Challenges for the Indian Banking System

Challenges for the Indian Banking system

The Challenges for Indian banking system:
Though Indian Banking system has not been adversely affected because of the global crisis, there should not be any room for complacency as there are several challenges facing the system in the context of very high expectations in supporting the economic growth of the country. Integration of economies and markets, fast evolution of competitive products much ahead of regulatory aspects, high speed with which transactions get effected through out the world because of technological advancement, innovativeness in information management will pose challenges in understanding the risks and successfully surviving in business.

Some of the challenges which the banking system faces in India in the current economic scenario are as under.

Competition:
Competition from different intermediaries through innovative products of assets and liabilities will be a force to be reckoned with. Competition both to mobilize resources and deploy them effectively will be a major challenge. Raising of deposits particularly term deposits will not be as easy as it was, because savers have better avenues to save both in terms of safety and return. Gold, real estate, shares and other forms of deposits with post offices, corporates, investments in mutual funds etc; have been on the increase where the rate of return particularly the real rate of interest is comparatively better. For convenience savings bank deposits will continue to be a preferred mode of savings and that also will be diminishing gradually when the plastic card culture picks up further.

Asset-Liability Mismatch:
The mismatch between deposits liability and advances recovery will be difficult to manage over a period of time. Banks will have more of short term deposits and long term advances as per the present economic scenario. The dynamics in the composition of assets and liabilities will have to be well factored into managing the risks, which in practice will be a difficult task. Banks themselves have admitted after the recent credit policy announcement that one-year deposit is as high as 72% of the total liability, compared to 52% a few years ago --- depositors are not renewing their money with banks.

Similarly advances once they pick up will be more for development of infrastructure which banks cannot afford from the angle of cost and asset-liability mismatch. Besides determining lending rates will be a major task and competition will be fierce to lend at as low a rate as possible. Good borrowers have different sources to tap and banks will have to satisfy with average and below average borrowers exposing themselves to severe credit risk.

In the union budget, Finance Minister had said that IIFCL together with banks will be able to fund the core sector projects involving investments up to Rs 100,000 crore through the take-out financing route. This will create asset liability mismatch and can affect the NIM of the banks adversely.

The aggregate deposits of scheduled commercial banks as on June 5,2009 stood at Rs 39,71,651 crores .The rate of increase in deposits in 2009 is showing a declining trend(22% in 2009 as compared to 23.1%in 2008) Similarly the aggregate bank credit which stood at Rs 27,57,210 crores as on June5,2009 also indicates a declining trend in the rate of growth(15.7%in 2009 as against 26.1%in 2008).Investments in Government securities shows an increasing trend which will have to increase further to meet the governments borrowings proposed around 4,51,000 crores this fiscal. Cash deposit ratio and investment-deposit ratio which stood at 6.04% and 32.10% respectively as on June 2009 only indicates the tendency to move to lazy banking. General increase in NPA levels also discourages further lending.

Asset Liability Management, containment of costs and non-performing loans will be the challenges in the immediate future... It is tough to fund long term assets with short-term liabilities. Further, it is expected that non- performing loans could rise in a few sectors.

Financial Inclusion:
Efforts made so far under Financial Inclusion have met only with limited success. Despite the increase in bank net- work, only 40% of the country’s population has their own bank accounts and the Population covered by a single branch continues to be high. As against 19000 people per branch in 1981, the figure has improved only marginally to 16000 in 2007. The observation as per some estimates that 34.9% of people having annual income less than Rs 50,000 and 5.5% of people earning more than Rs 4,00,000 and above still depend on money lenders for their financial requirements only indicate that the banking system has not fully exploited the business potential. The people excluded from financial inclusion include underprivileged section in rural and urban areas like farmers, small vendors etc, agricultural and industrial labourers, people engaged in un-organised sectors, unemployed people, women, children physically challenged and old people...
With the thrust on social and rural sector advancement in the budget, the need for further penetration of banking to make Financial Inclusion a reality will be insisted upon and the banking system will have to be in readiness to come up to the expectations. It is time to realize the business potential under financial inclusion and translate it into fruition. The task is stupendous and needs a mindset different from what has been demonstrated so far; it requires both business and social acumen. Will the HR and other resources can take up the challenge?

