Stressed assets on the books of Indian banks are higher than the net worth of the entire sector, said McKinsey & Co. in a report released on Tuesday. The situation is most acute for public sector banks where stressed assets are now about 50 percent higher than the total net worth of these lenders.
Highlighting the challenges facing the sector, the consultancy firm said that stagnant credit growth in a low interest rate environment; a high level of stressed assets; and dramatic changes in the technological and regulatory environment are creating a perfect storm-like condition for the Indian banking sector.
According to data provided in the report, total stressed assets on the books of public sector banks stand at Rs 8.53 lakh crore. In comparison, their combined net worth is at Rs 5.69 lakh crore. In the case of private sector banks, total stressed assets are at around Rs 1.08 lakh crore, as compared to the Rs 3.55 lakh crore net worth of these banks.
At the aggregate level, stressed assets are marginally higher than the combined net worth.
The report added that the level of provisions set aside by public sector banks is nowhere near enough to cover the declared stressed assets and falls short by almost Rs 6 lakh crore.
To cover for the large stressed loans in the system, India’s public sector banks will have to look beyond the government for capital infusion, McKinsey said. Between 2009 and 2016, the government has already infused about Rs 93,000 crore into public sector banks. The government intends to pump in Rs 10,000 crore each into public sector banks in financial years 2017-18 and 2018-19.
However, the capital requirement of the entire banking system is estimated to be much higher at Rs 1.85-2.75 lakh crore, the consultancy noted.
Unless this is corrected, a weak capital base and a large pile of stressed assets will impact the supply of credit to the economy, as public sector banks still account for 70 percent of the banking system.
Shifting Market Share
The paralysis that has gripped public sector banks due to the stressed asset problem is also leading to a shift in market share within the industry. Using this opportunity, private banks and non-banking finance companies (NBFCs) have managed to corner a larger share of the market over the last few quarters.
In terms of total assets, new private sector banks have managed to increase their market share to 21 percent of the total assets in the banking system as on December 31, 2016, as compared with 15 percent as on March 31, 2011.
Similarly, operating profits for private banks have risen to 32 percent of the total operating profits of the banking sector, as compared with 18 percent in 2011.
As the perfect storm continues, the industry is becoming increasingly polarized. Private sector banks outperform the state-owned ones and continue to capture an ever-greater share of the market, as the latter remained burdened by legacy and the constraints of public sector ownership.McKinsey & Co.
At a structural level, there are three key challenges for public sector banks, said the report. This includes a high degree of fragmentation, the lack of differentiation and the inherent restrictions that come with government ownership.
How Will This End?
In its report, McKinsey & Co has listed three possible scenarios that might emerge, depending on how the banks, the government and the regulator handle the situation.
If the current status quo continues, banks are likely to contract and become more unprofitable. India’s banking sector may then be unable to meet the financing needs of a growing economy.
If the government chooses to pump in more capital into banks without addressing structural issues facing the sector, there might be some temporary revival of growth. However, this temporary revival will become unsustainable in the long run.
However, if all stakeholders decide to address the key challenges and reinvent traditional business models, the sector can strengthen in the long run. This scenario should include consolidation in the sector.
At some point we are going to have to face the question that we do not need so many public sector banks, who do more of the same. We should look at a system where we have about one or two large global scale banks, three or four strong medium-sized regional banks and a clutch of smaller niche banksReny Thomas, Senior Partner, McKinsey & Co.
Consolidation, however, will not be adequate in itself, Thomas said. As part of the structural reform strategy, McKinsey believes that there is a need to bring in motivated and capable leadership at merged public sector banks to ensure successful consolidation. Privatisation of public sector banks may also become important, the report said.