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Forecast: Credit to continue upward

Forecast: Credit to continue upward

The Indian banking sector has withstood the global financial turmoil and continued to grow at a healthy pace. Among other things, Sanketh Arouje predicts that take-out financing will take off this year in right earnest.


The banking sector business has grown at a CAGR of around 23 per cent between FY 05 to FY 10. On account of lower capital expenditure by the industry, coupled with the apprehension of the banking sector to issue credit the sector witnessed a slightly modest growth in FY 10 y-o-y of around 16.7 per cent. However, the sector has witnessed a pickup in the current financial year, with a growth of around 20 per cent y-o-y as of October 2010. With the overall economy expected to grow at around 8.8 per cent for FY 11, and services and industry expected to grow at a faster pace of around 10.3 per cent and 9.5 per cent respectively, bank credit is expected to continue at a healthy pace.


Take-out financing to revive


Take-out financing is a method of providing finance for longer duration projects (say of 15 years) by banks by sanctioning medium-term loans (say five to seven years). It is an understanding that the loan will be taken out of books of the financing bank within a pre-fixed period, by another institution thus preventing any possible asset-liability mismatch as most of the liabilities of the banks are in the form of deposits which have tenure of less than five years. As per FY 09 RBI data on maturity pattern of deposits, around 7.4 per cent of the total deposit amounts for SCBs were for more than five year maturity. After taking loans from banks, the institution could off-load them to another bank or keep it. Although take-out financing as a concept has witnessed teething issues, the revival of the same is expected given the RBI allowing it via ECBs.


Shift to base rate system


The Indian banking sector moved to the base rate system from July 2010 as against the incumbent Prime Lending Rate (PLR) system. The base rate is calculated as the cost of deposits and cost of keeping aside cash to meet CRR and SLR requirements. With no bank allowed to lend below the base rate, the NBFCs and corporations with better ratings, which until the introduction of the base rate could negotiate and borrow below PLR from the banks, could now move to issuing commercial papers for their short-term capital requirements for tenures ranging from 15-365 days. Since the interest rates on commercial papers are linked to the yield on the one year government bond, they would turn out to be cheaper than banks loans for better rated companies. The banks can then invest in these commercial papers. The direct investments of SCBs in commercial papers rose from Rs 275 billion in July 2010 to Rs 438 billion in September 2010. In terms of share too, investments in CPs rose from 1.7 per cent of total investments to 2.5 per cent of the total investments in during this period. We expect this trend to continue and gain pace in the coming year.


Inclusion thrust widens reach


RBI has been actively encouraging financial inclusion. Only around 40 per cent of the Indian population is currently connected to the banking system. RBI has issued a directive to public sector banks to ensure that all these villages with population of above 2,000 be brought under the banking net by 2012 resulting in an addition of 145 million customers.


Mobile technology


As per the FY 10 RBI release, around 90 per cent of the public sector branches have been updated with core banking software, while around 97.8 per cent of the public sector banks’ branches have been fully computerised. In FY 10, the share of electronic transactions to total transactions stood at around 89 per cent in value terms and around 40 per cent in volume terms.


The next leg of growth is expected to be driven by mobile banking technology. This would also be in corroboration with RBI’s thrust on financial inclusion. There were around 525.9 million mobile connections in India as of November 2010, compared with around 69,160 branches and 60,153 ATMs. Mobile technology is expected to increase reach and ease. Corroborated with the business correspondent model and UID, this is expected to make banking services accessible to very small habitations by utilising mobile technology where setting up a branch is unfeasible.


Consolidation the way forward


The Indian banking sector has witnessed consolidation over the past couple of years. As per RBI data there have been around 25 mergers in the banking sector in the last two decades. Having a minimum capital of more than Rs 10 billion is one of the options that RBI is contemplating as the minimum capital requirement to obtain a new bank licence. Given that around eight domestic banks still have a net worth lower than Rs 10 billion, in FY 10, there is further scope for consolidation. Also, this would help banks meet capital adequacy requirements and finance large transactions and investments made by the corporate sector.


The author is Leader, Economic Analysis, Dun & Bradstreet India (www.dnb.co.in), and can be contacted at aroujes@mail.dnb.co.in.

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