Government Borrowings: In the budget for 2009-10, the fiscal deficit is projected to be at 6.8% and the Government has targeted to borrow to the tune of Rs 451,000crores. This will have some implications in banks’ balance sheet. Interest rates are bound to be high and the valuation of securities will get hit badly. Money for advances will drain and the business of lending will take a beating. Investments in securities will be a trend and to that extent composition of assets and liabilities and income pattern of banks will undergo change. Maintaining Identity of banks as lenders for productive purposes will be a challenge.

Capital Adequacy Requirements:
In tune with the business expansion and expectations of better and stringent regulatory compliance standards in the context of the financial turmoil the world has witnessed recently, the capital of the banking system will have to be augmented considerably. Banks which have international exposure and which have plans to further expand internationally have to find additional capital and other resources.

Consolidation:
Mergers and acquisitions will assume greater importance to meet the challenges of growing competition nationally and internationally. Although there may be space for all banks to operate, situations will arise where consolidation based on specialization of a particular line of business or activity will make more business sense to withstand competition. The concept of universal banking may have to be revisited and changes introduced suitably to get the acceptance of the markets and remain in business successfully.
Competition from international banks can be met only if we have banks of the same size, standing and international experience and expertise. All banks cannot aspire to grow big and it requires capacity and strength to grow organically and inorganically through acquisitions and mergers of banks spread over the international markets. Understanding different financial markets of the world, products, institutions, laws of the land and regulatory requirements can come only over a period of time and it requires lot of planning and careful execution. No doubt some of our banks have to necessarily acquire the status, compete, survive and earn international reputation. The task is really challenging but achievable as has happened in our IT field.
Maintaining NIM at the present level
Banks at present are able to maintain NIM at around 3%. as against international level observed at less than 2%. Will the banking system be able to sustain this in the context of increasing trend in non-performing loans, continuous pressure for reduction of interest rate on advances, declining trend observed in granting advances, higher demand for long term nature of advances under housing and infrastructure segments, competitive rates required for raising deposits, ever increasing operating expenditure etc. is a debatable issue.

Human Resources and Information Technology:
The banking system which was known to have the cream of human resources seems to be losing this status with the emergence of IT and other services segments in the economy. Shortage of staff and demand for emoluments as per the market trends to attract best talents are emerging issues. Succession planning and finding right leaders to run the system professionally may be areas requiring meticulous planning.

Technology has penetrated well into the system but is it adequate to take care of magnitude of financial inclusion envisaged in the coming years will be another issue to be sorted out. Further, containing overall cost for development of sufficient human resources and keeping fast changing technology updated is going to be a very big challenge. Mix of technology and human resources with technological skills and professional knowledge of banking to take care of expansion and future challenges will be a very crucial issue to be seriously taken note of.

Regulatory and supervisory compliance:
The regulatory and supervisory system in India has been observed to be effective and efficient and because of this we have a reasonably safe and sound banking system. As and when the economy expands, markets develop, new institutions come up and varieties of innovative products enter into the system, naturally risk perceptions will change, complexities will evolve and regulatory prescriptions and supervisory standards will get scaled up.

Regulatory cost for the banking system, although has not been exclusively and separately identified so far, it is going to be comparatively high in future and will have to be suitably factored in assessing the overall operating expenditure. Banks vigilance over all products particularly new and innovative products will have to be intensified for which there is a paramount need to equip the human resources with skill and knowledge on an ongoing basis. Frauds which cost the banking system heavily, if not monitored effectively can erode the confidence of all stake holders in the system. Managements will have to be made accountable for all their lapses and failures and expecting the Government to bail out has to go out of the minds of banks boards.


Customer Service:
With the advent of ATMS, internet and phone banking, and POS terminals, the element of human touch in rendering service is virtually given a go bye.
Neither the banks nor the customers seem to be interested in having personal inter-actions. The gap between banks and customers over a period has widened and has been widening further. The relationship is only through documents. The casualty is Loyalty, respect for each other and emotional relationship. Money minded and purely commercial relationship has been emerging at the cost of ethics and values. Can it go on like this? is another issue to be debated seriously. Even from the angle of adhering to KYC norms, it is essential and advisable to have personal rapport once in a while to understand the customer better.
Any bank which cares to maintain personal rapport with customers whether they are deposit customers or advance customers or some casual customers will have an edge over other banks and reap the benefit of enduring relationship in terms of business growth, improving Corporate Governance standards, satisfying social responsibility and enjoying loyalty. Banking business is run on mutual trust and confidence and this can be ensured only through human touch and intelligence.

Dr.T.V. Gopalakrishnan
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