India's banking sector troubles weigh on economic outlook

Cash crunch at the ATMs the country, which continues to reel under the burden of bad debts

A United Bank of India ATM with half closed shutters in Kolkata . ATM machines across India ran out of cash this month. Piyal Adhikary / EPA 

In India this month, ATM machines ran dry of cash, particularly hitting the states of Karnataka and Andhra Pradesh. People desperate to get access to the funds, somehow, saw the funny side of a grave situation as social media was inundated with jokes centered on the theme of India finally becoming a truly “cashless” society.

The jibes were references to Prime Minister Narendra Modi's shock announcement in November 2016 to ban the two highest value banknotes from circulation, the move aimed at cutting heavy dependence of Indians on cash and to curb black money flows.

While the demonetisation agenda was the reason behind extreme cash shortages in 2016, there has not been a consensus on the exact cause for the cash crunch this time around. Money being withdrawn for elections – a very expensive affair in India – and people hoarding notes were among the factors speculated.

The cash crunch at the ATMs is the latest issue to plague India’s banking sector, which continues to reel under the burden of bad debts. Confidence is eroding in the financial services industry, which this year has seen a number of high-profile corporate scandals. And this is not good news for Asia’s third-biggest economy. 

“The turbulence in the banking sector – be it the scandals, low cash in the ATMs, senior bank officials coming under a cloud – has affected the confidence in the sector and the decision-making by bank officials and consequently the economy,” says Babu Sivaprakasam, the head of banking practice at Economic Laws Practice, a corporate law firm in Mumbai.

India’s economic growth has picked up pace, expanding at 7.2 per cent during the quarter to the end of December, faster than China, to regain its title of being the world’s fastest growing economy.

But the troubles in the banking industry have played a role in prompting economists to cut their growth forecasts, with Goldman Sachs last month slashing its projections for GDP growth to 7.6 per cent from 8 per cent for the current financial year from April to end of next March.

The scandal that grabbed worldwide attention involved Nirav Modi, a celebrity diamond jeweller who is accused of a $2 billion fraud through issuing fake guarantees at a single branch of Punjab National Bank in Mumbai, India's second-largest state lender.

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This was followed by a string of issues that came to light, including allegations in connection with fraud against executives at two of India’s largest private lenders, ICICI chief executive Chanda Kochhar and Axis Bank chief executive Shikha Sharma.

“Everything in banking is to do with trust,” says N Chandramouli, the chief executive of TRA Research,  a brand insights and consulting firm. “It works on investor and consumer confidence.”

But there is a bigger, more deep-rooted problem, which may prove hard to rectify: bad debts at India’s banks amount to almost $150bn, according to unpublished Reserve Bank of India data reported by Reuters. Axis Bank last week revealed its first ever quarterly loss of about 22bn rupees (Dh1.21bn), as it increased its provisioning for non-performing loans.

Market analysts are concerned about lending growth – a critical component of economic growth momentum.

Some of the banks are holding corporate loans back as they focus on tightening procedures to try and prevent future frauds, a move  Vijay Sokhi, the founder of Mumbai consultancy Scico, says is denting the prospects of “ethical business” getting hold of much needed funds for expansion.

Mr Chandramouli, however, argues that having stringent checks and balances in the system will be beneficial in the long run. That said, there is no denying that banking sector has a problem of who to trust in the corporate sector as well, he says. “The entire gems and jewellery trade is suffering from the fact that there is no credit available. Therefore, you see an entire industry that contributes to the GDP and employs so many people, getting impacted.”

The troubles in banking are unlikely to be resolved soon. It will be years, before the system will be able to control the bad loans alone, according to Mr Chandramouli, who says “banking is the glue that runs everything else, so if banking fails, then everything else [the economy] is in trouble”.

There are those who believe that India’s economy and its banking sector will emerge stronger despite the headwinds.

“We’re hopeful that growth could strengthen in the coming quarters,” says SP Sharma, the chief economist at PHD Chamber of Commerce and Industry. “We’ve seen the economy reviving, although it isn’t back to what it was in the golden era. I think the banking sector problems can be resolved [as well].”

The RBI, the banking regulator in the country, has already set up an expert committee to look at the issues related to fraud in the banking industry and has asked banks to tighten international mechanisms.

The economy and the banking sector are in a “curative phase”, and Mr Sivaprakasam say that steps have been taken to ensure resurgence. It is all a good news for those monitoring the long term strategy of the government, but what the people on the street are concerned with is what the authorities are doing to address the day-to-day issues such as cash shortages at the ATMs.

“It’s [difficulties in cash withdrawals] become a part of life,” Mr Sokhi says. “If you have to get the money on the spot, then you have to be extremely lucky that the ATM near you has the cash.”

The RBI tried to calm concerns when the ATMs ran dry with a statement that there is “sufficient cash in the RBI vaults and currency chests”, but it nevertheless ramped up printing of notes in response.

“The shortage may be felt in some pockets largely due to logistical issues of replenishing ATMs frequently and the recalibration of ATMs being still underway,” said Jose J Kattoor, the chief general manager of the RBI.

There are those who are able to benefit from the gaps in the banking system. Payworld, which allows customers to withdraw cash from their bank account at mom and pop stores in rural areas and smaller towns, is one example. 

“India is still a cash based economy in smaller places,” says Praveen Dhabhai, Payworld’s chief operating officer.

There was a 30 per cent spike in transactions for his company this month as ATMs ran out of cash.

While the cash crunch is good business for Mr Dhabhai, elsewhere in India, things are not looking so rosy as troubles of banking sector continue to spillover into the wider economy.