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  • Team Carnelian

This time it’s different

Updated: Dec 12, 2022

Greetings from Team Carnelian!


“This time it’s different” are considered the most expensive words in our industry.


These words can be most expensive (in form of actual loss of capital) if you end up betting on something which never changes with time (like human psychology of greed and fear, inevitability of business cycles, New Tech in recent times, etc.).


These words can also be very expensive (in form of missed opportunity) if you ignore a structural changing scenario / major trend due to some significant developments (markets/regulatory, etc.) and link it to normal business cycles.


In this letter, we are going to talk about one such trend which falls in the second bucket - a big structural change which if you didn’t notice – one might miss a Big Opportunity. We have been writing and speaking about it over the last one year, but in this letter, we are only focusing on this one aspect.


We are talking about the impact of a series of structural changes taking place in the Banking sector especially in the credit space.


Historically the sector has been known for a very patchy, highly cyclical returns. A big cause of value destruction has been the NPA cycle and elevated credit costs. Regular & accelerated credit cycles always impact the credit growth and credit penetration.

This time is different – and why do we say so?


Credit is broadly categorized into two segments – retail and wholesale.

Post liberalisation, India witnessed two elongated bad asset quality cycles. During 1998-2001, retail lending was a very miniscule part, and large part of loans were to the corporate sector. We saw NPA levels reaching ~12-14% at a sectoral level.Till then the sector was largely dominated by PSU banks; private banks were beginning to get built – Most private sector banks focused on retail credit growth as a big opportunity, which got well reflected in the massive retail credit growth during 2002-2008.


During 2002-08, the retail credit in India jumped by ~7x to reach INR 5.2 tn in 2008. While the retail credit grew at such a rapid pace, it was followed by a huge increase in retail NPAs for the sector. In hindsight, we identify, poor credit assessment as the main reason for this caused by poor availability of data and CIBIL Infrastructure.


For e.g., ICICI Bank’s retail book jumped by ~25x during this period increasing the retail loan’s share from ~10% in 2002 to ~65% in 2007. This was followed by a retail NPA built-up for the bank – the retail GNPA reached ~8% in 2010 before it started recovering gradually. Similarly, lots of players including foreign players like ABN Amro, HSBC India, etc were also impacted due to this.


India also witnessed a very good credit growth on the corporate side during 2005-2013 when corporate credit grew by ~5x. This was followed by another massive asset quality cycle led by the corporate side where GNPA reached almost 11%-12% at industry level. It is commonly known that frauds, political influenced lending, and the lack of a legal framework to resolve bad assets was one of the biggest reasons for that. However, retail lending did not witness any major NPAs due to awareness and enforceability of the CIBIL score.

Structural developments over the last few years have significantly improved the banks’ ability both on credit assessment and credit enforcement:


CIBIL infrastructure: India started building the credit score infrastructure only in early 2000. Unfortunately, it’s impact and effectiveness were a miss in the 2005-2007 credit cycle, leading to a huge built-up of retail GNPAs, as discussed above). From thereon it started gaining momentum with each passing year and as we stand today with its strong implementation in place, the rating infrastructure has made asset quality very robust in India. We fortunately have not faced any retail NPA built ups since then in the last decade (including in 2014 where corporate NPAs were high and when we hit once in a century kind of pandemic crisis). This can largely be attributed to awareness and availability of infrastructure. No one today wants to mess with their CIBIL score no matter which economic strata of the society does one belongs to, as it impacts the availability and cost of subsequent borrowing.


CIBIL revolutionized the retail lending in India – not only did it lead to better and accurate data availability for credit assessment but has also improved retail credit penetration.


Insolvency and Bankruptcy code, 2016 – IBC! another master stroke! What CIBIL did to retail, IBC will do to wholesale credit over the next 8-10 years. IBC has moved control away from debtor to creditor and has created a sense of responsibility amongst the borrower about losing his company/asset. This was introduced at a time when India’s Non-Performing Assets and debt defaults were at 11-12% levels and older loan recovery mechanisms in existence - such as the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act (SARFAESI), Lok Adalats, and Debt Recovery Tribunals were almost ineffective. While it will take time (just like CIBIL) to see full effectiveness, some early success of larger cases speaks about the power of this act. We believe, incremental lending will be far safer and less prone to frauds. Of course, it will be subject to normal business cycle but that’s a part of the credit assessment, hence will not impact much.


Credit assessment (governance/lack of information): Historically, credit assessment has suffered from lack of reliable/accurate data and political influence. Both have undergone a sea of a change. Today Banks don’t need to rely only on the borrower for availability of data.


With the introduction and effective implementation of GST, it has now become feasible for bankers to get borrowers financial data which is accurate and available with ease. Inclusion of informal transactions within the GST and UPI ambits, has provided a plethora of information on financial transactions of the MSME sector which hitherto was not traceable. Data from these are now forming the basis for financial institutions to ascertain a corporate borrower’s cash flow position and identify credit worthiness. We are already seeing increased traction in lending to MSME’s on account of easily available information to lenders.


Digitisation: Digitisation has become one of the core strategies for most banks. Digital assets are playing a vital role in both credit assessment and sourcing of assets which helps in faster credit penetration with lower credit cost.


Few other enablers are

  • JAM (Jan Dhan-Aadhaar-Mobile) Trinity

  • Fugitive economic offenders act, 2018

  • Account Aggregator Platform

These path breaking reforms initiated over the last few years will enable creditors to address aforesaid issues structurally.


Upcoming digital infrastructure such as OCEN (Open credit enablement Network) is another big reform in making, which will further bring efficiency and balance of power between borrower & lender.


Democratisation of credit and lending to the unbanked in our view will be the hallmark for the next decade. PMJDY accounts have hit 462.5 mn in the last eight years, with deposits hitting a solid INR 1.74 lakh crore. Operative accounts as a percentage of the total, stood at a healthy 81.2% in August 2022.


More people using the banking network for transactions, larger will be the data generation, enabling increased lendability.


So, at one side, while all the above initiatives will lead to an increase in the lending universe, it will have a far-reaching impact on the credit growth. This coupled with better credit assessment due to availability of data will help contain credit costs that has impacted the banking system previously at regular intervals.

The result of above will be faster & inclusive credit penetration coupled with lower credit cost for the foreseeable future.


We envisage –


Credit cost will be in a much narrower band than any previous period. This will lead to risk appropriate pricing of credit, which will boost the ability of the sector to handle business cycle-led banking NPAs. Long term impact of this could be better pricing for customers, lower NIMs for the banking sector and also lower credit costs with improved /better/stable ROAs.


This will lead to a re-rating of the sector. High growth phase with stability in risk profile leads to re-rating. The winning formula will be Banks with better technology capability, robust liability franchise, wide reach & footprint and strong brand presence.


Banking Sector – In the Goldilocks Phase:

We have continuously iterated that India is poised to enter a high growth phase and it will be India’s decade. The financial sector thus is best placed to benefit from this economic growth.


The economic growth would funnel the increase in credit demand and lower credit costs which would boost the profitability of the lenders which in turn will have a multiplier impact on the credit growth making it in the goldilocks zone for the next few years.


As the stalwarts speak:

Any unforeseen global or domestic event leading to economic upheaval or bad business cycle could impact the banking sector, but one cannot predict the same – on a purely risk-reward basis the sector is perfectly positioned for superior wealth creation going ahead.

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