DURING India’s long experiment with socialist economics after gaining independence in 1947, many big industrial houses managed to survive as recognisably private firms. Banking, though, got it in the neck. “Major banks should be not only socially controlled, but publicly owned,” Indira Gandhi, the then prime minister, announced on All India Radio in 1969. Nationalisation followed.
Today, after 20 years of liberalisation, state-run banks can sometimes look like they are in terminal decline. Some branches are literally rotten, their concrete walls covered in slime and window bars rusted. Yet the reality is quite different. The state sector still controls three-quarters of deposits, and since the financial crisis its share has crept up (see chart).
In 2008 and 2009 foreign banks, burned by bad consumer loans and shaken by events elsewhere, withdrew credit. Some private Indian banks slammed the brakes on, too, including the largest, ICICI, which faced rumours of insolvency—scurrilous, as it turned out, but gleefully repeated by at least one state-bank boss at the time. The public banks, meanwhile, and in particular State Bank of India (SBI), which has a fifth of the market, had an influx of deposits and undertook a lending splurge. SBI’s balance-sheet doubled between March 2007 and March 2011.
SBI insists that its expansion did not reflect a Chinese-style, government-directed effort to offset the global slump. Yet although they remain tiny compared with Chinese giants like ICBC and China Construction Bank, there is often more than a whiff of Beijing about the Indian state lenders. Their loan books are skewed towards more socially worthy projects; their bosses’ pay is modest; and they have a hybrid status as firms that are listed but have the state as a majority shareholder.
The crisis led to a reddening of attitudes across the industry. The requirement that banks must hold up to about a quarter of their deposits in government bonds was no longer denounced as a racket to help fund the budget deficit but instead hailed as an enlightened form of liquidity management. The Reserve Bank of India (RBI), the central bank which regulates banking as well as setting interest rates, made clear its view that India’s approach was superior to the discredited Western models that it had long been told to adopt. It seemed as if India’s state-dominated system might not be a staging-post towards full liberalisation but instead the end destination.
Yet recently things have shifted again. In May SBI’s new chairman announced dire results, with lower lending margins, provisions for pensions and extra charges taken against its loans. The hit, including forfeited profits, was some $2.5 billion, equivalent to over a tenth of the bank’s equity. Since its capital ratios are too low to support fast growth, SBI needs to raise more equity. That means persuading the government, which does not want its 59% stake diluted, to stump up: not an easy task.
With rates rising and the economy slowing, some fear more bad debts could emerge at the state banks that lent freely during the downturn. Meanwhile the private banks seem perkier, with their share of loans beginning to rise. ICICI’s chief executive, Chanda Kochhar, says that after two years of building more branches to suck in sticky deposits, the bank is “in a happy situation” and ready to start increasing credit again. Aditya Puri, the boss of HDFC Bank, which remains the darling of investors thanks to its metronomic performance, plans to keep expanding quickly, too. Other financial firms with banking licences, such as Kotak Mahindra, have been shifting towards the lending business and away from capital markets where profitability has fallen, partly thanks to a rush of foreign investment banks into India.
Two reforms being flirted with by the RBI could make things more competitive. The first would offer foreign banks a deal by which they create proper subsidiaries in India (which should be easier to regulate) and direct more lending to priority areas such as agriculture. In return they will be allowed more branches. One foreign-bank boss reckons that India, much like China, will never allow foreign firms more than a 10% market share, but that would still be almost double current levels. Another is more optimistic, saying that the RBI’s stance is a “huge step”.
The RBI is also considering granting new banking licences to Indian-owned firms. There is some scepticism about the process. One Mumbai financial bigwig jokes that two licences will be granted—one, by the RBI, on the basis of competence, and the other by politicians in Delhi on the basis of bribe size. Still, the result should be an increase in the number of banks. India could end up allowing industrial conglomerates to own banks. That would put it at odds with most countries, where mixing business and banking is considered toxic, but would mean new entrants with financial muscle (although the butchest conglomerate of them all, Reliance Industries, said on June 3rd that it would not seek a licence).
Over the next year private banks will almost certainly win back market share. Farther out, the Beijing model of banking is in any case probably beyond the capacity of the cash-strapped Indian state. Loans are only about a third of India’s GDP compared with over 100% in China. The private sector will be needed to provide the capital to support more credit. Nor can India seal off its financial system to the same extent as China. Its businesses are internationalising faster, and its persistent current-account deficit and bad infrastructure mean it badly needs foreign investment.
As a matter of both preference and necessity, then, Indian’s banking system will become more linked with the world. Its resilience during the crisis partly reflected its competence, but also its insularity and underdevelopment. But if India’s economy is to rival China’s by size, its financial sector needs to become less, not more, like the Middle Kingdom’s.
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