#15 The Trilemma
Weekly Report: 31st Aug-4th Sep, 2020
Where do banks go from here?
Consider this. You have a tiny sibling who irritates you a lot. Your father makes some rules in the house and you have to abide by that, even if that means sharing toys with your irritating sibling. Your mother says that you can’t bully your sibling just because he/she hit you once (or several times). Finally, your friend tells you that you don’t need to share your toy. But wait, your friend isn’t even part of the family!
Now replace father with RBI. Mother, with the Finance Minister (Government) and your friend with the Supreme Court. That’s exactly how banks are feeling right now.
RBI wants banks not to be risk-averse, else it will be “self-defeating” for banks.
Government (FM Nirmala Sitharaman) met with bankers this week. She said:
“Covid-19 related distress must not impact the lenders’ assessment of their creditworthiness”
I can’t overstate how ironical this demand is. C-19 might be the ONLY exceptional time when banks CANNOT estimate the borrowers’ true profile. None of the financial models work in such a scenario. The extent of a particular business or finances on a customer can only be fathomed by the borrower him/herself, who, for obvious reasons, would likely not be honest with their bank.
Then there comes the mighty Supreme Court.
This particular matter is in the Courts because of a tiny technicality: interest on interest.
Certain borrowers have appealed to the SC that interest accrued during the moratorium period should be completely waived off.
What is their argument?
“Banks are making profits even during this crisis. They are hiding behind RBI.” They are using the following legal argument to support their case:
What is the counter-argument?
The legal counsel representing RBI and the Government points out that the above Section includes the word “may” and not “must”. Also, the whole point of waiving off interest is to help certain sectors survive this crisis. But if this is done, there is a risk to the banking sector going down as well (which is true - NPAs are anyway going to rise because of moratorium; with interest waived off, banks’ earnings will be wiped off too!)
What did the SC announce?
As you might know, Indian banks jump at any opportunity to delay recognising NPAs. So our legal system should not undermine our financial system. RBI is trying its best to keep banks in check. When the judiciary pokes its nose, it hampers a lot of the progress that is made till now.
The next hearing is on September 10th. Before that, the KV Kamath committee is supposed to come out with all the details of the restructuring.
Let’s see how it all turns out when I come back next week.
What’s up with RBI?
Remember the Monetary Policy Explainer? If not, here’s an ultra short recap:
RBI had included Start-ups in Priority Sector Lending (PSL) - A list of sectors where banks are mandated to lend a portion of their total loan book so that they are not neglected
Yesterday, RBI came out with the full list of instructions. What’s new this time?
The central bank noticed that some districts (yes, not sectors) weren’t getting due attention. In fact, it has identified 184 districts where per capita PSL is less than ₹6000. A higher weight/rank would be assigned if new credit flows into these areas (simultaneously, a lower weight/rank would be assigned to districts ALREADY getting a lot of PSL credit i.e. over ₹25000).
Voila! Nothing in this world works without incentive. By changing this simple weightage, banks “should” be motivated to lend more to financially excluded areas.
In case you think this is a brilliant move, this idea is as old as 2014. Some experts also think that other metrics such as credit-to-district GDP ratio or credit elasticity (demand) are better measures. What do you think?
Wait, what about startups?
Banks can lend upto ₹50Cr to start-ups (engaged in either agriculture or other activities). Economists at SBI say that this should be coupled with a credit guarantee scheme from the government, since lending without collateral and performance evaluation is generally a no-no from banks (ironical since they have no qualms in lending to crooks).
Speaking of crooks, urban co-operative banks (yes, like the infamous PMC Bank) have always escaped RBI’s attention because it is more focused on scheduled commercial banks. They have used this leeway to lend to crony capitalists and relatives of politicians!
To counter this, RBI has now slapped PSL targets on them, which is going to increase year after year (check image below). The idea is - if these banks are busy lending to sectors that need money, they’ll have lesser money left to lend to crooks! Brilliant!
The new norms also include new segments such Compressed Bio Gas plants, small marginal farmers, weaker sections, doubling of renewable energy limits and more. You can check out the full list here.
It’s good to see RBI updating the norms every now and then to keep up with the times!
Give me some videsi drama
This week, we talk about a new era that we’re seeing in the age of banking. After Varo Money, Jiko is the second Fintech to be granted a national bank charter. What’s more interesting is how it did it.
Unlike Varo, which went through the traditional route of establishing its calibre, Jiko did something much simpler - buy out a bank.
To be honest, I’m not really surprised. Jiko is founded by former Goldman employee Stephane Lintner - they have an uncanny expertise in mergers and acquisitions.
Jiko isn’t the typical bank - heck, it isn’t even the typical fintech.
When you deposit money to Jiko, it doesn't reside in a savings account or sweep-in deposit account. Instead, the money immediately gets put into US Treasury (government bonds). When you use your debit card to buy something, an equivalent amount of Treasury bills is sold to pay for it.
Wait, how does it lend money then?
It doesn’t. After the 2008 financial crisis, Lintner noticed that people’s hard-earned deposits suffered from unnecessary credit risk because of banks’ risky lending. In this way, customers ALWAYS know where their money is - in safe, government-issued securities. Not with a crooked businessman who escapes the country. Transparent banking 101!
How does it make money?
Good catch. Banks generally make money on the interest on loans, but Jiko doesn’t do that, so in all probability, it will always remain a small bank. It hopes to make money by providing its infrastructure to other big banks and through fees generated when you swipe their debit card at merchant outlets. If you visit their website, you’ll notice that they’re charging a flat $99/yr just to provide this service. So subscription revenues also form a part of its total income stream.
Jiko represents a stripped-down version of banking. Hopefully, Varo and Jiko will pave the way for more innovation in this area.
Show me the data!
This is a new segment I’m introducing this week, where I highlight interesting charts, tables and any sort of data that I come across - with a little explainer on top!
Tijori put out this interesting chart on it’s Twitter page - it lists out the revenue that banks generate from retail and corporate segment. As I’ve mentioned in previous posts, each has it’s own advantage and disadvantage, but let’s understand the outliers here:
Bandhan and AU Small Finance Bank (retail exposure >75%): Both these started out in micro-financing, where they lend tiny loans to a large number of people, hence retail is disproportionately high.
Yes Bank (corporate exposure ~60%): If you have high-quality borrowers, this number would’ve been really impressive. However, as we all know, most of the bank’s borrowers were not credit-worthy, which is exactly what led to it’s near-demise.
SBI released a report in which it pointed out that personal loans jumped back to pre-covid levels, especially in the salaried and gold loan segment. To understand how this affects banks and other financial institutions and who’s taking the maximum benefit out of it, read my earlier story on Adar Poonawalla’s (yes, the SERUM guy) NBFC venture.
Do note that, just like “Movers and Shakers”, this will not be a recurring segment. It will solely depend on whether I come across an infographic worth sharing, or not.
What else happened this week?
CaixaBank and Bankia, two of the largest banks in Spain, are in talks for a merger. Apparently, Spain has more bank branches per capita than any other major country in the Eurozone. Maintaining branches is expensive, especially since they’re under-utilised in this environment. Will we see a similar thing in India soon?
I’ve talked about banks being unable to lend. Of course, this effect had to trickle down to NBFCs as well. Since they borrow from banks to lend to others, they are now trying to re-negotiate lower interest rates so that they can survive. Some of them (such as Tata Capital) are even pre-paying banks so that they do pay interest on idle money.
That’s it for this week. See you next Saturday!
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Boring, yet an important disclaimer: Views/opinions expressed in this article are solely my own and not of my employer.