By: Avinash Anand (15th May 2016)
India has a diversified financial sector undergoing rapid expansion, both in terms of strong growth of existing financial services firms and new entities entering the market. The sector comprises commercial banks, insurance companies, non-banking financial companies, co-operatives, pension funds, mutual funds and other smaller financial entities. The banking regulator has allowed new entities such as payments banks to be created recently thereby adding to the types of entities operating in the sector. However, the financial sector in India is predominantly a banking sector with commercial banks accounting for more than 64 per cent of the total assets held by the financial system.
The Government of India has introduced several reforms to liberalize, regulate and enhance this industry. The Government and Reserve Bank of India (RBI) have taken various measures to facilitate easy access to finance for Micro, Small and Medium Enterprises (MSMEs). These measures include launching Credit Guarantee Fund Scheme for Micro and Small Enterprises, issuing guideline to banks regarding collateral requirements and setting up a Micro Units Development and Refinance Agency (MUDRA). With a combined push by both government and private sector, India is undoubtedly one of the world’s most vibrant capital markets.
Total outstanding credit by scheduled commercial banks of India stood at US$ 1.06 trillion! The Association of Mutual Funds in India (AMFI) data show that assets of the mutual fund industry have reached a size of Rs. 12.62 trillion (US$ 185 billion). During April 2015 to February 2016 period, the life insurance industry recorded a new premium income of Rs 1.072 trillion (US$ 15.75 billion), indicating a growth rate of 18.3 per cent. The general insurance industry recorded a 14.1 per cent growth in Gross Direct Premium underwritten in FY2016 up to the month of February 2016 at Rs. 864.2 billion (US$ 12.7 billion).
India’s life insurance sector is the biggest in the world with about 360 million policies, which are expected to increase at a Compounded Annual Growth Rate (CAGR) of 12-15 per cent over the next five years. The insurance industry is planning to hike penetration levels to five per cent by 2020, and could top the US$ 1 trillion mark in the next seven years. The total market size of India’s insurance sector is projected to touch US$ 350-400 billion by 2020.
India is the fifteenth largest insurance market in the world in terms of premium volume, and has the potential to grow exponentially in the coming years. Life insurance penetration in India is just 3.9 per cent of GDP, more than doubled from 2000. A fast growing economy, rising income levels and improving life expectancy rates are some of the many favorable factors that are likely to boost growth in the sector in the coming years.
Investment corpus in India’s pension sector is expected to cross US$ 1 trillion by 2025, following the passage of the Pension Fund Regulatory and Development Authority (PFRDA) Act 2013.
- The Securities and Exchange Board of India (SEBI) plans to gradually introduce more commodity products and allow more participants in the commodity derivatives market in India.
- The Reserve Bank of India (RBI) has granted in-principle licenses to 10 applicants to open small finance banks, which will help expanding access to financial services in rural and semi-urban areas, thereby giving fillip to Prime Minister’s financial inclusion initiative.
- The Reserve Bank of India (RBI) has also given in-principle approval to 11 entities to open payment banks which are expected to result in widening the reach of banking services and thereby improve the extent of financial inclusion as envisaged by the government. The setting up of 11 new payments banks can potentially free up Rs 1,400,000 crore (US$ 205.4 billion) per annum to fund the infrastructure sector, as per a study by the State Bank of India.
- A Reserve Bank of India (RBI) committee headed by Deputy Governor Mr Gandhi has recommended granting commercial banking license to multi-state Urban Cooperative Banks (UCB) having business of more than Rs 20,000 crore (US$ 2.93 billion).
- India’s largest microfinance company Bandhan has set up Bandhan Bank Ltd, banking and financial services company, post the receipt of license from RBI.
Several measures have been outlined in the Union Budget 2016-17 that aim at reviving and accelerating investment which, inter alia, include fiscal consolidation with emphasis on expenditure reforms and continuation of fiscal reforms with rationalization of tax structure.
The Union Budget 2016-17 has allowed foreign investment in the insurance and pension sectors in the automatic route up to 49 per cent subject to the extant guidelines on Indian management and control to be verified by the regulators.
Service tax on service of life insurance business provided by way of annuity under the National Pension System regulated by Pension Fund Regulatory and Development Authority (PFRDA) being exempted, with effect from April 01, 2016.
Capital gains tax exemptions have been extended to merger of different plans within a mutual fund scheme, which is expected to benefit investors in case of merger of mutual fund schemes.
