You use banking services every day. You may make a payment or buy something or receive some money. Banking encompasses your personal and work life. Like you need banking services, the country needs a robust banking sector for future economic growth. Banks take money from you as a deposit and lend it to individuals and businesses as loans. Overall, credit growth is critical for an economy to expand.
If banks do not lend enough, businesses will not get the money they need, and they will not create the jobs we all need. When an economy creates jobs, it creates a cycle of investing and spending. That further enhances the demand for goods and services and triggers further economic activity. India needs such a cycle to run at full speed to ensure that the poor get more opportunities for work.
If businesses continue to grow profits, stock markets will continue to perform. The role of the banking sector is significant for economic growth and the stock market’s health. India needs the banking sector to stay robust for years to ensure sustained economic growth. As an investor, the banking sector in India is your hope against any inflation or future international shock.
Public sector or government-owned banks have played a significant role over the decades. However, their inefficiency is a drag on the economy. The stock market puts a lower value on public sector banks than private sector banks. That is despite the banking and finance sector accounting for a third of the S&P BSE Sensex value and a quarter of the NSE Nifty.
Over the past five years, the Nifty Private Banks index gained 32%. However, during the same period, the Nifty PSU Bank index has shed 25% of its value. The dichotomy in the same sector tells us that public sector banks are holding back India’s growth. At least, the stock market seems to think so.The political sensitivity around the privatisation of public sector banks makes any discussion over the topic tricky. During a Budget speech, finance minister Nirmala Sitharaman spoke about the privatisation of the government-owned banks in Parliament. That was a bold statement to make. There is minimal action on the ground.
A new study published in the Working Paper released last week by the International Monetary Fund argues that public-sector banks are generally associated with lower employment and growth. While the government provides implicit guarantees by recapitalising public sector banks, higher credit growth is possible only if a bank has lower non-performing loans besides the necessary capital. With the predominant burden of executing government-driven priority sector lending, public sector banks cannot push up credit growth.
There is merit in nurturing the health of banks by reducing their non-performing assets. There is no limit to the money the government can put in public sector banks. The recently released Financial Stability Report by the Reserve Bank of India observes that public sector banks have substantial unrealised losses in their books at the beginning of the interest rate tightening cycle. That indicates risks to their financial health going forward, the report warns. For faster economic growth, India needs to encourage well-capitalised private sector banks to push the necessary credit growth.
What you could do
Banks are at the heart of an economy. America and China have giant banks that dwarf all other banks worldwide. India needs many more large banks like HDFC Bank for a seat at the high table. There is no debate that India’s successive governments would nurture the creation of such institutions. If India grows, the banking sector will grow. When determining your asset allocation, you cannot skip the banking sector. As investors, you are better off riding along with the wave and making a passive investment through mutual funds. If you are new to the world of investment, exchange-traded funds are your first step based on the Nifty Bank index.
Reducing Banks’ non-performing assets
There is merit in nurturing the health of banks by reducing their NPAs. The recent Financial Stability Report by the Reserve Bank of India observes that public sector banks have substantial unrealised losses in their books at the beginning of the interest rate tightening cycle.