State of Banking : 2006-07

N.A. Mujumdar

The "Reports on Trend and Progress of Banking in India", prepared by Reserve Bank of India (RBI) annually have always been authentic documents on the state of banking and the Report for 2006-07 is no exception. This is a highly analytical document covering not only commercial banks, but also cooperative banks, micro-finance, non-banking financial companies and the discourse on financial stability. This brief article seeks to focus on the following five aspects of commercial banks: Profile of Credit, Deposits Growth, Financial Performance, Financial Inclusion, and Migration to Basel II norms.

The operations of scheduled banks (SCBs) were marked by a large expansion of credit for the third year in succession. While credit to the retail sector, particularly housing and commercial real estate slowed down significantly, there was a marked improvement in credit flow to the Small Scale Industries (SSI) sector. Deposits growth accelerated. Net profits of SCBs increased sharply mainly due to a jump in net interest income stemming from the increase in the volume of credit.

Profile of Credit

Loans and advances of SCBs continued to register a high growth of 30.6 per cent in 2006-07: this was close on the heels of equally sharp rises of 33.2 per cent and 31.8 per cent in 2004-05 and 2005-06 respectively. Thus for the third year in succession, credit expansion was phenomenal. This run-away expansion in credit has to be contextualised. First robust macro economic performance continued to underpin the performance of banks. National income or gross domestic product (GDP) accelerated to 9.4 per cent in 2006-07 from 9 per cent in the previous year. Real GDP growth during the Tenth Plan period (2002-03 to 2006-07) averaged 7.6 per cent - the highest average rate of growth during any Plan period so far. Second, banks could sustain such an unprecedented growth in credit because they had built up liquidity in the form of excess investments in SLR (Statutory Liquidity Ratio) securities. By bringing down their surplus resources banks have been able to sustain such a phenomenal expansion in credit. This is clear from the fact that incremental Credit-Deposit ratio was as high as 110 per cent at end March 2006; and this ratio declined to 81 per cent at end March 2007. This is a welcome sign of some moderation in the run-away expansion of credit.

Although the performance of banks in priority sector lending has improved in recent years, there are sizeable variations in respect of various bank groups. Only five public sector banks achieved the overall target of lending to priority sector and sub-targets of lending to agriculture and weaker sections. Thirty one banks - 12 public sector banks and 19 private sector banks, achieved the overall target, but did not achieve the sub-targets. Ten banks - 6 public sector banks and 4 private sector banks - did not achieve the overall target as also the sub-targets.

In retail credit, the growth of retail portfolio of banks decelerated from 40.9 per cent in 2005-06 to 29.9 per cent in 2006-07. Within the retail sub-sector, credit for consumer durables recorded the highest growth at 63.3 per cent in contrast to the previous year's growth of only 17.3 per cent.

It may be recalled that RBI had expressed some concern about the recent rapid growth of bank lending to sensitive sectors, namely, capital markets, real estate and commodities Credit to these sectors decelerated sharply during 2006-07 from the rise of 74.4 per cent witnessed in 2005-06 to 41.2 per cent. While credit to real estate market decelerated sharply, credit for commodities increased substantially.

Deposits Growth

A distinguishing feature of banking developments in 2006-07 was the quantum jump in deposits growth. Aggregate deposits grew by 24.6 per cent in contrast to a growth of only 17.8 per cent during the previous year. Accelerated growth in term deposits contributed to this impressive performance. Three factors responsible for this phenomenon may be listed. First, there was a clear shift from postal savings to term deposits of banks due to favourable interest rate differentials and there was also the factor of extension of tax benefits to long-term bank deposits. Second, the demand for term deposits increased from the corporate sector entities which were cash-rich: they parked their surplus funds with banks. Third, non-resident deposits registered a growth which was much higher than that during the previous years.

Financial Performance

Operating profits of SCBs increased by 21.2 per cent in 2006-07 compared with an increase of only 6.6 per cent in the previous year. This was the result of higher increase in interest income and a lower increase in operating expenses. Net profits rose by 27.0 per cent as compared to 17.3 per cent during 2005-06. This improvement in banks balance sheets due to robust financial results led to increased interest in bank stocks. The banking stocks as represented by the Bankex (comprising 18 banking scrips) significantly outperformed the BSE Sensex: while the rise in BSE Sensex was 15.9 per cent in 2006-07, the rise in Bankex was 24.3 per cent.

The asset quality of SCBs improved further during 2006-07. While net non-performance assets (NPAs) to net advances ratio declined 1.0 per cent at end March 2007 from 1.2 per cent a year ago, the ratio of gross NPAs to gross advances fell from 3.3 per cent to 2.5 per cent during the same period.

Financial Inclusion

Financial inclusion refers to delivery of banking services at an affordable cost to the vast sections of disadvantaged and low-income groups who, for a variety of reasons, stand today excluded from the mainstream banking channel. RBI has taken a number of measures in recent years to facilitate faster financial inclusion. In fact 160 districts have been identified for 100 per cent financial inclusion: full coverage has been achieved in the whole of Union Territory of Puducherry and in 28 districts in 8 states. All districts of Himachal Pradesh have also achieved financial inclusion. One hopes that the pace will pick up and it will be possible to cover shortly a large section of the excluded population.

Migration to Basel II Norms

It may be recalled that capital adequacy norms were first introduced, under Basel I framework, in April 1992, when all SCBs were required to maintain a capital to risk-weighted asset ratio (CRAR) of 8 per cent in a phased manner. The stipulated minimum CRAR was raised to 9 per cent from end - March 2000. It may be added that the overall CRAR of all SCBs remained in 2007 at the previous year's level of 12.3 per cent. This means that increase in capital kept pace with the sharp increase in risk-weighted assets, which increased due to the rapid expansion in credit discussed earlier

The Basel Committee on Banking Supervision (BCBS) released a Revised Framework in June 2004. In the light of the revised framework, RBI issued the guidelines to banks on the new capital adequacy norms (Basel II) on April 27, 2007. The Basel II norms address three types of risks, namely credit risk, market risk and operational risk for minimum capital requirements. The Framework has a three pillar structure with minimum capital requirements as the first pillar, supervisory review process as the second pillar, and market discipline as the third pillar. While foreign banks operating in India and Indian banks having operational presence outside India are expected to migrate to the Revised Framework with effect from March 2008, all other commercial banks (excluding local area banks and RRBs) are encouraged to migrate to Basel II norms in any case not later than March 31, 2009.

Although banks are required to maintain a minimum capital to risk-weighted assets ratio (CRAR) of 9 per cent, on an ongoing basis, RBI may prescribe a higher level of CRAR, to some banks to ensure that the capital held by a bank is commensurate with its overall risk profile.

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