How does the banking or financial industry work?

The Indian banking sector was established pre-independence, during the 18th century. After independence the banking sector has become one of the biggest service sectors and has gone through several evolutionary changes in phases with nationalisation, mobilisation of capital, consolidation and liberalisation being the main aims. Banks play a vital role in strengthening a country’s economy by making idle savings available for interest. The Reserve Bank of India (RBI) is the top most bank of our country, it supervises the nationwide banking structure. Established in 1935, the RBI is owned by the Indian Government. It has the power to issue notes and implement monetary and credit policies. Next comes the Commercial Banks and Cooperative Banks. Because of the RBI, India’s banking sector is well-regulated, robust and transparent.

Commercial Banks include Public Sector banks (Nationalised banks), private sector banks, foreign banks, regional rural banks (RRBs). Commercial banks are run-for-profit organisations. These institutions accept savings deposits, provide interests against those savings, lend personal and business loans. Commercial banks cater to personal and industrial financial needs. Co-operative Banks are at the state level, district level, and other banks. The main purpose of Co-operative Banks is to provide rural-credit, they thrive on the principle of mutual help. These play the main role in rural cooperative financing.

Current Situation

• There has been an increase in the working population with access to a stable income since the establishment of the banking sector in India. This has enabled people to invest in long-term savings policies which has helped the banking sector, and eventually the Indian Economy experiences multitudes of growth.
• Extension of banking facilities into the digital landscape with tools such as internet banking, SMS services, telebanking, electronic payments, ATMs, has given ease of access and improved national financial literacy.
• The Domestic Banking Industry has greatly benefited from innovative bank models, small finance banks, high net interest margins, and low NPA (non-performing asset) levels. In the past decade the main goal of the banking sector has become customer retention as opposed to acquiring new customers.
• India’s Immediate Payment Service stands at level five in the FPII (Faster Payments Innovation Index).
• As of now, India has twelve public sector banks, twenty two private banks, and 96,000 rural co-operative banks in addition to cooperation credit institutes.
• In 2019, banking and related financial transactions saw thirty two merger and acquisition activities amounting up to US $ 1.72 billion.
• In the Financial Year 19 all public sector bank assets amounted upto US $1.04 billion and the total assets of the entire Indian banking sector amounted upto US $ 2.27 trillion in FY19.

Impact of Covid-19

• Amid all of this success the world was hit by the devastating Covid-19 pandemic in January 2020 which made its way to India by March 2020. The macroeconomic and microeconomic effects of the pandemic were devastating.
• Indian Economy was already trying to recuperate from a crisis even before the pandemic hit which is what made things worse, every single industrial sector was affected and the banking sector was no exception.
• Customers from the corporate sector and SMEs ( Small and Medium Enterprises) were scaled down drastically.
• Nearly twenty two industrial sectors have been affected so banks are coming to the rescue by restructuring loans of companies who have suffered huge losses during the pandemic.
• Nineteen industrial sectors, which were not in debt before the pandemic, have found themselves facing debts of upto Rs. 15.5 lakh crore.
• However, banks are not equipped to restructure all the loans, hence certain conditions have been formulated, only companies who match these conditions are eligible for loan restructuring.
• As past records show, banks might be more risk-averse after such loan write-offs. If the Covid-19 crisis continues customers will prefer to shift to digital routes and insurance policies.
• Even though banks are expected to set aside some mandated capital in order to make provisions for bad loans, however in a pandemic situation this is hardly a saving grace. These provisions were not enough in the wake of a lingering economic crisis, eventually economic growth of the entire country was hampered.
• Non-Performing Assets (NPAs) have been predicted to rise to 12.5% (2020-21) as per RBI’s latest Financial Stability Report, but if the covid crisis continues then it might increase to 14.7%.
• Hence, right now the main of the banking sector is to manage distressed debt , they might make use of market based mechanisms and IBC (Insolvency and Bankruptcy Code 2016). Business models have to be re-calibrated to accommodate changing market trends.
  *Strategic interventions have to be executed in order to reduce the chances of accumulating distressed debt and bad loans.

Conclusion

The banking sector is picking itself up from the initial blow of the pandemic but there is a long way to go. This is a new opportunity to deepen customer relationships and further digitise the banking sector. The future may see many banking reforms which may promote business continuity in these hard times. Banks are now better prepared for any such mis-happenings in the future. Financial Institutions will undergo capital infusions in order to maintain regulatory and growth capital. The Government may help out by providing some aid to provide stimulus for recovering  losses. The Banking and Financial sector will emerge stronger after the pandemic is over.

Also read:

1) 7 Different Types of Loans for Your Small Business
2) Home Loan: Steps to apply, Best Interest Rates on Home Loans & more
3) Dos & Don'ts For Managing Finances During Pandemic.
4) Should You Hire a Financial Advisor if You Run a Business?

FAQs

Q. What are Non-Performing Assets (NPAs)?

Ans. NPA refers to those loans which have not been paid out, it can be the principal or interest amounts which are in default or are late to be paid.

Q. What are Mergers and Acquisitions (M&A)?

Ans. Mergers and Acquisitions refers to strengthening companies and their assets by combining them with other companies. In acquisition one company purchases another and a merger is when two firms come together to form a separate legal entity.  

Q. What is India’s Immediate Payment Service (IMPS)?

Ans. IMPS is a real time payment service which is available 24x7. Through this you can transfer small amounts of money up to two lakhs.

Q. What does restructuring a loan mean?

Ans. It is an agreement between both lender and borrower to change a few conditions of the loan which usually benefit the borrower, the interest on the loan might be decreased or the monthly instalments may be lowered.

Q. What is distressed debt?

Ans. This refers to securities which are under financial distress and defaulted.

Q. What is IBC 2016 ( Insolvency and Bankruptcy Code)?

Ans. Insolvency occurs when a debtor (a person or a company) cannot repay debts at maturity. The IBC 2016 was introduced in order to resolve the issue of rise in un-resolved debts and NPAs. This Code applies to any debtor be it a company or an individual, it represents a time bound process to work out insolvency. It allows the creditors (banks) to take control of the debtor’s assets in the case of an insolvency and resolve the conditions of the loan.

Q. What is Capital Infusion?

Ans. In a firm, when one division is not doing very well as compared to others, new funds are fused into that division. This helps the division to pick itself up.