India’s state-owned banks are set to narrow their performance gap with their private sector peers as they reap the rewards of government reform and the nation’s rapid economic growth.
The government’s decision to merge smaller public sector banks that had weak performance metrics with larger state-owned lenders allowed for better economies of scale. Simultaneously, the central bank’s focus on improving asset quality across the banking industry helped state-owned banks improve their performance across metrics including problem loans, profitability and return on assets, S&P Global Market Intelligence data shows.
“I can see a marked difference in how public sector banks approach business and the hunger of growing the business,” Pratik Shah, financial services market segment leader at EY India, told Market Intelligence in a telephone interview. “There is a marked change, which I think is here … to stay.”
The median problem loan ratio of public sector banks improved to 3.96% in the year ended March 31 from 6.47% a year earlier. The ratio was 14.12% in the year to March 31, 2020. Private sector banks also improved their asset quality, though the incremental gains made were smaller than their government-owned peers. Private sector banks’ aggregate problem loan ratio improved to 2.18% as of March 31 from 2.51% in the prior fiscal year and 4.09% as of March 31, 2020.
Public sector banks’ median return on average assets (ROAA) improved to 0.92% as of March 31 from negative 0.32% at March 31, 2020. Private sector banks’ median ROAA rose to 1.47% from 0.56% over the same period.
Stronger balance sheets
Indian banks, both public and private, strengthened their balance sheets and boosted profits in recent years, thanks to the local economy’s strong recovery after the pandemic-induced slowdown, solid credit growth and higher interest rates. India’s economy is projected to grow by an average 6.7% per fiscal year from 2024 through 2026, the World Bank said in a June 11 report. The Reserve Bank of India expects the economy to grow 7.2% in the current fiscal year.
Public sector banks are set to build on their stellar performance in the past few years. “Public sector banks have now been at an inflection point since the last four years with significant turnaround in the performance due to RBI’s focused 4 R strategy: Recognition, Resolution, Recapitalization, and Reform,” Shah said. India’s Insolvency and Bankruptcy Code of 2016 has helped recover Rs 3.5 trillion and reduced resolution time from 4.5 years to 460 days by 2021, Shah said.
In several key metrics, public sector banks have caught up with or even surpassed their private sector peers. Bank credit accelerated in the second half of fiscal 2023–2024 among public sector banks but moderated at private sector banks, the Reserve Bank of India said in its Financial Stability Report released in June. Public sector banks also recorded a substantial reduction in their gross non-performing asset ratio during the fiscal half as it fell to 3.7% in the half.
The median net interest margin (NIM) among public sector banks improved to 3.01% in fiscal 2024, from 2.90% in fiscal 2023, Market Intelligence data shows. In comparison, median NIM at private sector banks fell to 3.99% from 4.09% in the prior-year period.
Bank mergers
Public sector banks have benefited from a series of government-implemented mergers over the past decade. These were part of policy reforms for the sector, which was rife with problems including rising bad loans and capitalization issues, according to analysts.
The results of those mergers are now being reflected on balance sheets. The government embarked on a consolidation of the public sector banking industry in 2020, under which 10 lenders were consolidated into four. India now has 12 public sector banks, and local media reports suggest that the government may push for more consolidation.
“As the mergers happened, as the branches started consolidating, banks started seeing operating leverage kick in. A lot of efficiencies of scale have kicked in,” Shah said.
Post-merger, banks were able to reduce their costs and utilize their resources more efficiently, as they were able to rationalise 5% to 10% of their branches, and business per branch as well as per employee has been growing at a compounded annual growth rate of 8%-9% in the last five years.
Further, creating a “good bank” and a focused team working on the “bad bank” helped release locked capital and build a path to profitability for the merged banks, Shah added.
