The week that has just gone by has not been a particularly great one for the banking industry. Bank after bank, especially the public sector ones, reported huge losses. Bank of Baroda was the latest to add to the tale of woes for the industry. It reported a ₹3,342-crore net loss for the quarter ending December 2015, earning the dubious record of registering the largest quantum of loss in a quarter for any entity in the banking industry.
A few were lucky; they managed to stay in the black but saw substantial erosion in net profits. Canara Bank, for instance, avoided straying into the red but had to shed 87 per cent of the profits it earned in the same quarter the previous year, having registered only a measly ₹85 crore as profits in the quarter ending December 2015. Not surprisingly, banking stocks suffered one of their severest drubbings last week in terms of stock price performance, with foreign and domestic investors hinting darkly about more blood-letting in the days ahead.
The new week has begun well with the index of banking stocks gaining around five per cent from the value at which it closed the previous week. But is it fair to say that, from the perspective of business fundamentals, the crisis in the banking sector is far from over? How have things come to such a pass? The conventional explanation is that banks have lent monies to borrowers, who are falling behind on repayments.
Matters of concern
Since interest incomes are linked to loans that are being serviced with regular repayments, banks are unable to recognise incomes on loans that have fallen behind in repayments. So, a good chunk of loans is not generating interest incomes for banks and, hence, the reduction in gross revenues even as interest charges have to be paid on deposits and other costs, such as salaries and rent, are mounting.
To compound matters, a percentage of outstanding loans on which instalments are in arrears would have to be provided for as a potential loss and charged to the profit and loss account. So the double whammy — of stagnant or falling gross income, coupled with mounting loss provisions — is hitting bank finances hard.
Banks are saddled with such losses on account of policy paralysis in governance at the Centre, while corruption and subsequent judicial intervention has led to projects languishing as work in progress. The global slowdown and softening of prices in core segments of the industry such as steel, non-ferrous metals and coal are adding to the woes of the borrowers and, consequently, incremental pain to the lenders.
As explanations go, this is as good a narrative of the state-of-play in the banking industry as any other. But the situation lends itself to an analysis of the problem from an alternative perspective as well. If we look at the problem through the prism of strategic management, the most striking is that the sector has ‘stuck to the knitting’, as it were, as strategic management literature never tires of warning businesses of the perils of doing the opposite. Banks have stayed close to their core calling of mobilising deposits from those who have surpluses and lending it to those in need of money.
No risky behaviour
This is in marked contrast to the behaviour of banks in the West in the years leading up to the global financial crisis in 2008. Managers then were certainly guilty of dragging these institutions to the edge of bankruptcy by straying away from the core function of lending and, instead, venturing into investments in exotic derivative instruments and underwriting investment risk in product areas about which they had little understanding of the risks they were getting exposed to.
In contrast, nobody could accuse the Indian banking industry of plonking monies on ‘credit default swaps’ or ‘collaterised debt obligations’ and such other exotic derivative products. It has mobilised deposits and lent it to borrowers in need of cash. Yet the fact remains that banks today are saddled with non-performing assets and consequent stagnation in interest incomes and mounting loss provisions.
Is the principle of ‘sticking to the knitting’, then, at fault?
What the current crisis in the banking industry tells us is that the problem lies per se not with the merit of the wise counsel in ‘sticking to the knitting’. Rather, it had to do with the fact they didn’t do enough of it. There is merit in doing what you know best. But there is also superior merit in expanding one’s share in the addressable market for ones product/services.
If the addressable market is large and the present business is catering to only an insignificant portion of this, then there is a risk of the business is tying itself to the fortunes of a miniscule minority.
A simple statistic helps illustrate this point quite vividly. The State Bank of India and its associate banks have lent 62 per cent of their monies lent out as loans to just one per cent of their borrower-customers. The numbers for other public sector banks are even worse. A mere 0.5 per cent of their customers have borrowed nearly 70 per cent of the total monies disbursed as loans. When a business links two-thirds of its fortunes to that of one per cent or less, of its total customer base, it is bound to face problems when that miniscule minority of customers is going through difficult times.
The larger fortune
As good as the notion of ‘sticking to the knitting’ is, there is also the adage that there is a fortune to be made by serving the needs of the people at the ‘bottom of the pyramid’, as the Late CK Prahlad pointed out ever so eloquently in his book, Fortune at the Bottom of the Pyramid. Official estimates of the Gross Value Added by the ‘informal sector’ of the economy shows that these ‘bottom of the pyramid’ outfits add nearly half the total value-added in the economy. Yet the banking sector is narrowly focused on the large and medium sized players with borrowings of ₹10 crore and above, to the exclusion of the vast majority of those engaged in productive economic activity.
The problem for the Indian banking industry is not that they have been ‘sticking to the knitting’. It is just that the size of the shawl they have knitted in the process is all too small for it to be of any value to the anatomy of the Indian economy.