The world economy is hardly hit by the financial crisis which originated from US during 200708. As the globalisation has become the most prominent phenomenon, therefore this crisis took whole of the world in its harsh grip.
The developed countries of the world have had the foremost impact and developing economies are no exception. India is not exactly into recession but slowdown has creeped into the economy with corporate layoffs; decline in GDP, exports, profits and fall in real demand of goods and commodities.
In the advanced countries the contagion spread from financial to other sectors but in India the slowdown in real sector has affected the financial sector.
This paper specifically focuses on the study of the impact of economic slowdown on the public sector banks of the country. It enrolls the analysis of various challenges that the public sector banks of the country are confronting in the ongoing era of economic slump and the survival mantra through building of strengths and exploitation of scattered opportunities.
ECONOMIC SLOWDOWN: AN INTRODUCTION
A small crisis, which began in some remote sections of US mortgages during 2007-08, bought forth every sphere of the globe from Washington to Tokyo, a host of developed countries, including Germany, Japan, U.K. and Asia is no exception. Due to the crisis in US, the major financial institutions collapsed and central banks have to come forward for their rescue. This recession casted its shadow not only on financial institutions but also on stock markets and the corporate giants.
Figure 1: Effect of Economic Slowdown. (Source: www.wikipedia.com)
As India is trading enormously with its counterparts, it too got affected. Sluggish GDP, decline in profitability of companies, lay offs, plunging stock markets, fall in real demand for goods and services, liquidity crunch etc are some of the indicators that above discussed global recession took India too in its grip. As Indian economy is well regulated by government therefore it is not too badly hit by global recession, but the experiences related to slowdown are prominent.
As the impact on India unfolds, it has also been observed that while in the advanced countries the contagion spread from the financial to the real sector, in India the slowdown in the real sector has affected the financial sector.
IMPACT OF ECONOMIC SLOWDOWN ON INDIAN BANKING SYSTEM
The Indian banks are financially sound, well capitalized and well regulated so, they are not directly exposed to the global crisis but Indian banking system is certainly hit by the economic slowdown. There is drying up of overseas financing and they have to rely upon RBI and domestic resources.
On the other side, banks are facing constraints in raising funds through capital markets because either investors' have lost their money or their confidence in the securities investment.
Domestic savings greatly cater to the financial requirements of public sector banks. There is steep decline in the quantum of deposits with public sector banks, as the customers are hardly smack by the loss of jobs in corporate sector, reduction in business profits due to economic slowdown and on-going food inflation in the country. Banks are facing liquidity crunch as the result of these factors.
The credit creation ability of the banks is the prime contributing factor to the earning ability of commercial banks. There is crunch on the supply side and demand for credit has also declined which have resulted in low profitability of banks. The banks are in pressure to maintain required profitability with financial back-up to affected industries at reasonable interest rates.
HOW STRONG ARE INDIAN PUBLIC BANKS TO COUNTER SLOWDOWN
Indian banking, appreciably, over the years, has emerged from being a purveyor of credit to be an engine of economic development. A historic review of the State Bank of India, a giant among the public sector commercial banks, and the subsequently in nationalized commercial banks, reveals the emerging promising trends in the deposit mobilization, deployment of credit with developmental dimension added to it, prioritization of sectoral financing and social responsibility assumed by the banks. Along with promising trends in the progressive march of the public sector banks, certain disturbing trends are noticed.
In an interaction with industry leaders, Indian Prime minister expresses his confidence on Indian banks in the time of global crisis by his speech "world economy is going through an unprecedented crisis which started in the financial sector in the US but has now spread globally. In this hard time, our first priority is to protect the Indian financial system from possible loss of confidence or contagion effects. I am happy to say that the direct exposure of our banks to problem assets is minimal as our banks are well regulated and also well capitalized. The additional liquidity provided or the reduction in REPO rate will help to provide credit at reasonable rates. The public sector banks have been instructed to ensure that they act counter cyclically in this situation to counter the general erosion of confidence."
All key indicators suggest that Public Sector banks (PSBs) maintained their supremacy over private banks in recent times despite pressures of global meltdown, these not only succeeded in lowering lending rates with maintaining record growth of net profits but also drastically reduced their non-performing assets (NPAs) as compared to private banks.
The aforesaid findings are contained in ASSOCHAM Financial Pulse (AFP) Study on "Performance Analysis of Indian Banking Sector", which tracked quarterly results of 25 national banks, (15 public and 10 private sector banks and show that PSBs have recorded impressive performance across all significant of banking parameters.
Sector
No. of Banks
Net Profit
Net Interest Income
Net NPA
Reduction in PLR
during Q3 (in basis points)
Public
15
57.29
49.98
28.83
75 - 125
Private
10
43.88
32.08
43.84
50 - 75
Source: ASSOCHAM Research Bureau
Quarter 3 Average Growth rate (in %)
The public sector banks have emerged strong across all key indicators as the global financial turmoil and slowing domestic economy put the banking sector on a test. The public banks have not only reduced the lending rates but have also managed to record higher average net profit and lower NPA level than their private sector counterparts as revealed by an AFP Study.
