Banking is in the middle and center of any economy. More so,  if it is predominantly owned by the Government of the country like in India.

Banking at the Middle and Center of India

Banking is in the middle and center of any economy, including India, for the simple reason that domestic credit moves the economy up and down. Domestic credit and GDP/ Inflation/ Employment are positively correlated. Gross Domestic Product (GDP), by Aggregate Expenditure Method, of a country is the sum total of Private Consumption + Private Investment + Government Consumption and Investment + Net Exports (C+I+G+NX). All these components need credit to expand.

Taking the case of USA, where almost 2/3rd of the GDP is made up of Private Consumption, we see an extensive network of bank and non- bank credit. According to Word Bank, as of 2020, the domestic credit to GDP ratio was 216.1% in USA. USA is number 2 economy of the world by purchasing power parity (PPP).

The number one economy of the world by PPP is China. As of 2020, the domestic credit to GDP ratio was 182.4% in China.

Compared to those two top economies of the world, the number 3, India, as of 2020, had the domestic credit to GDP ratio, a paltry 55.23%. Clearly, if India is to move up the podium, and achieve higher rates of growth, it must inject more credit in the economy. That brings Indian banking further in the middle and Center of India.

Structure of Indian Banking

The Table below provides a quick glimpse of structure of Indian banking as of 2021


The above table shows that almost 2/3rd share of deposits and advances in India is held by public sector banks. And within public sector banks, State Bank of India holds a little over 1/3rd of the public sector banks.

Net Non- Performing Assets (NNPA)- Conceals more than Reveals

In terms of Non- Performing Assets (NPA), public sector banks are big laggards; their NNPA (Net Non- Performing Assets) has been 3.9% compared with Foreign banks’ 0.49% and Private Sector Banks’ 1.42%.

It is worth noting that NNPA actually conceals more than it reveals. The reason:

NNPA= Net NPA/ Net Advances

Net NPA= Gross NPA- Provisions for Loan loses

A better indicator is Gross NPA to Advances. According to Financial Stability Report (FSR) of the Reserve Bank of India, public sector banks had a Gross NPA to Advances ratio of 9.45% in 2021 and it is likely to go up in 2022.

NPA has been an area of concern all over the world and a Gross NPA ratio of 3% is considered acceptable. But higher than that is considered a cause of concern.

In USA, one single ratio called Texas Ratio is highly monitored and regarded.

Texas Ratio= Non-performing Assets/ Tangible Common Equity + Loan Loss Reserves

Speaking on the occasion of ‘Audit Diwas’ on November 16, 2021, PM Narendra Modi said “You know very well how, in the past, NPAs were brushed under the carpet. However, we have put the truth of the previous governments in front of the country with complete honesty. We will find the solutions only when we recognise the problems”, he said.

The Real Issue: Non- Performing People (NPP)

Strategically speaking, the real issue facing Indian public sector banking is Non- Performing People, more than NPA. When you go to take project finance from a bank in India, a saying is ‘Man behind the project is more important than the project’. So is true about bank loans. The men and women behind bank lending are more important than the loans and advances.

Experienced bankers in public sector banks in India are often heard saying,

‘problem is upstairs’;

‘problem is political bosses’;

Government’s abrupt change in policies turn well performing profit making companies into loss making and on time paying borrowers into defaulters’;

‘there is the problem of moral hazard’. (moral hazard in simple words means borrower using loan amount for a purpose other than the original purpose for which it was taken).

It is not that there is no element of truth in what they say.

But at the end of the day, it is the money of the depositors that is held in trust by bankers, that they lend. And depositors of Indian banks are predominantly people of limited means. Bankers in India should have an additional responsibility to give money to only those who will pay back on time and in full.

How to do that is no astrophysics. That is Banking 101. 5 Cs of Credit is a well- known framework. 5 Cs framework means bankers, before giving loan, need to take closer look at Character ( Past Track Record of Loan Repayments of the borrower), Capacity (to generate surplus for himself / herself and pay back loan to the bank), Capital (Equity or borrower’s skin in the game), Collateral (valuable security to cover, just in case, for loss of capacity to generate surplus and repay loan), and Conditions (pre and post disbursements to check moral hazard).

With the 5Cs framework in place, Adverse selection is the problem of the banker. Adverse Selection means giving loan to someone whom it should not have been given.

In my 50 years of working with highly experienced bankers, I have not come across one single who ever said that NPA happens because of adverse selection.

What is the Solution?

A time tested and trusted solution is implementation of an appropriate Management Control System (Managerial Performance Management System), where Individual responsibility accounting is the key.

Indeed, I have devised over years, a 10- Element Model of High Performing Organization with Individual Responsibility Accounting as the key most element,  which can help enhance managerial performance in any organization including public sector banks. But that is for another time.

Note: It is based on my presentation at the Council for Strategic Affairs, USA on November 8, 2021.

DISCLAIMER: The author is solely responsible for the views expressed in this article. The author carries the responsibility for citing and/or licensing of images utilized within the text.