A CRISIS-PROOF BANKING SECTOR

Mr. T.T. Ram Mohan has written a very good article in The Economic Times on how Indian Banking Industry   came out of the crisis witnessed  by the Global Banking Industry. As the article has dealt with the strengths of the Indian Banking Industry and posed a question to the people who urge for banking sector reforms on the need of fixing in a system that ain’t broke, we reproducing the same here with due acknowledgements to the columnist for the benefit of our readers. 


The Sub-Prime crisis peaked in September 2008 following the collapse of Lehman Brothers. Many forecast that 2009-10 would be the year of reckoning for the Indian economy and for Indian Banking, both of which had successfully weathered the crisis until then. I disagreed. I said that banking would be a bright spot in the economy given the strengths inherent in the sector.


The pessimists have been proved wrong about the Indian economy — the economy is projected to grow at more than 7% in 2009-10 . They are going to be proved even more wrong about the banking sector. The Bankex has outperformed the Sensex during April-December 2009. It rose by 123% while the Sensex rose by 73%. In 2008-09 , the Bankex had declined by 40%, a little more than the decline of 37% in the Sensex.


We have to await the details of financial performance for 2009-10 but the RBI’s Report on Trend and Progress in Banking (2008-09 ) tells us what happened last year and gives us clues to what we might expect this year. It is indeed a revelation. In the midst of the worst financial crisis of the century and when banks in the industrial world were falling apart, the Indian banking sector fared as well as in the boom years.


Banks managed a return on assets of 1% in both 2007-08 and 2008-09 , slightly higher than the 0.9% return of 2006-07 . This should place the Indian banking sector amongst the most profitable in the world today . Banks elsewhere saw their capital eroded and required infusions of capital from governments. In India, capital adequacy actually improved in 2008-09 . What better indicators of banking soundness do you need than world-class profitability and improved capital in the midst of devastation in the banking sector worldwide?


After the Lehman collapse, pundits forecast that the moment of reckoning for Indian banks had arrived following years of commercial credit growth of around 30%. They said banks would face a mountain of nonperforming assets (NPAs) as Indian companies and the housing sector felt the impact of the global crisis. There are models that predict that a sustained credit boom leads to bank failures and even a banking crisis. This did not happen in 2008-09 and is unlikely to happen in 2009-10 either.


Bad times for the economy spell lower credit growth. In 2007-08 , commercial credit growth slowed to 22%. It slowed further to 18% in 2008-09 . But banks maintained their return on assets in 2008-09 at the same level as in the preceding boom years of 2004-08 . This is truly astonishing . It suggests that no matter what the ups and downs of the economy, the Indian banking sector can deliver a return of 1% on assets, a benchmark of good performance in banking. India today seems to have a crisis-proof banking sector.


What explains this phenomenon? One, banks’ ability to sustain spreads — return on advances minus cost of funds — at all times. Volume growth slowed down in the last two years. But the spread on loans actually increased in 2008-09 . A key factor driving large spreads in Indian banking is the high proportion of current and savings account (Casa) deposits. These account for a more a third of all deposits in Indian banking. Banks pay zero interest on current accounts and 3.5% on savings accounts.


Secondly, banks have woken up to the potential for fee income. Apart from conventional products that generate fees such as letters of credit, guarantees and mortgage products, banks now generate fee income from sale of mutual fund and insurance products.


Thirdly, falling interest rates in a slowdown lead to a surge in treasury profits on banks’ investment in government securities. By the same token, rising interest rates in boom periods should cause these profits to decline. They do, but there have been other offsetting factors: gains on equities and foreign exchange products.


Fourthly, the slowdown that we have seen in the past two years has not caused any increase in provisions on account of rising NPAs. That is because a deceleration from 9% to 7% may mean lower growth in earnings but it hardly spells disaster for companies. Besides, companies entered the crisis with sound balance-sheets after five boom years. There was a large increase in housing prices before the slowdown but this does not appear to be a bubble. It is based on genuine demand and increased affordability.


Experts told us that India’s antiquated banking sector was constraining growth. Reforms in the financial sector would deliver another two percentage points of growth. We have since found that the banking sector can support economic growth of 9%.


Banks, of course, need to do more. We need more sophisticated products. There is the challenge of financial inclusion. But those who urge banking sector reforms need to tell us what exactly needs fixing in a system that ain’t broke.


Source: http://economictimes.indiatimes.com/opinion/columnists/t-t-ram-mohan/A-crisis-proof-banking-sector-/articleshow/5418626.cms