The rise of retail banking

Wednesday, August 8th, 2018

Nice piece by Vivek Kaul in the Mint paper on how Indian banks are changing the focus of their business.

It talks about how, without any regulatory push, Indian banks are increasingly moving toward narrow banking with a focus on the retail segment.

This is of course a direct result of the NPA mess that is hitting balance sheet of public sector banks.

The public sector banks have been particularly badly hit and their bad loans ratio stands at 15.6%. Clearly, lending to industry has turned out to be the worst form of lending for banks. As on 31 March 2018, 22.8% of the loans to industry had turned out to be bad loans. In absolute terms, ₹ 703,969 crore of loans to industry had been defaulted on. Hence, loans to industry form around 68% of the overall bad loans of banks.



What Chart 3 tells us very clearly is that once a bad loan is written off, its chances of being recovered are very low. Between April 2014 and December 2017, loans amounting to ₹ 272,558 crore were written off. Of this only ₹ 29,343 crore or 10.8% of the loans were recovered from defaulters. This means that the rate of default on bad loans was 89.2%. A large part of these loans, are loans given to industry, which have been defaulted on.


It is therefore makes a lot more sense for these public sector banks to focus more on retail banking. And we can see that in the data:

By 31 March 2013, lending to industry and retail made up for 45.8% and 18.4% of the non-food credit, respectively. Five years later, the situation has changed completely and lending to industry and retail make up for 35.1% and 24.8% of the non-food credit, respectively.


We see this trend in incremental loans:


However, public sector banks may even find this sector to be difficult because they have to compete directly with the private sector where banks are far more competitive, dynamic and agile. Just look at this chart from an article by Ira Dugal at Bloomberg Quint:



While this reflects deposits and not lending, it shows the disruptive shift of money moving away from public sector banks and increasingly toward the private sector.

Other reasons for the stagnation in lending to industry is that industry itself does not have much demand for credit:

The RBI Order Books, Inventories and Capacity Utilisation Survey (OBICUS) tells us that the capacity utilisation rate of Indian manufacturing companies has ranged between 71-74% for a while now. There is huge idle capacity in India’s manufacturing sector. More than a fourth of the capacity is not being utilised. In this scenario, it doesn’t make any sense to expand, until there is enough demand for companies to first utilise this idle capacity. This also explains why there is little demand for industrial credit from banks.

Add to that the fact that planned investments are also being dropped:

Data from the Centre for Monitoring Indian Economy tells us that the investment projects worth ₹ 6,51,509 crore were dropped in 2017-2018, an increase of 57.2% from 2016-2017. This is another factor which tells us that the demand for credit from banks by the industry is weak. If projects are being scrapped, there is no reason for firms to borrow.

And finally, there is a move by large corporates to increasingly taking funding from non-bank entities. The falling interest rate scenario over the last few years meant that NBFCs could offer more competitive interest rates than bank that were slow transmit rate cuts. In addition, in a move to deepen the bond markets, there is a proposed regulatory push by SEBI directing large corporates to start taking twenty five percent of their funding from the bond markets.

When you put all this together, it is no wonder that banks are increasingly avoiding industrial lending and focusing on the retail sector.

Over the last five or six years I have seen a number of analysts and fund managers talk about how the NPA mess in the banking sector has peaked. With strict measures from the RBI and numerous positive regulatory changes like the bankruptcy code over the years, it seems like at least fresh pain will not be created in the industrial sector. But with no demand from corporates and with  existing NPAs still to be digested, it seems like it will be a while before the sector turns around.

About the author

Rishad is the founder of Kairos Capital. He started his career with Standard Chartered Wealth Management and has extensive experience in markets, particularly in terms of mutual funds and stocks.

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