Explained: Why RBI Has Reasons to Worry About Indian Banks' Pursuit of Maximum Profit

In FY24, private banks saw their profits soar by an impressive 41 per cent, while public sector banks (PSBs) witnessed a 35 per cent rise in the same
RBI Governor Shaktikanta Das
RBI Governor Shaktikanta Das

RBI Governor Shaktikanta Das's recent comments on the profitability of banks and the need to be cautious of the risk involved while pursuing it have once again echoed the uncertainty present in the lending system.

"Pursuit of business growth is important, but it should never come at the expense of taking on unacceptable risks," Shaktikanta Das said at a conference.

In FY24, private banks saw their profits soar by an impressive 41 per cent, while public sector banks (PSBs) witnessed a 35 per cent rise in the same. However, beyond just mere profits, it's the quality of loans being disbursed in the retail segment that has caught the eye of the apex bank.

A risky play in the retail lending space

In recent years, there has been a sharp rise in unsecured lending within the retail segment which is worrying RBI.

According to a statement released in the RBI bulletin, earlier this year, "the composition of retail credit has also been changing over time. The share of unsecured credit within the retail credit has been rising. Between 2007 to 2023, the share of unsecured advances in retail credit increased from 25 to 35 per cent."

Even the share of personal loans in total credit surged over the past year, jumping from 28.6 per cent in December 2022 to 30.9 per cent in December 2023.

As per Bernstein's analysis, the compound annual growth rate (CAGR) of transaction values via credit cards was 28.7 per cent from FY21 to FY20. This figure surged to more than 50 per cent between FY21 and FY23.

Last year, RBI had raised red flags over lending to NBFCs (Non-banking financial firms). While banks have reduced their lending to NBFCs to about 18 per cent from the earlier 29-30 per cent, the portion of unsecured loan lending still remains high, albeit at moderate levels.

“Our timely action (to curb higher growth in unsecured credit) has resulted in a situation where the growth in unsecured loans, which was in the order of 30 per cent year-on-year (before the RBI’s action in November 2023) for credit card outstanding, has now come down to 23 per cent,” Das said

The gross non-performing assets (GNPA) ratio for NBFCs stood at 3.9 per cent at the end of March 2024, down from 5.03 per cent at the end of March 2023 and 6.29 per cent a year before.

However, this decline in figure came after the regulator increased its scrutiny over the unsecured lending space, last year. The RBI came down heavily on NBFCs after it noticed lags in corporate governance and violation of operational boundaries.

All clean or a turbulent road

While both private and public banks clocked record profits in the last quarter, the lagging pace of deposits in terms of credit has been a rough road for banks as margin pressures continue to linger across their balance sheets.

“We now look at the sustainability of business models of banks and NBFCs. Root cause analysis of problems and vulnerabilities are undertaken. Advance action is initiated wherever we notice or smell a crisis,” Das said.

He also added that banks should avoid the “mindless pursuit of bottom lines.”

The loan-to-deposit ratio already reached an all-time high of 80.3 per cent in the March quarter. Stuck in a rock and a hard place, the banking sector still continues to dance on a euphoric tone with robust figures.

Last month Prime Minister Narendra Modi praised the banking sector's overall performance as the net profit figure crossed the Rs 3 lakh crore mark in FY24.

Nifty Bank, meanwhile, has delivered a return of nearly 7 per cent on a year-to-date basis, despite NIMs (Net interest margins) remaining under pressure.

This euphoric image was also backed by global brokerage firm CLSA recently, as it said in its report that, "balance sheets (of banks) are the strongest they have been in over a decade, and profits have rebounded sharply."

However, RBI's latest statement comes at a time when both private banks and PSBs are witnessing a steady CASA ratio against the rising cost of funds.

While profits will remain a key to gauging the euphoric performance of India's banking sector, it would be worth looking at how these institutions will take RBI governor's cautionary note against unsecured lending.

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