CHALLENGES DURING SLOWDOWN FOR PUBLIC SECTOR BANKS
Given the shakeouts at domestic environment and the changes that are taking place in the banking industry at the national and global levels, the Indian banks are facing the following changes:
Maintaining the Credit Flow: As a consequence of inflation in economy, on the supply side the interest rates have risen therefore borrowing has become expensive and a steep fall in domestic saving has also emerged. Therefore it has lead to liquidity crunch. It is a major challenge for the banks to ensure healthy flow of credit to the productive sectors of the economy. Even in normal times, economic growth requires efficient financial intermediation. An economic downturn, therefore, requires even more efficient financial intermediation- and this is a major challenge that the banking community has to address. There is a need to ensure a steady credit flow to the real sector of the economy in order to sustain demand even while maintaining credit quality.
Loopholes in Technology: Technology is one area where foreign and new generation private banks score over the public sector banks and old private banks. The new age of innovation will focus increasingly on meeting the needs of the individual, which will be driven by technology and initiatives on financial inclusion. Customer experience and tailored offerings is the key to bank survival and profitability. To make banking services available to the small rural fragments and economically weaker segments of the society presupposes strong technologically supported solutions for viability. Where a full-fledged branch cannot be opened immediately, banks could look at covering the unbanked areas through satellite offices.
Regulatory Forbearance: By far, the most contentious and most voluble debate triggered by the crisis has been about the flaws in the regulatory architecture of the financial system. It is a great compulsion upon the public sector banks that unlike private and foreign banks they have very less autonomy in decision making. Because of this, managing slowdown has become far more challenging. International slowdown poses challenges of implementing global governance standards, compliance with multiple regulatory requirements and managing cross border risks. While Indian banks are poised for huge international growth, they urgently need to transform themselves into more transparent entities- comparable with international best practices- to facilitate governance, compliance and to make them attractive to investors. Banks are ranked on the basis of the famous CAMEL (Capital, Assets, Quality, Management, Earnings and Liquidity) rating. Riding the CAMEL is challenging in times of adversity.
Basel II Norms: Indian banking sector has already migrated to the Basel II framework effective from March 31, 2008 and the remaining public sector banks are slated to do so by March 31, 2009. The migration to advanced approaches of Basel II poses several significant challenges to the bankers and also to RBI. The first challenge is the availability of long time-series data for computing the risk parameters required under the advanced approaches. Good-quality, consistent and reliable data and information relating to the loan portfolios of the banks as also sophisticated IT resources are critical to the
proper risk assessment under Basel II framework. Data limitation is a key impediment to the design and implementation of credit risk models. This may prove to be a major challenge for us in India, given the widespread branch network.
Risk Management: It is always risky to deal in finance. Besides Basel II framework is primarily about ensuring robust risk management in the banks. The advanced approaches for credit risk and operational risk envisaged under Basel II framework requires use of risk models by the banks. This in turn requires internal validation of these models by the banks. Its effective implementation, particularly the advanced approaches, will demand rapid and significant upgradation of skills- both at the level of banking system and also within RBI. In this context, the challenges that banks are likely to face will be multi faceted in the areas like assessing skill requirements, identifying and bridging the gaps, identifying talents, putting the available talents to optimum use, attracting fresh talents and change management. Banks would therefore, need to pay special attention to strengthening their risk management infrastructure in all dimensions including human resources.
Financial Inclusion: It refers to the process of extending financial products and services at an affordable cost to the weaker and vulnerable sections of the society in a visible and fair manner. It is especially true for the poor. Nearly 20% Indians are below poverty line. It is therefore a challenging assignment for public sector banks to include them in their customer base and serve them. The range of products and services include a no-frills banking account, savings products, access to small loans and overdrafts, credit facilities, money transfer facilities, life and non-life insurance and financial counseling/advisory services. It is also a challenging activity for the Indian public sector banks. To offer a holistic set that encompasses all these products and services, the conventional and innovative delivery systems need to be broadened and alternative avenues need to be explored.
Man-power Planning: Public sector banks do not really face attrition problems related to their human resources. They are not into layoff spree as such but the banks have to suitably realign their existing human resources from surplus to deficit pockets and readjust staffing pattern in a computerised environment. Surplus staff from very large branches, which are now computerised, need to be relocated or assigned newer jobs such as marketing etc. Mobility of staff has to be negotiated with employees' organizations as a measure to improve organizational efficiency and improve productivity. About 70% staff in each bank constitutes clerical and subordinate staff. In spite of many changes that the industry has faced over the years, the role of this category of staff has remained unchanged. There is the need to re-define the clerical roles in the bank and there is also a need to enrich clerical roles by introducing discretionary elements in front-line clerical roles and giving them responsibility of higher nature such as initiating correspondence, working in marketing teams, roles, public relation roles etc.
