The Travails of the Indian Banking Industry

What is happening inside the great and mighty HDFC Bank! The Chairman with long years of experience in the topmost echelons of bureaucracy and after a five-year stint in the bank suddenly realises that there are “happenings and practices which are not in congruence with his personal values & ethics”. Without elaborating it.

Are such aberrations specific to HDFC Bank or rampant in the Indian banking industry? Are the high valuations by the so-called tech savvy private sector banks justified and to what extent?

Are these banks really effective and efficient as they claim to be and the investing public believes?

Dig a little deeper and the health of the banking industry, including banks such as HDFC Bank slowly reveals a different picture.

Their high valuations seem to be wholly on account of the competition (read public sector banks) being even worse, much worse.

Public Sector banks, including SBI, have been losing market share year after year over the last 30 years. Over a ten-year period from 2010-11 to 2020-21, the government had to pump in Rs.3,74,012 crores as equity to just make up for their inefficiencies and losses. Even in the mighty and holier than thou SBI a sum of Rs. 36,750 crores had to be infused as equity. This is tax-payers money - ie your and my money. For what purpose? Just because they are inefficient and ineffective.

This is only one part of the cost that you and me are paying. Since, these banks are not making money on their lending business, they give miserly interest rates on their deposits. Just about equivalent to inflation rates and often below it. The depositing public is effectively losing the value of their savings if they keep it as bank deposits. And then there is the double whammy - interest on bank deposits attract income tax at the highest marginal tax rate.

So, the public has responded with its feet by walking out from patronising the banking industry more than is essential. Long term savings are steadily moving out from the banking to the Mutual Fund industry for the last 10 years. This has its own set of issues, which we will keep for another day.

One of the key functions of the banking industry is to move funds from the household sector to the productive sectors (agriculture, industry, services) which in turn creates jobs and income. Credit to GDP ratios are stagnant and compared to world averages quite low. Services which account for 55% of GDP gets only around 30% of bank credit. Both Agriculture and Industry, especially MSMEs, are starved for productive credit. Factors such as these lead to retardation in growth rates of income and employment of the country.

Look at UPI transactions where banks face competition from app based entities. UPI move money goes from one bank account to another, but over 95% of transactions go through non-bank apps. Why so? Are these app providers doing it for charity!

What is the solution? Wait for the Small Finance Banks to grow over the next 5-10 years so that there is effective competition and things improve? It is estimated that GDP growth with improve by around 2% per year if we are able to fix the myriad problems of our banking industry.

Or do away with the root of the problem - once and for ever. Abolish the Department of Financial Services, under whose stewardship over the last 56 years the banking industry has come to such a pass. The babus of DOFS with their immense powers enjoy virtually limitless control rent while having no equity stake! A better example of perverse incentives at play would be difficult to find.