2.3 India: Branch Networks and Total Credit, 2018

st A te - owned b A nks versus P riv A te b A nks in sout H A si A 61

bank data are readily available for it, and bank characteristics can be linked to firmlevel investment data—a real outcome variable of interest for this chapter.

The banking system assets of India’s scheduled commercial banks (SCBs) amounted to about 80 percent of GDP in 2018.6 SOCBs (called public sector banks, PSBs, in India) dominate the banking sector in terms of assets, credit, and branches. PSBs hold 66 percent of total SCB assets, while domestically owned private banks (PVTBs) have about 28 percent; foreign commercial banks (FBs) hold about 6 percent; and small finance banks (SFBs) control a minimal 0.3 percent.7 In terms of credit, PSBs control about 63 percent of total banking credit, PVTBs control about 29 percent, and other SCBs represent about 8 percent of total banking credit. By the end of 2018, PSBs operated 92,362 branches across India, three times more than the domestic and foreign private banks combined. The largest commercial bank by far is the State Bank of India (SBI), which controls 23 percent of total banking assets and 20 percent of total banking credit, and operates the largest branch network, with more than 23,382 branches and a dominant rural presence (figure 2.3).

Given their large branch network, PSBs can mobilize large amounts of retail deposits, which comprise the largest component of PSB funding (figure 2.4). Loan-to-deposit ratios are higher in other banks compared with PSBs, further reflecting their ability to mobilize greater amounts of deposits. Other banks must rely more on costlier modes of raising funds. For instance, SFBs rely largely on lines of credit to fund their lending activities (figure 2.4). Unlike other PSBs, SBI, as India’s largest bank and a government corporation statutory body, can readily raise funds outside of India by borrowing from international global markets. Thus, total SBI borrowings (10 percent of total liabilities) are higher than the borrowings of other PSBs (7 percent of total liabilities). Meanwhile, leverage, as measured by the tier 1 capital-to-total-assets ratio, is above the prudential minimum of 4 percent for systemically important banks and 3.5 percent for other banks—stricter limits than the Basel minimum of 3 percent. Leverage is less than 6 percent for PSBs (at 5.6 percent for SBI and 5.1 for other PSBs) and above 10 percent for other banks, indicating that PSBs are more leveraged than other banks.

As noted, SOCBs do not tend to have explicit mandates to address market failures

FiGURE 2.3 india: Branch Networks and Total Credit, 2018

a. SOCBs have much more extensive branch networks b. SOCBs extend most of the credit volume

Number of branches Total credit outstanding in scheduled commercial banks

SFBs 1%

RRBs 3% FBs 3%

SBI 20%

SBI 23,382

PVTBs 29% PSBs 63%

Other PSBs 43%

Other PSBs 68,980

Source: Reserve Bank of India. Note: FBs = foreign commercial banks; PSBs = public sector banks; PVTBs = domestically owned private banks; RRBs = regional rural banks; SBI = State Bank of India; SFBs = small finance banks; SOCBs = state-owned commercial banks.

62 H idden debt

or create positive externalities. Data on the sectoral allocation of credit and lending to typically underserved segments (such as small borrowers) and priority sectors (as identified by the Reserve Bank of India, RBI) show that PSBs do not focus on lending to these groups or sectors more than private banks.8 In fact, most PSB credit goes to large borrowers and to the industry sector, a nonpriority sector. However, given their size, PSBs provide the largest absolute volume of lending to small borrowers. PSBs tend to lend much more to public sector entities compared with other banks, even though this lending comprises less than 10 percent of total loans (figure 2.4). Smaller banks—namely, SFBs and regional rural banks (RRBs)—do target priority sectors and small borrowers. More than 40 percent of their total credit is devoted to these segments.

Overall, banks earn most of their income from their lending activities. Foreign commercial banks tend to earn more through investments, as well as from fee-based and foreign exchange services. PSB business models tend to be more traditional, focusing on earning income through government securities and similar investments (30 percent of total income) and lending (more than 50 percent of total income). Unlike most PSBs, SBI earns almost 10 percent of its income from feebased services—compared with an average of 3 percent earned by other PSBs. Because of its cheap source of borrowing, SBI has a higher net interest margin (2.4 percent) than other PSBs (2.0 percent). By contrast, net interest margin indicators for all other banks exceed 2.5 percent (reaching 6.7 percent for SFBs). Other efficiency indicators show that PSBs tend to be less efficient, devoting a higher share of their wage bill to intermediation costs (figure 2.4). This could imply overcompensation of the management or overemployment. The literature suggests the latter (Kumbhakar and Sarkar 2003).

In recent years, declining profitability has resulted in negative returns on capital and assets. Although some PSBs still have positive profit indicators—return on assets (ROA) and return on equity (ROE)—the general trend has been declining profitability. This is partially explained by lower levels of efficiency and rising costs and expenses (including staff costs and expenses), as well as rising nonperforming loans (figure 2.4).

In 2015, following the RBI’s accelerated efforts to ensure that losses expected from distressed debt were adequately recognized and provisioned, an asset quality review was conducted. It revealed a higher level of NPLs than previously reported across the banking sector—most notably at the SOCBs. Many of these NPLs were attributed to infrastructure projects that had turned sour and accrued during a period when PSBs benefitted from regulatory forbearance. During 2019, NPLs remain the highest in PSBs in the Indian banking system—at about 10 percent in SBI and more than 17 percent in other PSBs— while the ratio is on average less than 4 percent for other banks. Since the discovery of high levels of NPLs, many banks have worked hard to write off and resolve outstanding problem assets. However, legal delays, inadequate infrastructure, and a large pipeline of insolvency cases have stretched out and will continue to lengthen resolution timelines. In response to these legal bottlenecks, the government in July 2019 increased the resolution time frame to 330 days, from the previously stipulated 270 days.

In addition to declining asset quality, capital positions have been weak within PSBs and have affected their lending capacity (figure 2.5). Even before the NPL finding, capital buffers were low, and the government developed a public-private recapitalization response—the Indradhanush plan— announced in August 2015. Given the limited private participation in this plan, government ownership in PSBs has increased because of the state capital injections to prop up these banks. However, following the NPL discovery, PSBs’ capital positions deteriorated again as provisioning increased substantially with the need to adequately cover higher NPLs. Making matters worse, the introduction of Basel III starting in 2019 and the subsequent phase-in of implementation has led to higher prudential capital requirements. For the 2020