Jun 3, 20212 min read

Pandemic makes PSU banks starve for loan growth

Public sector banks have been losing their share in both deposits and loans to their private sector peers for several years now. The pandemic has made this even more acute.

Data from the Reserve Bank of India (RBI) shows that public sector banks saw their credit growth drop to a 13-quarter low in the March quarter of FY21. Year-on-year credit growth was a mere 3.6% for public sector lenders while their private sector peers saw a robust 9.1% loan growth. It is clear that the sharp deceleration of loan growth in FY21 was led by public sector banks. To be sure, foreign banks reported a 3.3% contraction in their loan book, adding to the overall loan growth deceleration.

In the past decade, public sector banks have lost market share hand over fist in loans to private sector peers. Their share has dropped to 58% in FY20 from as high as 75% in FY10. This is likely to have gone down even further. What has led to this decline?

The biggest constraint for public sector lenders has been capital. The need for capital has outstripped the supply from their owner, the government. Exacerbating the need for capital has been the sharp rise in toxic loans on their balance sheets. The bad loan cycle that involved large corporate loans during FY16-FY19 manifested mostly on public sector bank balance sheets. Many lenders saw their core capital erode below the mandated regulatory minimum. In the end, mergers among public sector lenders were seen as the only way out. While this toxic cycle engulfed public sector lenders, what explains their continued market share loss in a pandemic year?

Firstly, most public sector banks were preoccupied with their mergers. Second, the pandemic has decimated a large number of small businesses. Public sector banks have been the biggest lenders to the micro, small and medium enterprises (MSME), partly due to the government’s own push. The MSME segment has been the hardest hit and lenders have become risk averse yet again. Large companies, having just deleveraged, are not resorting to borrow cheaper from the capital markets. As such, the pandemic’s impact has meant that overall credit demand from the industry has come down.

For loan growth to revive, public sector banks need to show a revival in their loan growth. Most lenders now have enough capital to participate in the credit market. Even so, legacy bad loans still haunt and several are stuck in insolvency proceedings. The current financial year is unlikely to show a marked improvement although analysts expect public sector banks to turn in a better performance than before.

In essence, India’s banking sector has been privatised without any change in the ownership of banks. Private sector banks are continuing to corner market share in both deposits and loans.