improving indian banks’ performance by james a. hanson
TRANSCRIPT
Improving Indian Banks’Performance
by
James A. Hanson
Overview• India liberalized credit markets to support the real
reforms/more credit for the private sector. • Benefits but increasingly limited by
– Crowding out from public debt and deficits– Weak Incentives for debt service, related to weak judicial,
informational and institutional incentives
• Weak incentives in public banks, not generating enough capital for growth, especially of private credit.
• Need to focus on incentives for principal agents (banks)• Regulators face New Challenges • Resolution of problems more urgent now that other
sources of private sector finance drying up.
India Started bank liberalization in 1992Focus on Markets: price, alloc., competition• Reduced directed credit allocation (SLR)• Gradually liberalized interest rates, even on priority credit • Increased competition
– Let clients switch banks, Reduced RBI lending control – Licensed new private, quasi-private and foreign banks– Non-bank intermediaries grew until the 1997 crisis– Liberalized the capital market– Allowed offshore borrowing and capital inflow.
• Strengthened regulation and supervision, unlike most liberalizing countries
• Liberalization largely completed by 1997-98
Figure 1India: Money(M3 in Sept.): GDP,
Deposit Rate & Inflation
0.0
5.0
10.0
15.0
20.0
25.0
30.0
35.0
40.0
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
Inte
rest
Ra
te a
nd
In
fla
tio
n (
%)
0.0
10.0
20.0
30.0
40.0
50.0
60.0
70.0
M3
(%
of
GD
P)
M3/GDPM3+NBFCs % of GDP
Inflation (CPI)
Interest Rate 1 yr. Deposit
FreeRate
Ave. M3/GDP, 1987-92
Reforms Restarted Dep. Growth
Other Sources of Private Credit Grew
• NBFCs• Equity—easier rules and entry of foreign players• Bonds and Private Placements• Offshore borrowing.
But• NBFCs have declined since 1997 crisis• New inflows and demand for offshore funds drying up.• India’s capital market is one of largest but it is down
India is still bank dominated: Banks assets more than double market capitalization. Banks are critical
Private credit growth, bank performance were not up to expectations. Why?
1. Crowding out by Government Debt
2. Large Role of Public Sector Banks
3. Large NPLs– Weak judicial and informational framework– Public banks lack incentives
4. Profit Squeeze on Banks limits internal capital generation, raises risks.
Figure 2. India: Banks' Government Debt, Credit, and Investments Selected Years (percent of GDP)
0%
10%
20%
30%
40%
50%
60%
85-86 90-91 95-96 98-99 00-01
Credit Gov. Debt Other Elig. Invest. Other Investments
Crowding out: Gov. debt absorbed much of bank growth, reflecting its large deficit;
credit grew slowly
Gov. Debt/Dep. , 2000, Percent (IFS)Korea -3.6 Philippines 22.7Chile -3.1 Hungary 23.0Thailand 1.4 Pakistan 24.6Malaysia 2.3 Morocco 26.5Peru 3.2 Argentina 30.8S. Africa 4.9 India 34.6Czech Rep. 4.9 Russia 35.3China 6.0 Brazil 43.3Egypt 7.8 Mexico 48.8Venezuela 8.2 Algeria 50.6Bangladesh 10.9 Indonesia 56.3Poland 14.8 Turkey 64.7Colombia 16.4 Average 21.4
Gov. Debt is attractive but it must held even if it weren’t
attractive • Gov. Debt has low risk, low capital weight, no
priority sector obligation, making it attractive
• But macroeconomic constraints mean that Gov. debt has to be held, if not by banks, then by the public, meaning less deposits, so still crowding out
• Crowding out is now by interest rates, not by fiat, but it is still crowding out.
• Attractiveness of Gov. debt simply determines interest differential between public and private debt.
Large Public Sector Bank Role Figure 3. Asset Shares of Commercial Banks by Type
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
1993-94 2000-01
Nationalized Banks
State Bank Group
Foreign BanksReg. Rural Banks
Old Private Banks
New Private Banks
Large Public Sector Bank presence associated with slower financial and economic development, worldwide
• Weak incentives for sound lending and collection Credit Misallocation (bad lending & collection processes) Borrowers develop culture of non-payment. • Weak Governance:
– Multiple Conflicting Goals– Political Interference– Lack of clear incentives to staff, who become an interest group.– Weak Information/non transparency
• Lower effective lending rates crowd out private banks• Difficulties in Regulation & Supervision• Result is often costly “skeletons” for governments
Credit Misallocation: Banks’ Gross NPLs High by International Standards
Source: RBI, Trend and Progress in Bank ing , various years.