The Government of India plans to revise and improve few of its flagship schemes such as the Atal Pension Yojana (APY), aimed at providing pension coverage, and Pradhan Mantri Mudra Yojana, which funds small entrepreneurs, in Union Budget 2016-17 in order to increase the number of beneficiaries covered by these schemes and overcome shortcomings in implementation.
The Government has also announced several schemes to improve the extent of financial inclusion. The Prime Minister of India has launched the Micro Unit Development and Refinance Agency (MUDRA) to fund and promote Microfinance Institutions (MFIs), which would in turn provide loans to small and vulnerable sections of the business community. Financial Services Secretary Mr Hasmukh Adhia has announced that the ministry will launch a campaign for loans under Pradhan Mantri Mudra Yojana (PMMY) in order to double loan disbursement to the small business sector to over Rs 100,000 crore (US$ 14.67 billion).
Government of India’s ‘Jan Dhan’ initiative for financial inclusion is gaining momentum. Under Pradhan Mantri Jan DhanYojna (PMJDY), 210 million accounts# have been opened and 174.6 million RuPay debit cards have been issued. Government of India aims to extend insurance, pension and credit facilities to those excluded from these benefits under the Pradhan Mantri Jan Dhan Yojana (PMJDY). The Union Cabinet Minister has also approved the Pradhan Mantri Suraksha Bima Yojana which will provide affordable personal accident and life cover to a vast population.
The Union Cabinet has approved 100 per cent Foreign Direct Investment (FDI) under the automatic route for non-bank entities that operate White Label Automated Teller Machine (WLA), subject to certain conditions.
Minister of Finance Mr Arun Jaitley has formally declared the merger of Forward Markets Commission (FMC) with Securities and Exchange Board of India (SEBI), which help convergence of regulations in the commodities and equity derivatives markets.
The Insurance Regulatory and Development Authority of India (IRDA), as part of its endeavour to increase insurance sector growth, has allowed a new distribution avenue called the ‘point of sale’ person, who will be allowed to sell simple standardised insurance products in the non-life and health insurance segments, which are largely pre-underwritten.
Is the financial sector’s asset quality getting worse or better?
At a press conference on Tuesday, 26 April, after declaring the fourth quarter earnings for financial year (FY) 2015-16, Rajiv Lall, chief executive officer of IDFC Bank Ltd, interrupted his chief financial officer to make a point. The bank had just reported a jump in gross non-performing assets (NPAs) to 6.16% from 3.09% in the previous quarter. The question was on this surge in bad loans. Television channels were running tickers saying “Asset quality worsens”. Lall interjected. “An increase in the gross NPA number doesn’t mean that asset quality has worsened. We have provided for all these bad loans. So asset quality is actually improving,” said Lall.
Lall’s comment makes for an interesting debate at a time when most banks are reporting an increase in their reported bad loans. Should we see this recognition (which, by the way, is the result of a regulatory diktat) of stressed assets as a positive and argue that asset quality management at banks is improving? Or should we be alarmed at the level of stressed assets that have existed in the system without an upfront declaration?
Bankers argue that it is the former. Their contention is that they were following the law of the land and classifying loans as NPAs when dues were delayed by more than 90 days. That’s what the Reserve Bank of India (RBI) rule says. Never mind that companies had made a habit of delaying payments till virtually the last day. Let’s also ignore the fact that the asset quality review conducted by RBI detected questionable practices such as round-tripping of funds by companies and the repayment of short-term loans through overdraft facilities. All this was leading to an understatement of bad loans in the system and hence inadequate provisions.
Now that RBI has tightened its stance, we are doing as the regulator tells us, bankers say. Sure. But, the point worth noting here is that RBI has actually not changed any rules. It is just ensuring that rules are followed and that they are followed in the spirit of the law rather than the letter.
An analyst who covers the banking sector scoffed at the idea that this process of purging (so to speak) should bring greater confidence around the asset quality of banks. It’s like putting a band aid on an injury and saying that there was no injury to begin with, said this analyst requesting anonymity.
It’s true that the aftermath of the asset quality review is giving us a clearer picture of what lies within the banking sector. But it equally makes us question why banks were not disclosing this picture to begin with and why RBI’s bank supervision department didn’t catch this earlier. Even if you find that argument subjective, there are other reasons to believe that the worst of the asset quality problems are not behind us.
