Talking Point. Why are banks in love with retail?

There is a rush to start or become a bank these days, which is surprising, considering the problems the sector is struggling with — huge bad debts, low profitability and regulatory pressures. But two factors seem to be driving it — the access to low-cost funds and the prospects of high-volume retail lending. The new-found love for retail lending is not so bad in itself, but concerns emerge about the role banks are expected to play in our economy.

Until the 90s, the commercial banking system was dominated by the public sector (over 75 per cent of assets and liabilities) with the primary role of financing government public deficits through the pre-emptive SLR (statutory liquidity ratio), which was once as high as 40 per cent.

Another important feature was the clear demarcation in long-term and short-term finance, with specialised development finance institutions (DFIs) taking care of the former, and banks, the latter.

But since the early 90s, financial reforms led to the entry of newer private and foreign banks. They also had their negative spin-offs.

For banks, while pruning of SLR meant more resources to lend, newer regulations, such as Basel norms, necessitated larger capital, greater focus on asset quality and more transparency.

The DFIs also were adversely affected as they suddenly found themselves without the low-cost, long-term resources that the SLR regime provided.

Moreover, their long-term business was impacted by regulatory pressures of capital to risk-weighted assets ratio (CRAR) and asset quality. So institutions such as IDFC, created to support infrastructure, converted themselves into commercial banks. We can appreciate the rush to retail against this backdrop.

Banking is a low value-added business, commanding only small premiums (borne out by the modest return on assets), and profitability requires high volumes; retail credit is the low hanging fruit that can generate volumes. While private and foreign banks always had a retail focus, even the big PSBs, such as SBI (36 per cent of total assets) or even specialised institutions such as ICICI Bank (43 per cent) and HDFC Bank (33 per cent), turned to retail in a large way.

On the supply side also, banks are shying away from wholesale lending — weak investment demand is only half the story; the larger issue is the risk of non-performing assets.

According to RBI data, five sectors, namely, mining, iron and steel, textiles, infrastructure and aviation together constituted about 25 per cent of the total advances of scheduled commercial banks and, significantly, over 50 per cent of the total stressed advances. Infrastructure and iron and steel accounted for about 40 per cent.. Such large exposures was due to the demise of the DFIs and the absence of developed debt markets, which placed the onus of financing on PSBs.

This brings us to the important question of the role that banks are expected to play in the economy. We have travelled a long way from banks being intermediaries between savers and long-term investors; now they are marked by risk aversion, short-term profitability focus and a market valuation-driven business model.

This does not bode wellconsidering the huge investment gaps in infrastructure and the absence of mature debt markets.

The continuing rush of new entrants and the clamour for increasing the FDI limits in banking should be seen against this short-term business model of low-cost, low-risk, high-volume, high-profit business.

Infrastructure, core industries and agriculture — the so-called old economy sectors — have a great need for funds.

If banks are unwilling to take risks and settle down to safe and narrow banking, then who will? If shareholder interests take precedence, what about the larger economic purpose of a vital sector such as banking?

The writer is an independent consultant

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