Is Indian banking on the verge of temporary collapse?

As most of the public sector Indian banks came out with their Q4 results along with the annual results for the fiscal year 2013-14 last week, a sense of despondency gripped the Indian banking market with red alarms ringing in RBI and Govt. offices. The reason behind this alarming response to the annual results of the various banks, according to the industry experts, was quite simple. More than 23 of the 27 nationalized banks had their NPA’s increased in the period 2013-14 with actual profits realized being less than expected profits. More than 5 public sector banks had their profits in red. Except for Bank of Baroda and a few other banks (Q4 result of State Bank Of India hasn’t been announced yet), which managed to salvage and restore some confidence among the investors in the banking industry with their positive results, all other banks struggled to keep the momentum going. 

So, what all this turmoil in India’s banking industry convey us? Is India on the brink of a temporary financial/banking collapse? The answers to the above questions seem ominous and menacing in short. Increasing Non performing assets (NPA) has been a major problem that India has faced for quite some time now. The NPA’s have increased to 3.02% of the total credits in 2013-14 as compared to 2.27% in 2012-13. These percentage numbers might not look haunting until we have a clue of the total credit numbers that we are dealing with. The total credit that we are dealing with is Rs. 56.57 lakh crore. Yes, you read it right. That amount is equivalent to 4 times of India’s budget for the year 2013-14. Further, with the performance and profitability of the sectors like textiles, infrastructure, basic metals, and chemicals, which account for more than 60% of the total outstanding credit, going down, we can expect the situation to get worse. 

So, how did we reach such an adverse situation? Banking industry reached such a dire state today because of our excessive and blind focus on opening more and more banks to achieve the goal of financial inclusion, without empowering our banks with the opportunities to compete in a fair manner by giving them the chances to absorb profits. 27 nationalized banks competing along with numerous private players, in the form of private banks and NBFC’s, for a share in a market and economy which was still in a nascent stage killed the growth of our banking institutions and ultimately led to losses. Instead of allowing a few banks to operate and expand their businesses, we opened a large number of the banking institutions at the same time in order to achieve our long desired goal of “financial inclusion”. In running for that goal, we increased the competition beyond a feasible limit for the industry to be profitable. Banking is an industry which requires a huge amount of operating costs accompanied with higher risks. Therefore, it is next to impossible for small banking institutions to compete with larger players in the market and hence continue making profits. This affects the overall credibility of smaller banking institutions, which is definitely not good for the health of the Indian banking industry. Hence, it is imperative on the central bank of the country i.e. Reserve Bank of India to be prudent and wise while trading off between achieving financial inclusion and maintaining stability of the banking institutions. Stability of the banking institutions can’t be sacrificed for a unidirectional aim of realizing financial inclusion. There has to be a balance between the two. Hope this balance is maintained.