The Challenges Ahead Of Banks

The Challenges Ahead Of Banks

THE CHALLENGES AHEAD OF BANKS

                                                                     *G.JAYALAKSHMI., Ph.D Research Scholar

  

INTRODUCTION 

           

 

India’s banking industry is at a watershed. Evidence from across the world suggests that a sound and evolved banking system is required for   sustained economic development. India has a better banking system in place Vis a Vis other developing countries, but there are several issues that need to be ironed out.

           

A strong performance in the current year, strengthening the positive trends of the past, will certainly improve the short-term risk perception but focus must rest on key structural changes that have to occur if Indian banking is to be a positive force and not a drag on the rest of the economy.

           

It has met and successfully overcome several challenges over the last decade. But bigger challenges lie ahead. In this paper, we try and look into the challenges that the banking sector in India faces.

 

Interest rate risk

           

The first and most obvious challenge will come from rising interest rates. The current perception is that interest rates have stopped falling and are likely to remain steady, but if demand for resources picks up as firms start to invest in new capacity and boom conditions fuel consumption demand, then there may be a tightening of liquidity and upward pressure on interest rates.

 

Interest rate risk can be defined as exposure of bank’s net interest income to adverse movements in interest rates. A bank’s balance sheet consists mainly of rupee assets and liabilities. Any movement in domestic interest rate is the main source of interest rate risk.

           

            Over the last few years the treasury departments of banks have been responsible for a substantial part of profits made by banks.

 

Now as yields go up (with the rise in inflation, bond yields go up and bond prices fall as the debt market starts factoring a possible interest rate hike), the banks will have to set aside funds to mark to market their investment. This will make it difficult to show huge profits from treasury operations. This concern becomes much stronger because a substantial percentage of bank deposits remain invested in government bonds.

           

Banking in the recent years had been reduced to a trading operation in government securities. Recent months have shown a rise in the bond yields has led to the profit from treasury operations falling. The latest quarterly reports of banks clearly show several banks making losses on their treasury operations. If the rise in yields continues the banks might end up posting huge losses on their trading books. Given these facts, banks will have to look at alternative sources of investment.

 

 

 

Non-performing assets

           

The best indicator of the health of the banking industry in a country is its level of NPAs. Given this fact, Indian banks seem to be better placed than they were in the past. A few banks have even managed to reduce their net NPAs to less than one percent (before the merger of Global Trust Bank into Oriental Bank of Commerce, OBC was a zero NPA bank). But as the bond yields start to rise the chances are the net NPAs will also start to go up.

 

This will happen because the banks have been making huge provisions against the money they made on their bond portfolios in a scenario where bond yields were falling.

 

Reduced NPAs generally gives the impression that banks have strengthened their credit appraisal processes over the years. This does not seem to be the case. With increasing bond yields, treasury income will come down and if the banks wish to make large provisions, the money will have to come from their interest income, and this in turn, shall bring down the profitability of banks.

 

Capital adequacy norms

           

            A third and a key challenge will be the introduction of Basle II capital adequacy norms. These will make two demands on banks.

 

They will have to measure the risks they bear much better. For this they will need to overhaul their management information systems so that they have a clear and quantifiable idea of their risks.

 

            Then they will have to look for capital to back that risk and ultimately earn enough to be able to service that capital. R Ravimohan, managing director of Crisil, feels that the future is all about technology and risks.

 

There is a huge potential for undertaking risk assessment by using technology. It is imperative for banks to grow but the key issue is deciding where and how.

 

            New ways or managing risk and asset-liability mismatches, like asset securitization, which unlocks resources and spreads risk, are likely to be increasingly used.

 

Competition in retail banking

           

            The entry of new generation private sector banks has changed the entire scenario. Earlier the household savings went into banks and the banks then lent out money to corporate. Now they need to sell banking. The retail segment, which was earlier ignored, is now the most important of the lot, with the banks jumping over one another to give out loans.

 

The consumer has never been so lucky with so many banks offering so many products to choose from. With supply far exceeding demand it has been a race to the bottom, with the banks undercutting one another. A lot of foreign banks have already burnt their fingers in the retail game and have now decided to get out of a few retail segments completely.

 

The nimble footed new generation private sector banks have taken a lead on this front and the public sector banks are trying to play catch up. The PSBs have been losing business to the private sector banks in this segment. PSBs need to figure out the means to generate profitable business from this segment in the days to come.

 

Conclusion

           

Over the last few years, the falling interest rates, gave banks very little incentive to lend to projects, as the return did not compensate them for the risk involved. This led to the banks getting into the retail segment big time. It also led to a lot of banks playing it safe and putting in most of the deposits they collected into government bonds.

 

Now with the bond party over and the bond yields starting to go up, the banks will have to concentrate on their core function of lending.

           

The banking sector in India needs to tackle these challenges successfully to keep growing and strengthen the Indian financial system.

 

            Furthermore, the interference of the central government with the functioning of PSBs should stop. A fresh autonomy package for public sector banks is in offing.  The package seeks to provide a high degree of freedom to PSBs on operational matters. This seems to be the right way to go for PSBs.

 

            The growth of the banking sector will be one of the most important inputs that shall go into making sure that India progresses and becomes a global economic super power.