The banks also need to develop existing staff in newer competencies through a systematic and rigorous training and also recruit, if necessary super specialist and specialist in areas like technology, treasury management, marketing, FOREX operations and project management. The existing
managers need to be developed as turn-around managers through training in self-management and inculcation of skills in problem solving, conflict management and change management. Needless to say that succession planning in managerial cadre must occupy central concern for bank management in the time of economic slowdown.
Size and International Play: As per the roadmap released by RBI for foreign banks, which is in line with WTO commitments given by India in 2005, foreign banks may be permitted to have overall investment of 74% in the private banks of India from April 2009. Based on this, the view in the sector is that consolidation within the banking industry is imperative and the domestic players have to enlarge their capital and product expertise if they want to continue playing a significant role.
Addressing quite a few challenges that include seeking and serving new markets, embracing technology, taking a final call on outsourcing and financial inclusion.
PROSPECTS FOR PUBLIC SECTOR BANKS
Although there are problems of falling margins, rising NPAs, liquidity crunch during the time of economic slowdown but the fact is that, India's banking sector is relatively insulated from the worst effects of the crisis because more than half of the areas do not even have basic financial services and hence what happens in financial markets will have no impact on them.
In recent times public sector banks have outperformed other banks of the country and the fact remains that the Indian banking industry has not realized its vast potential chiefly because of the slow pace of structural reforms. Presence of unbanked is enormous in our country. Public sector banks have the following strengths to build upon:
RBI support: As public sector banks of the country are regulated by RBI till today, therefore the role of central bank becomes far more crucial at the moment when banks are confronting thorny times. RBI has adjusted its monetary stance over the last couple of months to expand liquidity of banks. This includes:
Significant reduction in the CRR (RBI reduced the cash reserve ratio for scheduled banks by several times. CRR of 9 percent on 6th Oct 2008 stands to 5 percent for the financial year 2009-10)
Reduction in percentage of SLR (For the financial year 2009-10, RBI has slashed SLR to 24% from earlier 25% since 1997)
Considerable reduction in repo rate (The repo rate was cut by 250 basis points from 9.0 per cent to 6.5 per cent by December 8, 2008, further for the financial year 2009-10 RBI slashed the repo rate by 25 basis points. After cut, repo rate now stands at 4.75 percent)
Opening a special repo window under the liquidity adjustment facility (LAF) for banks for on-lending to the non-banking financial companies (NBFCs), housing finance companies (HFCs) and mutual funds (MFs)
Extended a special refinance facility, which banks can access without any collateral.
The Reserve Bank is also unwinding the Market Stabilisation Scheme (MSS) securities, roughly synchronised with the government borrowing programme, in order to manage liquidity. RBI has allowed counter-cyclical adjustment of provisioning norms for all types of standard assets and risk weights on banks' exposure to certain sectors which had been increased earlier counter-cyclically, and expanding the lendable resources available to the Small Industries Development Bank of India (SIDBI), the National Housing Bank (NHB) and the Export-Import Bank of India (EXIM Bank).
Tapping the Untapped: The true prospects for Indian banking sector lies in tapping the untapped segments of the population, both in rural and urban markets, in order to sustain its growth. Thus, by focusing on financial inclusion, Indian banks can ensure efficient utilization of capital, leading to higher profitability and, in turn, more strength to compete with risks and foreign entrants. Through greater financial inclusion it is possible to provide savings, loan and insurance products at affordable prices and this can generate additional income and employment in a very significant manner.
Encashing Customer Confidence: Indian household has a psychology that their money is safe with government banks. Private and foreign banks are offering world-class services to their customers but still the Indian customers' lack trust with private and foreign banks in this regard. Customer confidence is the key to survival of business. It's an opportunity therefore, for public sector banks.
Vitalizing what is Available: Public sector banks have a widespread branching network across the country. There are number of rural branches too, which have become loss making with passage of time. The need of hour is to stimulate all of them for financial inclusion to encounter economic slowdown.
Mature Governance: There has been a significant and positive change in the way India has been managing its external sector with respect to changes in global scenario. The prudent and cautious polities of government and RBI pose a great help and ensure a bright future to public sector banks in times of slowdown.
New policies and mature governance have helped India face numerous global crises and yet maintain an enviable growth rate. While most economists worldwide believe that the slowdown of US will impact the global economy but a sizeable number of Indian entrepreneurs and economists believe in India's ability to withstand global- upheavals.
CONCLUSION
Because of the globalization policy of Indian government the Indian banking sector is inextricably linked to its external sector. This linkage is now in two ways, with India both contributing to and benefiting from its external alliances. The slowdown is a temporary and short-term phenomenon. As the U.S. economy has started showing signs of recovery so conditions elsewhere shall also start improving. To harness the opportunities offered by
globalization and combat the concomitant risks it brings, the banking sector in India will have to exhibit the agility to adapt the ever-changing environment as well as retain the soundness of its financial system through adoption of appropriate and prudential regulatory, supervisory and technological framework on a par with international best practices.
