Public Sector Banks Have No Business Model

By the time August comes around, the rains in Mumbai have slowed down. The August rain in Mumbai is more like the romantic rain of Pune, where you can walk hand in hand with your partner, as the rain god smiles.

In this romantic rain late yesterday evening, I stepped out to look for a kaali-peeli, with the Uber prices reaching very high levels, on yet another weekend evening. As soon as I stepped out of my building I realised that I wasn't carrying enough cash to be able to pay the cab fare.

This meant that I would have to go to an ATM to withdraw money. The ATM closest to where I live, as usual had the out of cash sign on display. The second ATM I went to had the following sign on display.

You think you have seen almost everything, when it comes to the public sector banks in India.

And then you see this.

This is the most basic of things, which every bank should be able to take care of (and I am not even talking about the spelling mistakes in Hindi). One honestly wonders, if the public sector banks cannot even handle these basic things, should they even be in the business of banking.

At the heart of banking is the concept of maturity transformation, where lenders lend money to the bank for the short-term, and the bank in turn lends out money for the long-term. In this way, the short maturity of the deposit is turned into a longer tenure of the loan.

Let's take an example of home loans given by banks. The bank borrows money in the form of fixed deposits. Most fixed deposits tend to have a tenure of five years or lower.

On the other hand, home loans are typically given out for a tenure of 15 to 20 years. Basically, by borrowing in the short-term and lending for the long-term, a bank makes money, on the difference in interest rates. The key word here is that the bank has to "lend," to be viable.

Let's look at the Figure 1, which basically plots the credit deposit ratio of public sector banks, at the end of every financial year, over the last few years. The credit deposit ratio is obtained by dividing the total credit outstanding at the end of the year by total deposits that the bank has at the same point of time.

Figure 1: Credit deposit ratio of public sector banks  

What does Figure 1 tell us? It tells us that the credit deposits ratio of public sector banks has been falling over the years. As on March 31, 2013, the credit deposit ratio of public sector banks had stood at 77.8%. This basically meant that more than three-fourths of the deposits had been given out as loans.

As on March 31, 2018, the credit deposit ratio had fallen to 69%. What does this mean? It basically means that banks are not able to carry out enough lending against all the deposits that they have raised over the years.

In fact, Figure 1, does not tell us gravity of the situation. For that we need to plot the incremental credit deposit ratio i.e., the total loans given during the course of any year by these banks divided by the total deposits raised during the same year. Let's take a look at Figure 2.

Figure 2:  

What does Figure 2 tell us? It tells us that over the years the total amount of credit given by public sector banks against the deposits raised, during the course of a year, has come down dramatically.

In 2012-2013, more than 80% of the deposits raised were given out as credit. In 2016-2017, not a single new rupee of loans was given. In fact, the total outstanding credit of public sector banks, actually contracted. In 2016-2017, the banks raised Rs 5,90,604 crore of deposits, without giving a single rupee of a new loan, on the whole. This was primarily on account of demonetisation.

This meant that the maturity transformation model of banking totally collapsed for public sector banks. In 2017-2018, the banks have been able to reverse it and lend close to 75.5% of the deposits raised during the year. Nevertheless, in absolute terms the overall lending was a very low Rs 1,40,118 crore. In comparison, the public sector banks had lent Rs 6,28,209 crore, during 2013-2014.

Of course, over the years, a lot of lending carried out by public sector banks has gone bad. Having said that, if these banks are to be in the business of banking, they need to be able to lend money. There is no point in raising money from people in the form of deposits, and then not lending it or simply investing all the money in government bonds (something that the government would love, but will hurt the overall economy).

What does not help that 59.4% of deposits of public sector banks as on March 31, 2018, were term deposits, on which banks pay a higher rate of interest in comparison to current and savings account deposits. Hence, giving out loans is important.

Of course, in the past I have talked about narrow banking i.e. most public sector banks should be allowed to make "only" retail loans. While that is already happening at some level, the smaller public sector banks need to be given a full fledged mandate to do just that.

Now let's take a look at the incremental credit deposit ratio of private sector banks, in Figure 3.

Figure 3:  

Figure 3 tells us very clearly that the incremental credit deposits ratio for private sector banks is significantly higher than the public sector banks. In 2016-2017, it reached a low of 67.2%. This was a year, when public sector banks did not lend any fresh money, on the whole.

In this scenario, it is worth asking do the public sector banks have the wherewithal to take on private sector banks, especially the new generation private sector banks?

My answer is no. As I have mentioned in the past, the privatisation of the Indian banking sector has already started and in the years to come, it will only go from strength to strength.

Regards,


Vivek Kaul
Editor, Vivek Kaul's Diary