Which is the most profitable company/entity in India at the half-way stage this financial year? The odds are against guessing this right. No, not the obvious R-word from the private sector. Nor the oil-marketing corporates of the government sector. It is a government-owned bank — SBI — which reported ₹34,636 crore of consolidated net profits as at the end of September 2023, the highest too in its history.

Joining this good run are other banks and by March 2024, the sector is likely to record net profits of up to ₹2,50,000 crore. And to top it, their bad debts are below 0.80 per cent on a net basis (after provisions) as of September-end.

Banks’ liquidity, a measure of funds available for lending, is good. Though the RBI’s monetary stance has been “withdrawal of accommodation” with the repo at a recent high of 6.5 per cent, the Liquidity Coverage Ratio of banks was at least 20 per cent in excess of the minimum prescription.

Further, despite sluggish deposit accretion, the Credit-Deposit ratios of most banks, especially the PSUs, remained low. SBI, PNB and Union Bank, all large banks, had CD ratios below 72 per cent, demonstrating ability to lend “higher for longer”.

As for capital, the RBI’s Financial Stability Report released on Thursday says the capital to risk-weighted assets ratio and the common equity Tier 1 ratio of scheduled commercial banks stood at 16.8 and 13.7 per cent respectively (against 8 per cent under Basel norms).

So, is it a Goldilocks scenario for banks? What of the immediate future? What can upset their apple cart? What are the potential risks?

It can be safely asserted in the context of tight supervision and regulation by RBI and a demonstrated policy of sovereign/State-sponsored bailouts (a la Yes Bank) that there will be no solvency risk for Indian banks.

The risk factors

However, there are five macro areas where risks may arise.

Bank lending for the next round of infrastructure and capital investments has just about started now after the balance sheet clean-up. Loans which are linked to State government entities, like solar power units which have PPAs with States, run the risk of defaults in payments as many State government finances are stretched. Many of these exposures could be chunky and big.

Though the fiscal deficits of States at the aggregate is lower than that of the Centre, individual State governments face severe cash flow mismatches, hemmed in by borrowing limits. Banks will be well advised to set internal exposure limits to State governments/linked entities after an assessment of the fiscal/financial position of the States.

Internal risk models for individual States similar to the Bank Exposure Risk Index could help address this risk. Loans for roads on Toll Operate Transfer basis can also face stress if projections have been overpitched.

Second is the risk from what a seemingly run-away stock market, giving an “illusion” of wealth to an entire new generation. Just look at the number of new demat accounts opened in the last five years and the PE ratios that most sectors command. There is a transitional generation which does not believe in savings, invests hugely and does not shy from leverage, because the returns are attractive.

This “maya” of wealth and the linked borrowings, generated by exuberant indices is a systemic risk to retail exposures. Integrated supervision by the financial and market regulators could address this emergent risk. Banks may also like to subject retail portfolios to more rigorous stress tests. (Higher risk weightage has more of an indicative than any mitigatory value.)

Tightening governance

Third is the possibility of default becoming a contagion because of inter-connected lending and lax governance norms of the regulated entities (not necessarily banks). Banks lend to NBFCs who lend to corporates who may already have borrowings from the same banks. There may be other permutations of connected lending too. This is an area where focused risk monitoring is required. Related is the issue of lax governance which leads to the AIF-kind of evergreening attempts. Regulation cannot be a substitute for good governance.

Fourth is the challenge to SMEs arising from a world that is re-globalising. It is neither flat as written about nor round. Geopolitics is driving trade, investment and labour in unpredictable directions. FTAs and the RECP ambitions of Bangladesh and Sri Lanka may lead to vulnerabilities for India’s small scale sector. A strategy of export-led growth/prospects of export-oriented units may be fraught with risks.

While the larger units will cope, the smaller units including retail trade may have impaired cash flows at some point owing to these factors. It will be worthwhile watching how banks assess these possibilities and weather-proof themselves.

Finally, the character of liabilities seems to be changing in line with international trends. Digitisation and neo-trends in consumption are putting pressure on retail deposits. The franchise-led, branch-based deposit pitch may have run into limitations in the Tier 1 and 2 centres and definitely in current account deposits. It is observed that banks with higher credit-deposit ratios also have low liquidity coverage ratios.

While in the normal course, this may be seen as an entity-specific issue, it could prove to be a deeper rebalancing issue/risk for the system if the nature of Indian savings undergoes a structural shift. Caution and prudence thus need to be the eternal watchword for bankers, more so when things are going ahead swimmingly.

The writer is a commentator on banking and finance