Banking sector: Tiding over the pandemic pandemonium

• The ripple effects of the novel coronavirus (COVID-19) are being felt by India’s banking sector. The pressure on the banking system is mounting with each passing day and higher defaults on debt are imminent.
• Banks will face competition from rivals who offer higher deposit rates on their SB/FD as well as NSC, KVP, etc.
• As income and cash flows of existing borrowers on both production and consumption side will be adversely affected because of COVID-19, they will find it difficult to honour loan repayments on time and in full.
• The RBI has taken a series of measures to solve these problems, though they have not substantially raised credit flow in the corporate sector. Banks should be nudged to lllengage in lending activities, while safeguarding them against bad loans.

The ripple effects of the novel coronavirus are being felt by India’s banking sector. The pressure on the banking system is mounting with each passing day and higher defaults on debt are imminent. This health pandemic and the consequent upheaval that will spill over into the country’s financial period will be marred by economic hardships and some serious difficulties for the banks. Banks will face a lot of challenges both on the deposit side as well as on the lending side because of COVID-19 as under:

(a) Challenges on Deposit Mobilisation (tough competition from entities offering higher rates with low risk): Deposits account for the major resources for a bank (about 85-90%). As of now, the system is flush with a lot of liquidity due to various interventions by RBI like targeted long-term repo operations (TLTRO) meant for NBFCs and special liquidity facility for mutual funds (SLF-MF) etc. The FM Smt Nirmala Sitharaman also announced a Rs 30,000 crore Special Liquidity Scheme (SLS) for NBFCs, HFCs and MFIS.

Due to ample liquidity in the banking system, banks have reduced the interest rates on savings bank (SB) deposits and fixed deposits (FD) by a large extent. SB rate for some of the big banks like SBI now stands at below 3% and FD rates for period > 1 year stands at below 6%. But deposit is the life blood of banks. With deposit rates falling to such low rates, banks will find it tough to retain their existing deposits as well as mobilise fresh deposits.

Banks will face competition from rivals like India Post Payment Bank and other Payment Banks (PBs), Small Finance Banks (SFBs) and National Small Savings Organisation (NSSO), now called as National Savings Institute (NSI) etc. who offer higher deposit rates on their SB/FD as well as NSC, KVP, etc. Banks also see a flight of deposits into overnight funds and liquid funds because of attractive rates. At least high net worth individuals (HNWIs) and big corporates who are more interest rate sensitive, have higher risk appetite and also better informed can shift a major part of their SB/FD to overnight funds and liquid funds and other mutual funds.

(b) Challenges on Lending Side (Low Credit Off-Take and enhanced delinquency/loan default rates from existing borrowers due to impending recession/economic slowdown): Loans are the bread and butter for a bank. They account for the largest share of the assets of a bank and the major contributor of its income. With COVID-19 and consequent lockdown, almost all the manufacturing and service sectors of the economy are badly hit because of reduced production or complete shutdown. Agriculture and allied activity sectors are also affected because of lockdown. Sectors like construction, hospitality comprising aviation, surface transport, travel & tourism, hotels & restaurants, private hospitals & nursing homes, personal care like beauty parlour & salons and MSMEs are affected most. Many people working in both formal as well as informal sectors have lost their jobs. So, COVID-19 will affect both the demand and supply side of the economy.

A weaker scenario for jobs, incomes and consumption will lead to low supply. Banks, which provide loans to both the supply side (production loans to producers-business firms) as well as the demand side of the economy (consumption loans to consumers) will be seriously affected. This will result in reduced loan demand from both sides. Furthermore, as income and cash flows of the existing borrowers on both production and consumption side will be adversely affected because of COVID-19, they will find it difficult to honour loan repayments on time and in full. This will lead to enhanced loan delinquency/default rates from existing borrowers.    

Gaining cognizance of this fact, the RBI has taken adequate measures to improve liquidity in the banking system, so as to improve the availability of credit/loanable funds with the banks, in order to help NBFCs, MFIs and Mutual Funds and Corporates. RBI has also reduced the policy REPO rate by about 135 basis points to 4.40% in the recent past to reduce the cost of credit. It also reduced the Reverse REPO rate by 0.40% on March 27-2020 to 4% and by 0.25% on April-17, 2020 to 3.75%, by widening the usual corridor of 0.25% between REPO and Reverse REPO to 0.65%. The substantial reduction of Reverse REPO rate by RBI is intended to make parking of surplus funds by banks with RBI unattractive and thereby nudge the banks to lend more to the productive sectors of the economy. RBI has also allowed three months of moratorium (repayment holiday) to borrowers, small or big, to tide over the cash crunch during this Corona crisis and regulatory forbearance of not classifying these loans as NPA.

Despite the plethora of measures undertaken by the RBI, however, there is no substantial credit flow in the corporate sector, especially the MSME segment despite all the ameliorating measures of the RBI. MSME segment is starved of credit because of the COVID pandemic. Both PSU and private sector banks are alike in this respect of providing credit to the starved sectors of economy, especially MSMEs. The reason could be banks have become more risk averse and have low business confidence due to the future uncertainties in the economy arising out of COVID pandemic. They are not coming out of their lazy banking attitude (investing money in risk-less government securities rather than lending) despite RBI and GOI’s push to lend to MSMEs, NBFCs, MFIs even when it is backed by some sort of government guarantee. RBI and GOI should do more moral persuasion and nudge the bank chiefs to lend to the Corporate sector, especially MSMEs in order to help the economy to come out of this crisis. 

Banks need to be protected against such bad loans because in a post-COVID world, banks will be critical in helping the economy get back on its feet. This is especially true in the context of agriculture/rural economy and MSME sectors which need the helping hand the most to come out of this crisis by dispensing credit liberally at softer terms. However, since lending is a risky business, banks will have to take a carefully calibrated risk. Critical factors will be lending to the right borrowers with proper appraisal and risk mitigants factored in. Other critical issues will be credit monitoring, follow up, supervision and slippage management.

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Prof. D. N. Panigrahi is currently working as a Professor in Finance and Bank Management with Goa Institute of Management (GIM). Prior to joining GIM, Prof. Panigrahi had worked with Institute of Management Technology, Nagpur (IMT-N) as an Associate Professor in Finance and Bank Management for 12 years from April 21, 2008 till February 11, 2020. He is an M.Sc. (Physics), MBA (Finance – FMS, Delhi University), CFA & MS-Finance (ICFAI-India), CAIIB & DFS from Indian Institute of Banking & Finance (IIBF), Mumbai. He has 17 years of teaching and research experience in Management and Banking and 21 years of industry experience as a Professional Bank Manager with two reputed PSU Banks. He is also actively pursuing fellowship programme on Actuarial Science.

His current teaching and research interests include Corporate Finance, Investment Management, Personal Financial Planning & Wealth Management, Commercial Bank Management, Actuarial Science, Risk Management, Financial Literacy, Retirement Finance and Pensions.