Home » Meaningful Minutes » 5 Key Challenges Faced By Indias Banks

Meaningful Minutes

It will take you 3 minutes to get a comprehensive perspective on financial topics
2 related articles that add to your knowledge
One number fact that you should know
How it helps?
  • Zero maintenance charges
  • Zero fees for demat account opening
  • Volume based brokerage
Reach Us
Learn the art of Investing

Read More >

  • 5 key challenges faced by India's banks

    Banks are the backbone of every economy. It is very important that banks remain healthy financially. Otherwise, a financial crisis can hit a country leading to recession like the US in 2008.

    This is especially true for developing countries like India. "The banks are the lifelines of the economy and play a catalytic role in activating and sustaining economic growth, especially, in developing countries and India is no exception," S S Mundra, deputy governor of the Reserve Bank of India said in a speech recently.

    However, India's banks face different kinds of problems, which have affected their profitability and financial stability, as per S S Mundra's speech.

    Read more about the trends to follow on bank interest rates here

Here is a look:

  • Asset quality:

    The biggest risk to India's banks is the rise in bad loans. The slowdown in the economy in the last few years led to a rise in bad loans or non-performing assets (NPAs). These are loans which are not repaid back by the borrower. They are, thus, a loss for the bank. Net NPAs amount to only 2.36% of the total loans in the banking system. This may not seem like an alarming figure. However, it does not take into restructured assets - when a borrower is unable to pay back and the bank makes the loan more flexible to be paid back over a longer period of time. Restructured assets too put pressure on a bank's profitability. Together, such stressed assets account for 10.9% of the total loans in the system. And these are just loans which are identified as stressed assets. 36.9% of the total debt in India is at risk, according to an IMF report. Yet, banks have capacity to absorb only 7.9% loss. So, if these debts turn bad too, banks will face major losses.

    Click here to read about India’s growth prospects

  • Capital adequacy:

    One way a bank tries to ensure it is protected from bad loans is by setting aside money as a 'provision'. This money cannot be used for any other purposes including lending. As a result, banks have lower capital available to use for its various operations. The Capital Adequacy Ratio measures how much capital a bank has. When this falls, the bank has to borrow money or use depositors' money to lend. This money, however, is riskier and costlier than the bank's own capital. For example, a depositor can withdraw his/her money any time they want. So, a fall in CAR (often called as CRAR or Capital to Risk Assets Ratio) is worrisome. In the last few years, CRAR has declined steadily for Indian banks, especially for public-sector banks. Moreover, banks are not able to raise money easily, especially public-sector banks which have higher number of bad loans. If banks do not shore up their capital soon, some could fail to meet the minimum capital requirement set by the RBI. In such a case, they could face severe issues.

    Read more about how banks fund their capital needs here

  • Unhedged forex exposure:

    "The wild gyrations in the forex market have the potential to inflict significant stress in the books of Indian companies who have heavily borrowed abroad," Mundra said in his speech. This stress can affect their ability to pay back debt to Indian banks. As a result, the RBI wants banks to ensure companies they lend to do not expose themselves to unnecessary debt in dollars.

    Click here to read about the BASEL III norms

  • Employee and technology:

    Public-sector banks are seeing more employees retire these days. So, younger employees are replacing the elder, more-experienced employees. This, however, happens at junior levels. As a result, there would be a virtual vacuum at the middle and senior level. "The absence of middle management could lead to adverse impact on banks' decision making process as this segment of officers played a critical role in translating the top management's strategy into workable action plans," the deputy governor said. Moreover, banks - especially government-owned banks - need to embrace technology to offer better products. This will also help make banks more efficient.

    Read about the impact of demonetization on interest rates here

  • Balance Sheet management:

    In the past few years, many banks have tried to delay setting aside money as provisions (for future bad loans). One reason for this is that a bank's chief executives have a short tenure, during which time they want to post higher net profits and cheer investors. "It must be appreciated that CEOs/ CMDs would come and go but the institutions are perpetual entities. The only thing which can perpetuate their existence is a stronger and healthier balance sheet," Mundra said. Deferring provisioning is harmful in the long term. It reduces the bank's ability to withstand financial pressures. This is even more problematic considering the poor capital adequacy in Indian banks. In fact, investors would be more happy if the management addresses and sorts out problems rather than posting high net profits that cannot be sustained in the long term, the deputy governor said.

    Click here to read about financial ratios used to analyse stocks

    • IMF has a warning about India's weak banks and it is a wake-up call for Jaitely Read more

    • Decoding India's small-change problem Read more

  • Rs 8,000 crore

    Public-sector banks rely on the government for capital infusion. These banks are unable to raise capital on their own. However, the government has limited room to set aside money for these banks. In fact, it paid only Rs 7,000 crore of the Rs 11,200 crore promised for banks in 2013-14. Even in 2015-16, the government has only promised Rs 8,000 crore-just half of the sector's total capital requirement.

    Click here to read how interest rates affect equities markets