Tuesday, Dec 06, 2022

Changing the lending paradigm: For banking, small is the new big

Considering that big corporates are over-leveraged, banks need to explore new avenues for profitable lending to spruce up their balance sheets.

 The concept of differentiated banks was first discussed in 2007; but the RBI felt that the time was not opportune for them. The concept of differentiated banks was first discussed in 2007; but the RBI felt that the time was not opportune for them.

Risk aversion stemming from the stress in financial assets has been one of the primary reasons for restrained bank credit growth in recent times. Overleveraged corporates cannot be lent to anyway, especially when the banks are faced with question marks over the repayment schedule and looming defaults by a bevy of triple ‘A’-rated industrial groups.

So, given the context, looking beyond the blue chips and focussing on lending small is working out to be the most practical alternative for the government and the banking regulator, both as a means of nudging banks to push lending as well as fueling growth in the economy. For the Reserve Bank of India, a slew of new specialised bank licences marks a big incremental push in opening up the country’s banking sector, quite in line with its Governor’s belief in the Chinese adage: “Cross the river by feeling the stones.” Six months after giving in-principle licences to two entities for setting up commercial banks, the RBI issued licences for newly-licensed full-service banks and set the ball rolling on eleven payments banks and ten small banks, which could open up the lower-end of the country’s banking sector. A third category, wholesale banks, are said to be on the anvil. In this context, lending to smaller, unbanked people or entities falls well into the NDA government’s strategy of pushing funds to the unbanked, through its Jan-Dhan programme and other financial inclusion programmes — all of which are expected to touch a certain momentum once the opened accounts see direct fund transfers from the Centre in the due course, including food, fuel and fertiliser subsidies.


There is no contesting the fact that the formal banking sector has simply fallen way short of the requirement, considering that despite the 157-odd domestic banks operating in the country -26 public sector banks, seven new private sector banks, 13 old private sector banks, 43 foreign banks, four local area banks, and 64 RRBs — just about 40 per cent of the adults had formal bank accounts till two years back.

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Compounding the problem is that fact that the symbiotic relationship between the corporate sector and banks during the boom years of the mid-2000s has led to most scheduled commercial banks, especially the public sector ones, ending up with excessive exposure to a particular sector or sectors, even as the corporate increased their leverage manifold and invested in creating excess capacities. Unravelling of the risks could perhaps still be managed if the banks’ capital positions were strong, but if that is not the case the risk of an implosion in the banking sector looms large.

Small is big

Sixty per cent of India lives in semi-urban and rural areas, which will not be touched to a large extent by the new technological advances being made by banks, including internet banking and the e-commerce opportunity. The concept of differentiated banks was first discussed in 2007; but the RBI felt that the time was not opportune for them.

Thereafter, the concept was once again discussed in a paper, ‘Banking Structure in India – The Way Forward’, brought out by the Reserve Bank in August 2013. Traditionally, like other emerging markets, the Indian economy has been bank-dominated. So whether it is for project development or working capital needs of the corporates, banks have been the primary source of credit. With the gradual widening and deepening of India’s financial markets, banks have been expected to gradually shift their focus to SME and retail clients while leaving the long-term resource contribution to other players such as pension funds and insurance companies, which have long-duration liabilities on their balance sheets.

Over the last two years, both the government and the central bank have consistently nudged banks to redouble efforts to bring smaller players — individuals and industry — into the fold of the formal banking system. New institutions such as the MUDRA Ltd are likely to propose innovative new ways of channelling flows to small producers. The RBI has revamped priority sector guidelines so as to reemphasise lending to excluded or nationally important sectors in a changing economy. In particular, it set new targets of 8 per cent of adjusted net bank credit to small and marginal farmers and 7.5 per cent for micro enterprises, while allowing medium-sized firms, social infrastructure such as toilets, and renewable energy investments to qualify for priority sector credit.


The situation on the big corporate lending continues to be mired in problems. The labyrinthine maze through which several large infrastructure projects have been funded point to extremely low or negligible levels of equity contributions leading to extremely high levels of leverage and virtually no skin in the game for the promoters. These infra projects were launched by a handful of promoters that has run out of even such thin level of equity to contribute their fair share for revival of the stalled projects, not to talk about commissioning of new projects.

The Global Financial Stability Report released by IMF recently has noted that 36.9 per cent of India’s total debt is at risk, which is among the highest in the emerging economies, while India’s banks have only 7.9 per cent loss absorbing buffer, which is among the lowest. An analysis of a sample of 3,700 companies by Credit Suisse has highlighted that 37 per cent of the debt held by these companies is with companies having Interest Coverage less than 1.

Turning the focus around

Amid all of this mess, the refocus on the smaller players in the Indian economy draws inspiration from the fact that the local area bank model, which the RBI started a couple of years ago and since performing with mixed results, was not given a fair chance. The payments banks, according to the central bank’s proposal, will accept deposits and offer remittance services to migrant workers, low-income households and small businesses in a technology-driven, relatively secure environment. The central bank is betting on small banks to take basic banking services, including acceptance of deposits and lending, to unserved and underserved sections of the population. Eight out of 10 entities are already operating in the microfinance business, and they are gearing up to start banking operations in the next 18 months. The idea of a small bank that serves the relatively neglected sections of the local population — farmers, small industry and shopkeepers — in a bid to bring about financial inclusion is appealing in its practicality.


Adding to this diversification effort, the RBI has focussed on the MSME sector, which has the potential to foster strong growth by creating local demand and driving consumption. Currently, MSMEs contribute nearly 8 per cent of the country’s GDP, 45 per cent of the manufacturing output and 40 per cent of the exports. They provide the largest share of employment after agriculture and are nurseries for entrepreneurship and innovation. To specifically address the issue of delayed payments to the MSME sector, Trade Receivables Discounting System (TReDS) has been conceptualised as an authorised electronic platform to facilitate discounting of invoices and bills of exchange of MSMEs.

What the RBI believes in is that if momentum has to continue, then corporates have to either find fresh equity on their own or make way for others who can contribute such equity both for the existing projects and also for new ones. The small consumer thrust is expected to provide further impetus to accessibility of finance and render the credit intermediation process more efficient, thereby contributing to a sustainable and inclusive growth. A cut in interest rates is expected to come as a shot in the arm for furthering this agenda.

First published on: 29-09-2015 at 02:26:04 am
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