small and medium enterprises on the back of growth in nonterm deposits @ 11.7%. https://www.mckinsey.com/featured-insights/india/mastering-the-new-realities-of-indias-banking-sector

Public sector bankson-boardingThese will have to clear their stressed assets as quickly as possible. The banking ordinance and the recent defaulter repayments offer a window of a chance to do this. Growth will need an infusion of funds and the Banking sector is today much stronger owing to the banking ordinance of 2017. Recoveries of loans are expected to rise to 1.8 Lakh Cr from 74000 Cr in 2017.

Though problems of undercapitalization and weak assets remain, Moody’s rating in late 2018 expressed a stable future given the high growth rate of the economy in the 7 to 8% range.

The future:

The Boston Consulting Group, FICCI, and All India Banking Association, in their report “Productivity in Indian Banking 2017, Hidden Treasure” look at the future of Indian banking in the digital era and finds them in a position to do so. Their costs of customer onboarding, transaction handling, and credit rating buredatabasesases are on par or better than OECD banks. The BCG report highlights

1. Banking revenue pool mix will change significantly over the next 5 years –requiring adjustments in strategies and business models
2. Corporate segment which is ~40% of advances revenues today to shrink to ~27% by FY22 –driventhe  by movement of large Corporate to debt markets and discouraged by lingering bad debts in corporate segments
3. Retail lending revenue pool growth is close to its peak sustainable rate. Expected to stabilizethe  at current rate
4. Savings bank revenue pool to get a fillip due to higher digitization, rising balances in Jan Dhan accounts, and effects of rising prosperity on balances
5. MSME to offer promising upside as share in lending revenues increases from ~20% today to ~24% by FY22 –driven by substitution of informal credit with reforms like GST & digital payments at POS
6. Evolution in savings habits towards mutual funds will provide an inflection in bank’s fee and advisory income –banks could gain share over non-bank distributors to shore up their profitability.

The project that deposits will grow at 11% CAGR largely due to savings from small account holders – due to Jan Dhan Accounts, and also the continued pressure on black money transactions through GST, EE-waybills, and RERA in the realty sector growth of 1 lakh crores by 2022. It looks plausible.

It sees anadvancessadvanceson-boarding growth of nearly 2 lakh Cr largely in retail lending and MSME, currently, only 45 lakh SME borrowers exist against 510 lakh units and using credit bureau database and tracking thru GST returns the banks have a large scope to expand this market segment. This too is defensible.

The report posits that income would increase by 1 lakh Cr in the same period based on retail lending income where default rates are near stable at 2the .5 to 2.9% band and fund management activities a for higher deposit base.

We can safely conclude that the Bank sector would undergo correction, it would be subdued till infusion of funds and reforms are in place, but it is solid enough to grow steadily in the future.

NBFCs have a large share of retail trade and transactions as well as housing finance. The digital platforms are fairly advanced and stable. They will grow but maybe face competition from banks.

Financial Markets with the Indian equities having a market cap of 70% of the GDP this is a large player in the financial system in India.

Equity

Indian companies have been present in the global markets for a long time but they are small and have no dominant position owing to their poor R&D base. Over the past few years this is changing through acquisitions of foreign companies – see Tata Motors + JLR and many others.

With their R&D and supported by labor arbitrage there is no reason why they should not grow faster and supply not only poor markets in Africa but also in Europe and the USA.

Growth would also come from the revival of cyclical markets in commodities and increased govt spending on infrastructure, this will also reduce the stressed assets and help growth.

Bonds and FDI

The Corporate has been increasingly relying on Bonds and FDI to meet its fund requirement as it finds resistance from the banking sector. The bond market at 6.5 lakh Cr in 15-16 is about as big as the Institutional banking sector and will grow to keep pace with corporate growth.

Mutual funds and Insurance

The saving is moving from bank deposits to mutual funds and today the Assets Under management are about 8.7 lakh Cr. This sector will continue to grow on a digital backbone that has not only reduced the customer acquisition cost by 90%from INR 1500 to INR 150 but also reduced the minimum portfolio from about INR 200K to INR 20K. This opens up a market from 3 million customers to more than 30 million.

Likely, Banks would also make inroads into this, nevertheless, the sector would grow.

Insurance

At 0.7% of GD, P this sector is small and has large growth potential as its premium to GDP is comparable to China but about 1/3rd of Thailand and 1/5th of Korea.

To conclude the financial system appears to be in a good condition. It has the systems and processes in place to grow, it has opportunities to grow.

Indian economy cannot but grow and reforms would accelerate growth. This would be the basis for the growing financial sectors listed above. The digital economy push, coupled with disincentives for ctransactionstion through demonetization and GST will push India towards its position as a global player and this ride will be helped by a modern ready growing digitally enabled financial sector.