Indian banks: Challenges might spoil the 'best of times' in two years, feels McKinsey
As in FY23, the top three banks in India have a P/B multiple of 2.5 – far higher than the 0.5-1.5 band for banks in some major countries.
With robust credit growth, sharp improvement in asset quality and health growth in margins Indian banks rarely had it so good. That’s universally acknowledged. But will the good times continue?
If global consultancy major McKinsey is to be believed, the next two years might be not as smooth with multiple challenges with slower growth of deposits, rise in operational expenses and possible erosion of interest income making the journey rough for the banks, reported The Economic Times. McKinsey even said that return on assets for the banking industry that stood at 1.1% in FY23 might slide to 0.80-1.0% by FY25.
What’s more, banks in India registered higher return on assets (ROA) than global peers triggering premiums in valuations with higher price-to-book (P/B) multiples. As in FY23, the top three banks in India have a P/B multiple of 2.5 – far higher than the 0.5-1.5 band for banks in some major countries.
The consultancy major examined the performance of as many as 80 banks since the beginning of FY19 and came up with a report titled “Indian Banks: Building Resilient Leadership”. The report admitted that the banks are wallowing in the highest profitability in the past decade with reducing credit cost and healthy net interest margins.
However, McKinsey red-flagged the concern areas and said that household savings may gradually drift away from bank deposits. It also expects upward pressure on inflation and said that the two factors might combine to make funds costlier for banks that is likely to impact their profitability.
On the human resource front, the banks would increasingly face the challenge of attrition – something that they are already experiencing at the younger end of the manpower spectrum. The competition for skilled talent would raise the HR cost.
On the operational front, Indian banks might face the heat of compliance on data security and privacy issues that could also push up costs.
“To improve performance, the industry will require investment in digital capabilities to service the growing mid and mass-affluent; focus on new opportunities such as digital commerce and financial inclusion in the rural sector; and build on tech resilience and digital & analytics capabilities,” Peeyush Dalmia, senior partner, McKinsey was quoted as saying.
There is a challenger on another front. Banks in India face apprehensions of reduced fee especially because of increased competition from fintech companies for fee income. Rising attrition and competition for skilled talent will also push up costs.
Dalmia also said that Indian banks would need to raise spending in technology to 9-10% of total income from the current band of 5-7%. Banks would also need to expand into under-penetrated rural and agriculture segments and improve wealth management skills especially for the mid and mass-affluent segments through expansion of their digital capabilities.
The consultancy firm expects banking credit growth to remain healthy and maintain a CAGR of 12-14%. However, lending banks would need to shift focus elsewhere such as Tier 2 and Tier 3 cities to drive growth in this domain. McKinsey estimates that around 80% of the customers for personal loans are from Tier 2 and smaller towns up from around 70% in fiscal 2018.