On 22 April, The Financial Express, reported, based on RBI data, that more than Rs.3 trillion in loans are classified under the SMA-1 category (accounts where repayments are overdue by 30-60 days) and another Rs.3 trillion in loans are in the SMA-2 category (accounts where repayments are overdue by 60-90 days). It is only reasonable and prudent to expect that some part of this will find its way into the NPA bucket over the course of this year. As of end-December 2015 quarter, gross NPAs of the 39 listed banks were at Rs.4.38 trillion. This number is sure to rise—both because of the one-time hit from the asset quality review and also due to the organic growth in NPAs.
There is another reason to be cautious. The asset quality review has so far only revealed the asset quality picture of banks. What about non-banking finance companies (NBFCs)? Do NBFCs have similar issues hidden in their books? According to RBI’s December Financial Stability Review (FSR), there were 11,781 NBFCs registered with RBI. Of these, there are 210 Systemically Important Non-Deposit accepting NBFCs (NBFCs-NDSI). The aggregate loans and advances of the sector grew by 14.2% year-on-year in September 2015, after a 16.3% growth in March. The gross NPAs of the NBFC segment were at 3.5% as of September, says the FSR.
To be sure, the NPA rules for NBFCs are less stringent than those prescribed to banks. Until last fiscal, only accounts overdue by more than 180 days were classified as bad loans at NBFCs. This will be brought in line with the 90-day NPA rule that banks adhere to in stages by March 2018. Even so, RBI would do well to scrutinize the balance sheets of NBFCs, particularly those lending to sectors such as infrastructure that have been the source of a lot of stress.
There is also the issue of the asset quality of Life Insurance Corp. of India’s (LIC’s) debt portfolio. On Thursday, 28 April, Mint’s Ravi Krishnan highlighted the potential concerns emerging from LIC’s lending activities. RBI, together with the Insurance Regulatory and Development Authority of India, may need to comb through LIC’s books as well to snuff out any asset quality concerns that may exist there.
To sum up, despite what bankers say, it’s going to be a while before anyone can confidently say that the asset quality of the Indian financial sector is improving. And no, most don’t see the current coming-out of bad loans as a positive.
The Insolvency and Bankruptcy Code will help improve the ease of doing business and will be a big positive for the banking sector as it aims to ensure a consolidated legal framework for resolving bankruptcy, says a Nomura report.
Rajya Sabha or the Upper House of Parliament on 11th May passed the Bankruptcy Code, paving the way for India to have the law.
“India currently ranks 136 in the World Bank’s resolving insolvency ranking; it takes 4.3 years to resolve insolvency and the recovery rate (at 25.7 cents to a dollar) is very low. Therefore, a consolidated legal framework for resolving bankruptcy will play a key role in improving the ease of doing business in India,” Nomura said.
According to the report, there are multiple laws dealing with insolvency in India, which lead to delays. This Code will consolidate the existing framework and create a new institutional structure, including setting a time-limit of 180 days within which the resolution has to be completed.
Moreover, the Code is a big positive for the banking sector, which is currently burdened with stressed assets. As it gives banks (creditors) a legal path for recovering their dues in a time-bound manner, it said, adding that “it should make lenders more confident in lending and borrowers more accountable”.
“Overall, the Code is a very positive financial sector reform,” the report added.
The Lok Sabha had passed the Bill on May 5. As it has now been passed by both the houses of Parliament, India will have a bankruptcy law once the President signs the legislation.
The Code has enabled provisions to deal with cross border insolvency and establish an ‘Insolvency and Bankruptcy Board of India’ to exercise regulatory oversight over insolvency professionals, insolvency professional agencies and information utilities.
Planning commission roadmap: Vision 2020
India is today one of the most vibrant global economies, on the back of robust banking and insurance sectors. The country is projected to become the fifth largest banking sector globally by 2020, as per a joint report by KPMG-Confederation of Indian Industry (CII). The report also expects bank credit to grow at a Compound Annual Growth Rate (CAGR) of 17 per cent in the medium term leading to better credit penetration. Life Insurance Council, the industry body of life insurers in the country also projects a CAGR of 12–15 per cent over the next few years for the financial services segment.
Also, the relaxation of foreign investment rules has received a positive response from the insurance sector, with many companies announcing plans to increase their stakes in joint ventures with Indian companies. Over the coming quarters there could be a series of joint venture deals between global insurance giants and local players. The relaxation in the foreign direct investment (FDI) limit to 49 per cent can result in additional investments up to Rs 60,000 crore (US$8.81 billion).
Exchange Rate Used: INR 1 = US$ 0.0147 as on March 01, 2016
Sources: Media reports, Press releases, Reserve Bank of India, Press Information Bureau, www.pmjdy.gov.in, Union Budget 2016-17, planning commission.