In the wake of the pandemic that has left behind a global economic crisis, several fault lines and weak points have been exposed across business enterprises, sectors and economies. The banking sector, too, has not been immune to the aftershocks of the pandemic.
India’s banks have got into battle-mode and are deploying every weapon in their arsenal to protect margins—prioritizing business continuity planning, cost-cutting measures, stringent credit norms, rapid digital adoption, enhanced collaboration with fintech players, capital efficiency focus and risk mitigation strategies.
Given the healthy capitalisation metrics and uptick in economic activity, one can expect India’s banks to bounce back with speed and at scale.
Navigating the COVID-19 storm is turning out to be longer than expected – especially for the banking ecosystem. The impact of the COVID shock has been unprecedented, resulting in the emergence of multiple challenges on the economic, financial, operational and systemic fronts. A recent McKinsey analysis reveals a worrisome picture for the global banking system, indicating a two-fold compounded problem–the pain of credit losses aggravated by revenue shrinkage owing to muted economic growth in the coming years. Globally, the demand uncertainty and credit write-offs are expected to cause a decline in the banking RoE to lower than 1.5% in 2021 with a gradual recovery to 9% by 2024.
‘’This will likely play out in two stages – loan loss provisions that far exceed the 2008 crisis levels over a period of 12-18 months (‘the deep freeze’), followed by a period where banking revenue growth lags gross domestic product (GDP) growth (‘the gradual thaw’). Depending on the scenario, from $1.5 trillion to $4.7 trillion in cumulative revenue could be forgone between 2020 and 2024. In our base-case scenario, $3.7 trillion of revenue will be lost over five years—the equivalent of more than a half year of industry revenues that will never come back’’ – McKinsey
Source: McKinsey
COVID’s domino-effect
With the COVID uncertainty spilling over beyond the health consequences, banks in India too, are faced with similar problems. McKinsey estimates that in the aftermath of the pandemic, foregone revenues could amount to INR 5 Trillion, with irrecoverable loans ballooning to INR 6.7 Trillion for India’s banks till 2024. India’s banking sector- a critical, highly-regulated industry, often considered the bellwether of the economy is facing multi-pronged headwinds– slowing demand, income uncertainty, loan delinquencies, deterioration in asset quality, heightened credit risk from sectoral exposure, intense competition from nimble fintech players emerging as alternatives, pandemic-related disruption to physical operations and managing a distributed workforce, regulatory policy changes related to loan moratoriums (40% of the loan portfolio as of Aug end), higher provisions and stress testing, liquidity concerns and the need to rapidly scale up the technology in the new normal.
Building resilient growth
At the root of the problem is a contraction in the real economy, which has cast a dark cloud on the prospects of the banking sector. It is, however, heartening to note that India’s banks have improved capital adequacy parameters with a jump in provision coverage ratio (PCR) to 65% and RoE touching 2.5% in fiscal year 2020. A recent CARE Ratings report highlights the performance of India’s banks (FY20):
| Metrics | Public Sector Banks | Private Sector banks | Small finance banks | Foreign Banks |
| Interest on deposits | 4.96% | 5.26% | 8.2% | 3.65% |
| Cost of funds | 4.92% | 5.41% | 8.66% | 3.73% |
| Return on advances | 8.16% | 10.10% | 19.87% | 8.45% |
| Return on equity | -4.16% | 3.3% | 15% | 8.76% |
| Net Interest Margin | 2.37% | 3.42% | 8.34% | 3.26% |
| Capital adequacy Ratio | 12.9 | 16.5 | 20.2 | 17.7 |
| Gross NPAs | 10.3% | 5.5% | 1.9% | 2.3% |
With new emerging challenges for banks, time is of the essence. In the absence of urgent measures, McKinsey predicts that banks’ RoE could dip to negative territory 9% by FY22. It is imperative that banks act fast to prevent COVID’s collateral damage. Incorporating robust risk practices, cost control measures along with enhanced operational efficiency through technology build-up could very well be the secret sauce for a turnaround story resulting in a 15-16% RoE by fiscal 2024.
Balancing risk vs credit growth
With SMEs, MSMEs and corporates being thrown off guard by the pandemic crisis and the resultant decline in business activity especially manufacture, owing to supply chain disruptions, delayed payments, liquidity issues, relatively muted CAPEX demand and a hike in operating costs, the stress on loan repayments and reduced credit off-take has adversely impacted banks. A EY study (May 2020) highlights the loan exposure of India’s banks in sectors that took a beating due to COVID.
It would be prudent for banks to build a robust technology infrastructure while embracing real-time technology tools, data analytics and predictive models to ensure a quality loan book, sound underwriting practices and accurate assessment of borrower creditworthiness.
Driving digital transformation
Recognising the evolving dynamics, many banks have proactively shifted their operations to the digital landscape as well. For example, SBI’s YONO app, a one-stop banking platform boasts of being the largest digital bank globally, having a customer base of over 24 million, with 30000 additions each day.
Reaffirming the overwhelming customer acceptance of digital banking, SBI Chairman, Rajnish Kumar opined ‘’Progressively, we are seeing that there has been a shift away from branches and even from ATMs. The number of transactions on ATMs have come down from 55 to 29 per 100. On the other hand, the digital transactions, which are on mobile and internet banking, have gone to 55 out of 100 transactions. This shift is permanent and is going to remain. People are experiencing the convenience of digital and mobile banking. Now, any new branch we are opening, it is branded as a digital branch. Bank’s digital lending book is growing. We are moving to a scenario where based on the data analytics, and eventually for the new-to-bank customers, using the big data, banks will be able to offer instantly the loan products and that is a big benefit.’’
A BCG survey highlights the traction towards digital banking, globally:
A digital-first approach to banking would also require capital investments in data centers and technology architecture to ensure data privacy and secure transactions, in the backdrop of escalating cybersecurity attacks. In consideration of the steep digital trajectory, the position of a dedicated Chief Risk Officer has assumed greater importance. Leveraging upon new-age technologies also has the potential to boost efficiency in operations and processes. McKinsey’s report suggests that the key contributor to higher RoE and margin retention for India’s banks is to enhance productivity by 30%. A bottleneck in the growth journey is the high cost-to assets. The table below highlights that there is significant toom for cost optimisation strategies for India’s banks.
| India’s banks | Global banks | |
| Cost to assets ratio | 2.2% | 1.4% |
Concluding Thoughts:
The pandemic is a wake-up call to banks to keep their ears to the ground and continuously focus on deriving cost efficiencies and ramping-up digital infrastructures. Given the magnitude of the shock, it would be prudent for banks to revisit the drawing board, use the COVID disruption to rethink the future roadmap and fortify their defences to weather similar adverse COVID-like black-swan events in the future.
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