What To Do With Banks

What To Do With Banks

Time to junk the concept of universal banking and turn to niche banking to ring-fence risks

One of the stumbling blocks to the revival of the Indian economy is the poor health of public sector banks, which own more than 72% of the assets and 77% of the deposits of the industry. Not surprisingly, the finance minister has to keep reiterating the government's intention to infuse fresh capital into PSU banks. This is to restore confidence in the system, which is apparently to serve the small saver but has been twisted and bent to cater to crony capitalists. The banking industry has been the problem child not only of India but of the global economy, going back to the Great Depression. The Glass-Steagall Act was passed in the US in 1933 to limit commercial banks' securities activities, clearing the way to demarcate savings and lending institutions and investment banks. The idea was to protect the risk-averse depositors from the leveraging associated with dealing in securities. The scope to make big profit from accepting funds at lower rates and lending at higher rates is limited. Expanding physical presence to garner a big share of the market requires huge capital. In contrast, there are bumper gains to be made from advisory services and dabbling in the debt and equity markets on a relatively lower base. The M&A wave in the US in the 1990s saw commercial banks acquiring stake or tying up with securities firm for that much-needed bump to the bottom line. The Gramm-Leach-Bliley Act of 1999 repealed the provisions restricting affiliations between banks and securities firms, sowing the seeds for the blowout of the too-big-to-fail banks in 2007-2008 as exotic derivatives were deployed to top the league tables, ignoring capital adequacy.

The subsequent forced merger by the government of weak and strong financial organizations has resulted in a handful of institutions dominating the US's banking space. Though capital requirement has been enhanced and proprietary trading scrapped, prospects of a systemic failure have increased due to the small numbers. In India, PSU banks replicate efforts, manpower and capital to expand into each other's territory to chase customers. Their bottom lines are influenced by income derived from non-banking activities. Their assets are prone to turn sour because credit sanctions are not always commercial transactions. Mergers can create a few capable banks with scale. The issue is if the alliance should be based on balance sheet strengths and weaknesses or geographical presence to achiever wider reach. Core banking is making brick-and-mortar existence redundant. Interestingly, this leads to two crucial questions. Should banks be viewed as FMCG companies, vying for attention on the basis of brand loyalty acquired through superior service? Or are banks going to become e-commerce entities delivering the basic needs efficiently? FMCG stocks are favored for consistent payouts, while Internet startups are enjoying huge valuations despite making losses because of the potential. Banks combine the best and the worst of both.

Just as the FMCG sector is no longer viewed as evergreen due to dependence on monsoon to drive rural growth as the urban market has flattened out, PSU banks are burdened with the cost of reaching out to the lowest denominator. Like e-retailers who are prone to categorize themselves as tech companies rather than slot themselves with retailers in the real world enjoying poor discounting, banks are embracing technology for the ease of doing business and increased penetration. Unlike cyber malls, however, their valuations factor in the non-performing assets rather than the huge unbanked population as India urbanizes. The second dilemma is if India should go back to the era of institutional lenders confined to corporate clients rather than encourage universal banks. 

The regulatory framework for banks operating in various niches will differ. Investors will be able to pick stocks in the sector suiting their profile. The discounting due to the thin margins earned by attracting and lending money will be mediocre compared with those for bottom lines supported by trading income. Yet as the business of savings banks will pivot on the credit track record of retail borrowers, they will be viewed stable and safe. 

Investment banks will focus on maximizing treasury opportunities and big-ticket players will be specialists in devising innovative ways of raising capital, thereby rewarding risk-takers. VC and PE funds are meeting the needs of startups. Microfinance and SME lending institutions can take care of the small borrowers. The proposed Mudra Bank is aimed at the unorganized sector. Thus, clubbing banks as per the markets they cater to, with different capital requirement, will lead to better monitoring and containment of risks.