Figure 4India:Non-Performing Loans by Bank Groups
(% of Loans)
0.0
5.0
10.0
15.0
20.0
1997 1998 1999 2000 2001
New Private
Public Sector
Old Private
Foreign
11.112.4
6.8
5.1
NPLs represent misallocation
• Either borrowers are getting credit they cannot repay—poor selection of borrowers
Or
• Defaults mean someone must bear the cost, other borrowers (higher rates), depositors (lower rates), or taxpayers (bailout).
Q. Why are NPLs High? A. Poor Incentives.
1. Weak legal (judicial) framework – Slow Judicial Proceedings, BIFR– Debt Tribunals have not been enough– Will new ordinance become law and make a
difference?
2. Poor information on borrowing1. And 2. Mean Poor incentives:
– Why pay? – No credit record to maintain.
Why are NPLs high (cont.)?
• Public sector banks have NPL problems worldwide. In India worse than even “old” private banks, which have similar clientele.
• In Public sector banks, what are incentives – To choose borrowers well?– To collect promptly?– To use good contracts?
Competition has pushed down bank margins
Average Interest Margins
0
0.5
1
1.5
2
2.5
3
3.5
4
4.5
95-96 96-97 97-98 98-99 99-00 00-01
Pe
rce
nt
of
As
se
ts
public banks private banks old private banks new foreign
Public Sector banks face a squeeze fromcompetition, poor lending, and high costs
Source: RBI, Trend and Progress in Bank ing, 2000-2001
Provis.
OthCosts
Figure 6 India: Costs, Provisions and Net Profits (Sum= Net Revenue)
2000-2001
0
1
2
3
4
5
6
7
public sector banks old private banks new private banks foreign banks
Pe
rce
nt
of
As
se
ts
NetProfits
Provis.OtherCosts
Wages
0.42
2.03
0.620.81
0.93
Profits have fallen
Figure 7. India: Net Profit by Bank Group 1995-96 to 2000-01
-0.50
0.00
0.50
1.00
1.50
2.00
95-96 96-97 97-98 98-99 99-00 00-01
% o
f Ass
ets
Foreign
Public
Old Pvt.
New Pvt.
Need more profits to• Write-off bad loans
• Keep pace with growth
• More private lending
• Stronger regulation and supervision– Best Practices– Basel II
• Privatize?
More Profits require:
• Better lending• Lower costsOr• Larger spreads (lenders pay more,
depositors get less)
Or Gov. will have to add capital
Prerequisite to more private credit
Reduce Crowding Out
Better Performance(1): Better Legal & Judicial Framework Better incentives to service debt• New bankruptcy law will help/BIFR
revamping. • Debt tribunals need
– more support, – faster deliberations, and – penalties for willful default and delay
• New ordinance: will it work?
Better Performance (2) : Better Information Framework
Improve incentives to service debt, select borrowers better.
• Credit registry
– who will manage it?
– include non-banks and small borrowers.
Better information improves Access
• Small have asset: good credit rating
• But system must go down to small loans
• Which institutions can best provide access?
• Currently, priority sector loans getting bigger, and rates constrain small lending.
Better Performance (3)Cutting Costs in Public Banks
• VRS will help, but needs to be managed• Computerization needed, but funds are
lacking. Why can’t India export banking services?
• Reducing or selling branches• Mergers
Needed: An Exit Policy for Banks
Better Performance(4)Better Incentives for Better Lending
• Public banks need to improve incentives for – Selection of sound borrowers– Collection of debt service
• Privatization: – Few examples of public banks that work well. – But low profits and lack of interest by foreign
investors may make privatization difficult.
Challenges to Reg & Supervision
• Private Banks and Moral Hazard
• Deposit Insurance levels
Strengthening of Regulation & Supervision to Best International Practices
For example, exposure limits, connected lending, income recognition, provisioning, and prompt corrective action.
Particularly important for private banks without a reputation to protect.